How to help employees use pay rises effectively to benefit their overall financial wellbeing

Employees (and some employers) think financial wellbeing can be achieved by getting a pay rise. But as many of us will admit, increased pay can often just lead to increased spending, a phenomenon known as ‘lifestyle inflation’. Research from Direct Line Life Insurance found that the novelty of a pay rise wore off within six weeks, and one in five workers wouldn’t cope financially if their income reduced to its previous level. So how can employers help make sure that pay rises are used effectively to benefit employee financial wellbeing?

How to help employees use pay rises effectively to benefit their overall financial wellbeing

Of course, not everyone will have received a pay rise this year, but according to the Office of National Statistics, average weekly earnings increased by 2.9% in 2019. So for those employees who did receive a pay increase, what can employers suggest to make the most of it?

Help them understand the real impact

Although employees should celebrate getting a pay rise, it’s also important for them to be realistic about what the improvement really means. After income tax, national insurance, pension contributions and perhaps student loan repayments, a pay rise can start looking considerably less like a life-changing windfall. A £1,000 pay rise for a basic-rate taxpayer could equate to only around £60 extra each month, after deductions. Employees should also be aware of inflation – so although they will be getting more money in the new year, they will also likely be paying more for their daily cost of living.

It can be especially confusing if a pay rise means a shift into the higher-rate tax band. Make sure employees are aware that they are only taxed 40% on the amount of pay over £50,000, not their entire salary.

As an employer, you can help make this clearer by showing what employees’ projected monthly pay will be after the increase, not just the overall gross yearly income. The same is true for any one-off bonuses – consider showing both the gross figure, and the net amount after deductions. Even if you don’t calculate this, you could include a link to a salary calculator that employees can use themselves to work it out.

Encourage them to plan what they’ll do with it

When faced with an increase in income, we can all be tempted by the urge to treat ourselves. Often spending the increase before it is received!

And while a small treat is well deserved, it’s a good idea to encourage employees to take time and reflect on their financial position and goals before automatically spending it all. It is very easy for any increased income to just get absorbed into daily spending. But there’s a great opportunity for those who are savvy to use their increased income to improve their financial situation.

Once employees know what the actual difference in their pay will be, it could be a good idea to encourage them to keep their spending at its current level, and set up a standing order to automatically use the extra money for another purpose; paying off debt, building up an emergency fund or saving for the future. If you send out written confirmation of pay rises, it can be a good idea to include financial tips on what to do with that pay rise in the letter.

Paying off high-interest debt should be the first thing that employees do with any increased income – and setting up a standing order to transfer the pay rise to pay-off debt is one way to automatically speed up their debt repayment timeline. The bonus of this, is that once the debt is repaid, they have freed up even more disposable income, essentially getting another pay rise!

After high-interest debt is tackled, building an emergency fund should be the next focus. Neyber’s 2019 DNA of Financial Wellbeing research found that one in three employees had less than £1,000 in savings. That’s a lot of people who may need to turn to debt if an unexpected expense occurs. Encouraging employees to build up an emergency fund of at least three months’ worth of expenses can really reduce financial stress and provide a buffer against any negative future events.

Finally, it’s important that employees prepare for the future. Either encouraging saving into an ISA for important life milestones, such as a house purchase or home improvements; overpaying a mortgage or increased contribution to pension.

Give them the option to boost their pension payments

While an increase in income will also mean an increase in the amount getting put into pension (as it is based on percentages), a pay rise can also be a great time to get employees to consider if they need to increase the percentage they are contributing. Our research found that only around one in three employees think they will have a good lifestyle in retirement.

Employers could include information to help employees calculate if they are on track for their desired retirement income. Make it easy for employees to increase their pension contribution, by including information or sign up forms with the pay rise documentation.

It’s also a good opportunity to remind employees that an increase in salary means an increase in pension contributions, which reduces the negative impact they can feel about sacrificing part of their salary. If possible, let them set this up in advance, before they even see what the potential ‘full’ pay increase could be.

Help reduce the impact of moving into a higher tax band

For those employees who will get a pay rise that will tip them over £50,000 into the higher rate tax band, there could be significant impacts. Although the 40% tax is only on the amount over £50,000, there are other knock-on effects:

  • reduced tax-free savings allowance
  • reduction in child benefit
  • capital gains tax increase
  • dividend tax increase
  • not eligible for marriage allowance.

If employees are only just tipping into this band, ensure you explain the benefits of salary sacrifice schemes ,which could see their income drop back into the basic rate band – either through increased pension contributions (which will also get government tax relief) or any other schemes offered, such as cycle to work.

A pay rise is a significant financial milestone, but it can easily be mindlessly spent. Make sure you take steps to ensure your employees know how to maximise the full benefits of their increased pay.

This article is provided by Neyber.

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