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Should You Pay Off Debt or Save For Retirement?

by Michael Webb
Should You Pay Off Debt or Save For Retirement

Although conventional investment wisdom dictates that saving for retirement should begin as soon as possible even if you have debt or an emergency fund, the saying goes: Don’t put all your eggs in one basket. By starting to save early, you maximize the money’s potential to grow. Furthermore, you should not let money slip through your fingers by failing to contribute enough to your 401(k) to receive the full match from your employer.

It is also true that people experiencing financial difficulties will turn to their retirement accounts in order to meet their basic needs if they have no other options.

Because Common Sense Isn’t Always Reasonable

Logic doesn’t always prevail. If we could afford it, a lot of us would be debt-free. If you delay saving for retirement while accumulating debt, but are unable to ever repay it, eventually you will have to retire and you will find yourself unprepared. Additionally, possibly still in debt. In this day and age, it’s not uncommon for people in their 50s and 60s to find themselves in this type of position. It is almost too late to begin planning for retirement, and that is not a good situation to be in.

Also, your investments might earn a much higher return, especially if the years return significantly more than 15%. Your money should at least see some growth and outpace inflation, even if you have to put in more effort over the course of several years. This is the historical average of 10% returns for the stock market. Not only that, your money will continue to compound tax-deferred in a 401(k) or IRA, so it can grow even faster. If you miss out on one or two great years, your total savings could take a huge hit.

Debt will only grow if you shift some of your money to investments. When you’re younger, you may have large amounts of debt several times, but realistically, you may be in and out of debt several times throughout your life. You’ll be better-off financially than you would be if you were only paying down debt and saving for retirement.

Disparity Between Solving Today’s Problems With Tomorrow’s Money

There are millions of people who attempt to do everything all at once. All of their bills are paid on time, savings are put away for an emergency, and they contribute a small amount to their 401(k)s. Having to move at a pace that is slower than expected will cause problems down the road, when unexpected expenses arise.

Forbes reported that six times as many people will borrow against their 401(k)s in an emergency if they don’t have an emergency fund. Forty-six percent of workers who lost their jobs chose to completely forfeit their 401(k) accounts.

When difficult economic times hit, your emergency fund acts as a shield to protect your retirement savings. Today’s crisis can be managed without draining tomorrow’s resources.

What Is Your Current Debt Burden?

Keep in mind the interest you’re paying, as well as your debt. Those who have a higher balance of interest-bearing credit card debt or student loan debt, for example, should consider paying down that debt prior to saving or investing the majority of their additional funds. What’s the point? The interest rates you could expect to receive as an investor are probably much higher. To have more financial freedom, planning to pay off high debt as quickly as possible is beneficial.

Regularly making those payments and budgeting for them may be a good idea if your debt has a low interest rate, for example a car loan, government student loans, or a mortgage. Additionally, it may be possible to deduct some interest (like a mortgage) from your taxes, meaning there are additional benefits to paying off the debt slowly. You might receive a higher interest rate on your investment than you are paying on your other debts, so in the long run, you will end up ahead.

When Saving Should Be Made a Priority

Many financial advantages accrue to saving first and paying down debt later.

There are numerous good reasons:

  • Access to an employer 401(k) match program
  • Debt with a very low interest rate
  • No emergency savings

It may make sense to start saving first if you have a credit card or other debt with a very low interest rate.

Even in the event that you have access to a retirement savings plan through your job, especially if there is an employer match available, it is still smart to build up a savings account before you pay off any debt. To get the maximum employer match, contribute at least enough to receive it. You are turning away free money if you aren’t doing this.

If you leave your retirement savings until you are debt-free, you’ll be forced to use your most valuable asset — time — to repay the debt. Even small contributions to your retirement plan will increase significantly thanks to compound interest.

When all is said and done, the main reason to save more than you pay down your debt is to build an emergency fund. In order to pay for an unexpected car repair or a trip to the emergency room, you may have to add to your credit card debt.

Just focus on paying your debt instead of saving if you have no savings. Borrowing can become a revolving door, and debt is definitely necessary.

There is nothing to worry about. To name a few: Quite a lot of things, especially these days. Many have felt this crisis as a result of the coronavirus, according to a June Bankrate survey: More than 23% of the respondents said their biggest financial regret during the current coronavirus pandemic was not having enough emergency savings to help them survive the crisis.

If you have money saved up in an emergency fund, the difference between facing difficult times and ending up in bankruptcy court will be on your side.

If You’re Capable of Doing Both, You Should Be Doing Both

It is important to mention the possible implications of someone paying off debt and/or saving for retirement, because a lot of people are both capable of doing so. Retirement is still decades away, but it is important to start early in the game so you have a leg up when you retire.

Even if you earn enough money to make ends meet while also having student loans, some believe that you shouldn’t save more than you can in order to invest; instead, they believe you should invest as much as possible.

To put it another way, we are discussing those who are trying to be both successful and financially stable, but who do not necessarily have the resources to ensure that they are financially secure.

Instead of debating whether to pay off debt or save for retirement, we can state that paying off debt and contributing to a retirement plan are both fine options. Both tasks can be accomplished, but focus on one at a time.

For example, if you owe $40,000 in student loans, have a car loan with a high balance, and have several large credit card balances, you might use this term. You’ll have to set your priorities so that you can make the payments. Even though this doesn’t mean you have to abandon saving for retirement, you shouldn’t be putting money into your retirement account at this time. You can keep making them, but only a small amount.

Most people agree on one point: in these tough economic times, save as much as you can. No matter how much debt you have, you should always make an effort to contribute a percentage of your income that will maximize your employer’s 401(k).

Typically, this means that you’ll be getting a 3% employer match if you contribute 6% of your income.

You can always choose to contribute 4% of your pay in order to get a 2% employer match, or contribute 2% of your pay in order to get a 1% employer match.

You don’t always have to turn the faucet off. Instead, you simply have to turn it down to a drip. You will earn more money if you are able to balance paying off debt while doing this.

Check Your Budget To Help Reduce Debt and Save Money

It is critical to include an expenditure category for every goal, from paying off debt to accumulating retirement funds. Even if your monthly contributions are minimal, you are laying the groundwork for good habits.

If you’re tracking your spending for a month or two, you should use a household budget worksheet (PDF) to help you track where you spend and where you can save. To establish a baseline, go through the bills you’ve received recently, as well as bank and credit card statements. as well as saving and spending targets Instead of counting your time, think about how you’re really spending it. You may find additional money. It is possible to secure a better monthly cell phone plan by decreasing the amount of minutes used on your account.

When Should It Be a Priority To Pay off Debt?

Paying down high-interest consumer debt is important because it helps you deal with ongoing money management issues.

You’ll be paid back, no matter what, if you reduce your interest payments. It is typically more than you could make investing your money in the stock market, and more than you could earn simply saving money in a savings account.

The following four things can help you get started on repaying your debt:

  1. Use the “Expendable Income” formula to calculate how much money you have left to spend.
  2. Come up with a list of your monthly, weekly, and even daily expenses and see if anything can be eliminated.
  3. Constrain yourself to using only that amount, and use paying down debt as a major component of your budget.
  4. Using this information will help you to figure out your personal financial goals, allowing you to set priorities in your budget. We’re assuming that paying off debt is your highest priority in this instance. Once you’re finished paying your bills on a monthly basis, you will have a bit more money to spend on necessities.

Another thing to think about is a balance transfer credit card. The most common result of consolidating your credit card debt is that you can get a low-rate card to pay all of your credit card balances.

Debt reduction is almost always preferable, but there are circumstances where it isn’t.

Once you have enough money saved in your emergency fund, consider using that money to pay off debt quickly. Even though interest is very high, high-interest debt can prevent you from reaching your financial goals and result in you losing money. If this is the case, then you should focus on paying off that high-interest debt.

An important step in building a budget is devoting your primary resources to debt reduction while also having an emergency fund.

Don’t let taxes into the equation when deciding whether to pay off tax-deductible debt or save. When you deduct the loan interest from the total cost of the loan, the deduction is probably worth less than the total interest you would have paid on the loan over the course of the year.

Emergency Funds Can Help You Avoid the Unexpected Obligation of Debt

As unexpected expenses like car repairs often require immediate outlay of funds, make saving money for such occurrences a goal. Start with one month of savings, and work your way up from there. Enhance it as you can.

“Bad” debt can be avoided or minimized by having an emergency fund. Typically, ‘bad’ debts are things like credit cards or payday loans. Higher interest rates means it will be harder to save or pay off debt.

While credit cards are the most common funding method for unexpected expenses, emergency funds can be used for unexpected costs instead. While debt has a role to play, it may be wiser to use it wisely over time.

Protecting One’s Savings in the Face of a Coronavirus

This could be a good time to start saving, especially for those who have a steady income and are able to work from home.

Consider their new patterns now that Americans are spending more time at home. Consider whether you need to adjust your plan to avoid overage fees by looking at your cell phone and cable bills. You might be able to get bonus services that you previously paid for, like a house cleaner or baby sitter. You have now found a way to remove these unnecessary expenses from your budget, which will allow you to save an additional amount of money.

Alternatively, if you are in a situation where your income has been reduced, then you should discuss with your creditors and service providers about temporary payment relief options.

A low interest rate also usually means that people are less likely to save, but more likely to borrow or spend. On the other hand, however, you shouldn’t let these low interest rates discourage you from saving because hard times often arrive when you’re least expecting them. So, make saving a habit now so that you can rely on your money in case of an emergency.


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The Advantages of Paying off Your Debt Ahead of Time

If you’re in significant debt now, you know the emotional burden that comes with it. You waste time worrying about how you’re going to pay your bills and meet your budget each month, especially when you consider all the effort you have to put in just to earn money. It’s possible that you will miss sleep over your finances. Getting out of debt frees your mind and emotions to devote all of your mental and emotional energy to getting ahead in life.

You’ll also have more money available for retirement savings and other investments after getting out of debt.

Depending on how you look at it, paying off your debt could benefit your retirement savings in a roundabout way. You can even tell yourself that you’re doing this to prepare yourself for retirement while you are paying off your debts.

While the general public may not realize it, there are other advantages that most people aren’t even aware of. Make sure to understand that while the terms of any loan agreement are fixed, investment activity’s results cannot be controlled. A stock’s value can go up and down, but debt does not. So, in other words, debt is out of balance with investment.

While you are devoting more resources to paying down debt than setting aside retirement contributions, the stock market crashes and 40% of your retirement assets are lost. However, what will happen to your debt if that were to happen? Despite everything, you still owe as much on your debt as you did before the crash.

In this manner, making payments on your debt is like a sure bet. Not only does it erase your interest expense, but it also provides you with an improved cash flow in the future.

Prioritize Eliminating “Expensive Debt”

Similarly, there is bad debt. You may be in a good position to expand your retirement savings if you have only “good” debts like cars and mortgages.

Review your outstanding debt obligations and the associated interest rates to see if you can make a dent in the balance. Choosing between higher-interest debt (like a credit card) and lower-interest debt (such as an installment loan) should be of primary importance. Instead of getting the interest you would earn, you’d pay a higher amount in interest.

Don’t pay just the minimum. Once you have paid off the interest rate debt with the highest rates, focus on the next debt on your list. How’s it going? Rather than repaying your debt, you should allocate the same amount you put toward debt repayment to retirement savings.

Borrowing Is Cheaper, but the Opportunity Cost Is Higher: Paying the Debt First

The problem with paying off debt and not saving for retirement is that you will most likely go back to making debt payments when you retire.

Your annual contribution limit to tax-advantaged retirement accounts, such as 401(k)s and IRAs, is limited by the IRS. If you don’t use this opportunity, you’ll never get it again.

Another reason to save for retirement is that delaying investing means you miss out on time to grow your investments.

In other words, if it takes you five years to get your debt paid off, what might you do?

Had you continued to work for that employer for the five years in question, you could have contributed $5,000 a year to your retirement plan, which was also matched by your employer for a total of $2,500. You would have $48,232 after five years if you had all your money invested in stocks providing an average annual return of 10% per year.

In other words, if you can repay your debt instead of funding your retirement, you must assign a monetary value to the opportunity cost of debt repayment. You can see, as demonstrated here, that it’s quite expensive to do, and this is why you should seriously weigh the costs and benefits of a choice between two options.

To Get the Minimum Match From Your Employer, Save for Retirement

Sounds great, doesn’t it? What you’re getting is essentially a matching contribution to your 401(k) or 403(b) retirement plan from your employer.

If you set aside 5% of your paycheck, for example, and your employer matches it, you have doubled your savings the very first time you save. That means that $100 is saved twice to go from $200 to $400 in one step, without any extra budget maneuvering on your part.

As you gradually increase the percentage of your pay you place in your retirement account, eventually your employer will kick in a matching contribution.

Think About a Few Debt-Reduction Goals That Will Help You

The level of debt you have influences everything from the decisions you make to the kinds of activities you participate in. When trying to buy your first home or expand to a larger home, examples include that. You might be unable to obtain a competitive interest rate if you carry too much debt relative to your income. Payment of debts ahead of other priorities may help in achieving this goal.

The good news is that not having all debt doesn’t mean you should put your retirement savings on the back burner. In most cases, we have multiple deadlines and goals to contend with, so it’s unrealistic to expect that you can retire your debt and start saving for retirement all at once. To get to a manageable debt ratio, it is essential to know how long it will take to do so.

Consider Consolidating Your Debt Before Paying It Off

If you’ve decided that you want to pay off debt, the best way to go about it is to have your debt consolidated. Consolidating your debts is a straightforward process: you take multiple debts and combine (or consolidate) them, and then pay down the one you’ve made lower interest payments on.

There are numerous other options that we suggest you explore, such as: a balance transfer, debt consolidation, or a home equity loan or line of credit.

A balance transfer has your debt transferred to a 0% APR credit card. If you can pay off all your debt during the 0% APR promotional period, this is the way to go (usually between 15 and 18 months).

This type of loan is appropriately named. It is specifically designed to pay down your debt. While taking out a personal loan isn’t necessary since you don’t have to put down any collateral, you can pick your own repayment terms and interest rates.

Only if you own a home can a home equity loan or line of credit help you pay off debt. Using the equity you’ve built up on your home, you can use the equity in your home to obtain a loan or line of credit that you can use for debt consolidation. We discourage paying off debt this way because you will have to put your home as collateral.

Accelerate Your Retirement Savings

Even if you don’t have all of your debt paid off, you can save more for retirement. It is completely dependent on your priorities and goals. In order to find the right balance between paying down debt and saving, it is important to consider your financial priorities.

The process of coming up with a retirement plan and understanding how much you can put away for retirement can be stressful. Instead, focus on making a few, simple steps to help you reach your long-term goals.

You can boost your retirement savings every year until you are at the level of contributions that will get you to your retirement goal. It is unlikely that this additional small amount will significantly reduce your monthly budget, but it will have a positive long-term impact on your retirement security.

Investing in Retirement

You may be able to set aside money for retirement at your company. You may invest funds that are directly deposited into your checking account each pay period using an automatic direct deposit. Compound interest can provide you with greater financial benefits in your golden years.

Retirement investing offers several advantages. Pretax money could allow you to choose a plan that uses pre-tax dollars, which means you pay less in taxes on your income. Even after you withdraw the money, you will still owe taxes. But hopefully, you will be in a better financial position when you do.

Retirement investing through work also offers the added benefit of company matching plans. You can choose between matching a percentage of your salary or an investment. That’s money that’s given to you absolutely free, so you keep it if you continue to work at the company for the required amount of time and invest sufficiently to earn the match. A good way to get into a healthy saving habit is to make retirement investment a simple automatic deduction from your salary. Let the money work for you over time by allowing the interest and possible company match to compound for you.

Consider Speaking With a Financial Advisor

A good way to plan for the future is to know your financial position. When you’re swamped, ask for assistance. A financial advisor can walk you through your various financial options. Would you like to buy one? To learn if your company’s retirement savings plan offers this service, check with your human resources department or your employer.

The True Moral of the Story? Do Not Live Beyond Your Means

We can see there is a significant monetary price to prioritizing debt payments. Despite that, there is one overriding reason you might want to pay off your debts: so you do not become reliant on debt as a way of life.

For the most part, individuals who are in debt in their 30s are also in debt when they’re younger. Because debt is a habit that is difficult to break, this often happens. If debt is often used to pay for a lifestyle that you could not otherwise afford, it becomes even more difficult. You may be surprised to find that you’re more susceptible to falling into that trap than you previously thought.

Lifestyle debt, such as mortgages, car loans, and student loans, is nearly impossible to escape unless through bankruptcy or several bankruptcies. In light of the fact that credit usage is increasingly important to your overall financial well-being, you must know that this is a possibility. Once it has happened, no action short of extreme measures will reverse it.

Final Thoughts

In any case, having a retirement savings plan is a no-brainer. Retirement savings and debt are two separate concepts, so why take into consideration debt when considering whether or not to put money into a 401(k) or an IRA retirement plan? You have to prepare for both your current and future retirement needs even if you have an employer match. Your retirement plan should be just as important as your rent, car, cellphone, and cable in your overall budget. Even if you don’t have debt, you should always plan for retirement.


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