Your next military paycheck is likely to be at least a little larger than usual. The 3% increase in military pay is taking effect, as well as an increase in Basic Allowance for Subsistence (BAS), and, depending on where you live, a Basic Allowance for Housing (BAH) increase.
Even when your pay is offset by the repayment of the Social Security taxes not withheld in the last part of 2020, you're still likely to see a small increase in the size of your take-home paycheck.
So, what should you do with that extra money?
It's tempting to find things to spend it on -- a nice meal, making payments on a new car or a special purchase that you've been eyeing. And spending a little bit on something fun is a great idea. But the bulk of that extra money should go towards improving your financial foundation.
The first three steps in building that financial foundation are emergency funds, paying off debt, and saving or investing. Automatic transfers are an important tool that can be used towards each of those steps.
If you don't have an emergency fund, or it's not quite big enough for your needs, set-up an automatic transfer to move your extra pay into your emergency fund. How much of an emergency fund do you need? Everyone's situation is different, based upon their family size, financial obligations, sources of income and other variables.
Most experts recommend starting with a smaller emergency fund while you still have debt, and then increasing it to three to six months pay as a fully funded emergency fund. But no one starts there. Start wherever you are, and put aside a set amount each month to build up the fund. Your smaller emergency fund might be as little as $500 if you're single, living in the barracks or living driving distance from family, or as large as several thousand dollars if you are stationed overseas, have a larger family or have quite a few financial obligations.
Paying Off Debt
Once you have a basic emergency fund, the most important thing you can do is pay off debt. Most debts, like credit cards or loans, will allow you to set up an automatic transfer. Depending on how you budget, it might work best to do this each pay period or each month. Even a small extra payment each month will help eliminate debt faster.
Saving and Investing
The next step is to have some savings for upcoming expenses, and then to start investing for the long-term, like retirement.
Saving is putting away money for specific future expenses. Savings are kept in savings accounts, money market accounts or Certificates of Deposit. This money is used for expenses that will happen in the near future -- perhaps up to five years away. (Sometimes longer, depending on your specific situation.) Use your pay increase to create special savings accounts for less frequent expenses like vehicle registration, holiday spending or furniture purchases. Once again, an automatic transfer is a simple and effective way to build those specific savings so that you're prepared when the expense happens.
Investing is putting money into riskier, less liquid investments that have the potential to grow more. This might include investments in a tax-advantaged retirement savings account like the Thrift Savings Plan or an Individual Retirement Arrangement. It may also include non-retirement investments such as mutual funds or brokerage accounts. Any money put into an investment should not be needed for at least three to five years.
If you're one of the many service members who finds yourself with a larger paycheck in 2021, use this opportunity to make some real progress toward your financial goals. Use preset transfers to make the process automatic and painless. (Pro tip: set up your automatic transfers for two to three days after payday, so you have time to cancel them if something goes wrong.)
This one simple action can pay off with a lifetime of better finances.