Raise Your 401(k) Retirement Contributions Right When You Get a Pay Raise
Congratulations! You are likely to score a raise this year. According to HR.com’s 2025-2026 Salary Budget Survey, 97% of employers plan to increase their employees’ compensation in 2025, with 78% of respondents planning to give average raises of 3 to 4 percent. Receiving a raise presents a terrific opportunity to turbocharge your retirement savings. While taking the extra cash and splurging on a new gadget or a fancy vacation may be tempting, I would advocate for a more strategic approach, at least for a portion of the increase: immediately increase your retirement contributions. Timing an increase in your retirement contributions with a salary increase is a shrewd move that leverages behavioral economics principles to outsmart your brain and improve your long-term financial security.
Harness The Loss Aversion Bias In Your Favor When You Receive A Pay Raise
Loss aversion, a cornerstone of behavioral economics, posits that individuals experience the pain of a loss more intensely than the pleasure of an equivalent gain. Suppose you were to suddenly decrease your take-home pay to increase retirement contributions before a pay raise. You would need to pare back spending on other areas, like eating at restaurants, traveling, or shopping to keep your budget balanced. You’d likely feel the immediate “loss” of disposable income more acutely than the long-term “gain” of a more significant retirement nest egg.
By linking the 401(k) contribution increase to when you receive a pay raise, you are effectively framing it as an “addition” rather than a “reduction.” This subtle shift in perspective minimizes the perceived “loss” and makes the decision to save more psychologically easier to accept. Practically, it also means you don’t need to cut your spending in other categories, which is much more palatable.
Resist The Mental Accounting Bias Of Treating Your Pay Raise As “Found” Money
Have you ever decided to treat yourself after receiving an unexpected birthday gift or a tax refund? In these situations, many people choose to spend the extra money on something they wouldn’t ordinarily buy, such as a new gadget or a trip. While we may normally be much more frugal with our monthly paychecks, we tend to view “found money” differently and, therefore, spend it differently, too. This is what economists describe as mental accounting.
Mental accounting, a concept introduced by Nobel Prize-winning economist Richard Thaler, refers to the cognitive bias where individuals categorize and treat money differently based on its source or intended use. Mental accounting often leads people to spend unexpected windfalls, such as lottery winnings or bonuses, on non-essential goods and experiences while treating regular income more conservatively. Understanding this bias is crucial for making more rational financial decisions, including what to do with a pay raise.
Thaler conducted experiments on this phenomenon, illustrating how this bias can occur in our daily lives. For example, imagine a scenario where you want to watch a movie. You purchase a $10 ticket in advance and head to the theater. When you arrive at the theater, you realize you lost the ticket (this experiment was conducted before smartphones, where you could easily pull the ticket up on your phone). Thaler asked one group of participants if they would pay $10 to purchase another movie ticket. 46% said they would buy another ticket.
In a second scenario, participants were asked to imagine going to a movie theater and realizing they had lost a $10 bill when they got to the ticket counter. Thaler asked this group if they would still pay $10 to buy the movie ticket. 88% of respondents said they would still purchase the ticket, nearly double the first scenario.
As an article in Decision Lab explains, “In theory, we have lost the same amount of money ($10) in both scenarios, so our response should be the same for both questions. However, according to the mental accounting model, we tend to categorize our money into different budgets. In the first scenario, $10 has already been spent from our movie budget, so spending an additional $10 on the movie would make it seem incredibly expensive. In the second scenario, we attribute the lost $10 cash to a general spending budget instead, so we don’t feel that the lost cash has affected our movie budget despite the same loss of $10. As we can see, by treating the same value of money differently based on how we have categorized it, we are more prone to making illogical financial decisions, such as irrational spending or poor investment decisions.”
In the context of salary increases, try to resist mentally categorizing your raise as “found” money, which can increase the risk of overspending. Instead, think of your raise as a predictable increase in income and be intentional about its allocation. By consciously directing part of a raise towards retirement savings, you’re effectively insulating yourself from succumbing to this behavioral bias and allocating your hard-earned dollars toward your long-term financial well-being.
Counteract Lifestyle Creep After A Pay Raise
One of the most insidious threats to personal finances is “lifestyle creep.” As your income rises, you tend to increase spending to maintain a particular lifestyle. This can lead to a vicious cycle where higher earnings are quickly offset by increased expenses, leaving little room for additional savings.
Increasing your retirement contributions with each raise proactively combats lifestyle creep. You’re locking in a portion of your income growth for the future, ensuring that your savings rate keeps pace with your earnings. This disciplined approach prevents spending from spiraling out of control. It also allows your retirement nest egg to grow steadily over time and amplifies the power of compounding, which can add thousands to your net worth in retirement.
The Bottom Line For Pay Raises
Increasing your retirement contributions with each raise is shrewd strategy to significantly enhance your financial future. By leveraging behavioral finance principles as well as automating the process, you can outsmart your brain, combat lifestyle creep, and ensure that your retirement savings are on track to meet your long-term goals.
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