What to Do with Your Pay Raise


One nice thing about military pay is that you get a cost-of-living raise (almost) every year, even without being promoted or reaching a time-in-service milestone.

Military pay is 3.1% higher in 2020 than it was in 2019 for the same rank and time-in-service. This could mean an additional $40 to $400 in your paycheck each month.

While you could use that raise to upgrade your lifestyle, it's also a great opportunity to make progress on some of your financial goals. I reached out to some of my financial professional friends and asked them what you should do with that raise. I was surprised by the answers I received!

Paul Allen from Redeployment Wealth Strategies answered my question with this response:

"Advice like "pay down debt" or "invest half your pay raise for retirement" aren't bad, but they might not be the best advice for every individual. The best advice for the individual is to apply that additional money to most efficiently execute your financial plan."

He continued, "Your financial goals drive your plan and your plan drives what you do with your money. Instead of one-size-fits-all conventional wisdom, you could make a plan to help reach your unique financial goals."

On one hand, he's not wrong. Personal finance is personal for a reason -- we're all in different situations, have different needs, and different desired outcomes. On the flip side, there are a couple of things that are generally considered good choices no matter what your situation or goals.

Build an Emergency Fund

An emergency fund is the foundation of a solid financial plan. Different people have different emergency fund needs. A single person living in the barracks might just need enough for a major car repair or a last-minute plane ticket home -- maybe $1,000. A large family with a mortgage and tuition could need much more, but you don't have to start with a huge goal. The important thing is to set up an emergency fund and make regular contributions.

Pay Off Debt

Once you have at least a small emergency fund, focus on paying off debt, especially high interest debt like credit cards and personal loans. Paying off debt provides two important benefits: It decreases the amount of interest you pay, and it frees up money in your monthly spending plan. Being debt free gives you control over more of your monthly income.

Save for Retirement

Military members have a great tax-advantaged retirement plan, the Thrift Savings Plan (TSP). It's simple to go into myPay and increase your TSP contribution 1% or 2% (or more if you want to build up that balance). One great thing about using myPay to control your TSP contributions is that, if you discover that you absolutely can't survive with a higher contribution, it's quick and simple to put it back down a little bit.

Start That Transition Fund

I believe strongly that every service member should be saving in a transition fund. A transition fund is a chunk of money that you'll use when you leave the military. Like an emergency fund, the amount of your transition fund will depend on a wide variety of factors, including your plans (knowing that plans change all the time), how many people rely on your income, your regular financial obligations, and your employability in the civilian workforce.

Even if you don't plan to leave the military any time soon, it's smart to start your emergency fund. Why? Two reasons: 1) Life is unpredictable and 2) It's easier to start small and build up gradually than to suddenly realize that you're getting out in a year and you need to save tens of thousands of dollars.

Some people like to keep their emergency fund and their transition fund separate; other folks like to use the same money for both purposes. Neither is wrong, but if you have just one account, you may want to increase your goal amount. Amazingly, regular emergencies don't take a break just because you're in the middle of a big transition.

Give Yourself a Bonus!

If you're already working hard toward saving and paying down debt, a little reward may help keep you motivated. Maybe you take this month's raise, or even a couple of months' worth of raise, and splurge on something you enjoy. As financial adviser Daniel Kopp from Wise Stewardship Financial Planning explains, it "feels like a special reward, the grown-up version of the special treat we got as a kid. You get the dual benefit of looking forward to that increased level of spending on things that are important to you, AND you will enjoy it more since it's a break from the routine."

I love that advice. While it is important not to splurge all the time, a little fun is an important part of sticking to your larger plans.

Take a minute, talk to your partner if you have one, and figure out how you're going to make that raise help you reach your financial goals. Almost any decision is better than letting the extra money disappear into your regular spending.

(In case you are wondering, my husband's raise is going toward our daughters' yearly college tuition increases.)

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