Pay Off Debt or Save for Retirement? Learn How to Prioritize Your Finances
6 MIN READ
Published August 29, 2023 | Updated September 01, 2023
Millions of Americans dealing with credit card bills, student loans, and mortgages wonder if they should pay off debt or save for retirement. The answer is complicated and depends on several factors, such as your income and spending trends, age, and the total amount of debt you have. Ideally, you should strive to do both at once.
Importance of Financial Planning to Accommodate for Debt and Retirement
Financial planning allows you to meet your life goals. It acts as a guide so you can be in control of your income, spending, and investments. Having concrete financial goals and a feasible plan allows you to track your progress, save for the important things in life, and handle financially challenging events better. With the right plan, you’ll be able to pay off your debts sooner, and start saving for a comfortable retirement.
There may be obstacles on the way, such as a sudden emergency, car repairs, and medical debt, that are difficult to get out of. Having a plan in place for managing such emergencies will ensure you don’t get derailed. It will also ensure that you’ll be able to save for your retirement while you’re paying off debts.
Assessing Your Financial Situation
Deciding whether you should pay off debt or save for retirement is a very personal decision. Before you can make a decision that is right for your situation, it’s important to take some time to assess your financial situation.
Here is a step-by-step guide to assessing your financial situation:
- Evaluate your debts. Make a list of everything you owe, including credit card debt, mortgage, car loans, and student loans. List balances, interest rates, and minimum monthly payments. This will give you a better idea of what you should prioritize. For example, credit cards carry very high-interest rates, so paying those off should be a first priority.
- Maximize your employer match. If your company offers a 401k match, you should always invest at least enough money each month to get the full match. Not doing this means you’re missing out on free money.
- See how much you’ve put aside for emergencies. Ideally, you should have three to six months’ living expenses saved as an emergency fund in a high-interest savings account.
- Create a budget. Once you have this information on hand, make a budget. Compare your income against your monthly expenses to see how much you have left to contribute to savings or debt payoff.
- Cut expenses or increase income. After making a budget, if you think you don’t have enough on hand to make monthly debt payments and contribute to your retirement fund, you may want to find ways to reduce expenses or increase your income through a side hustle.
Pay Off Debt or Save for Retirement Calculator
Once you have a clear picture of your financial situation, you can use a pay-off debt or save for retirement calculator to decide on the best course of action. There are several online calculators that will help you to calculate which option will allow you to save more in the long run by comparing the interest you’ll save when you pay off your debt to the interest you may earn by saving for retirement. Knowing how much interest you’re earning on average through your retirement savings and how much interest you’re paying on your debt is an easy and quick way to determine the right course of action.
Should I Pay Off Debt or Save for Retirement?
There’s no simple or straightforward answer to this question. Logically, you should base your decision purely on interest rates. Not all debt is equal; there’s good debt and bad debt. For example, mortgage debt is completely different from credit card debt because you’re paying toward an asset. If the interest rate you’re paying on debt is more than what you can potentially earn by saving money, you should focus on getting out of debt first.
Mortgage rates are currently 7.40%, but even if they’re higher than what we’ve historically seen, it doesn’t make sense to pay off a mortgage instead of saving for retirement. Financially, it makes sense to pay off high-interest debts first. But there’s also a psychological aspect to finances. For example, paying off debt first may ease your stress levels and help you sleep better at night.
If you can manage to put some extra cash towards your debt each month while still contributing enough to take advantage of employer matching, that would be the best solution. If you can only do one or the other, focus on paying off high-interest debt first.
Pay Off Credit Card Debt or Save for Retirement?
Current credit card rates are 22.59%. If you have accumulated a substantial amount of balance on your cards, it makes more sense to pay it off aggressively, even if you have to temporarily scale back saving for retirement (provided you’re taking advantage of employer matching).
Historically, S&P 500 offers an annual return of 10.15%. Despite the benefits of compound interest, it’s financially wise to pay off credit card balances first before you start focusing on your retirement savings.
Strategies for Paying Off Debt
If getting out of debt is your priority, consider these steps to pay it off at the earliest opportunity so you can get back on track with your savings.
- Make a list of all your debts, along with interest rates and outstanding balances.
- Use the debt snowball method for debt repayment. Start by paying off your smallest debt first. Once that is paid, roll the payment you were making before to the next-smallest debt.
- To save more money in interest, use the debt avalanche method, where you focus on paying off debt with the highest interest rate first before moving on to the next most expensive debt on the list.
- Use windfalls, tax refunds, and any extra money to make extra payments on your debt.
- If you have debts from multiple sources, use debt consolidation to combine them into a single payment. If you have a good credit score, you may be able to qualify for a low-interest rate.
- Pick up overtime hours or consider starting a side hustle temporarily to help boost your progress.
Strategies for Saving for Retirement
Once you’re debt-free and have put aside enough emergency savings, it’s time to focus on saving for your retirement. Here are a few strategies to consider:
- If you have an employer-matching 401k, invest enough in the account to take advantage of the match.
- Aim to save at least 15% of your gross income for retirement.
- Focus on maxing out your Roth IRA contributions. Roth IRA contributions are after-tax, but your money will grow tax-free. You’ll also be able to withdraw money tax-free in your retirement.
- Avoid withdrawing money from your retirement accounts unless it’s an emergency and you have exhausted all other options. You’ll lose out on investment growth if you keep withdrawing money.
- Saving for retirement is all about consistency instead of complex investment strategies. Invest every single month, and you’ll see your money add up and grow over time.
Balancing Paying Off Debt and Saving for Retirement
You don’t have to choose between paying off debt or saving for retirement. If you’re able to make more than the minimum amount due on your debts while also putting aside money for retirement, that’s the best option. You’ll make progress toward both goals and be in a better position in the long run. Here are a few tips to help you find the perfect balance:
- Create a budget to see how much money you have left over after all your expenses.
- Find places to cut costs so you can free up more money. Review your discretionary spending, such as vacations, dining out, and entertainment.
- Find ways to earn more money and use that added gross or net income to contribute towards both goals.
- Aim to make more than minimum payments on your debts while investing enough in your retirement plan to take advantage of the employer match. As long as you’re able to do both, you’re on the right track.
Importance of Seeking Professional Advice
Knowing where you stand currently is crucial to plan for the future. If you’re overwhelmed and stressed, it’s best to seek professional investment advice. Consult a personal finance professional to explore your options. A financial advisor can take a look at your budget, expenses, debt, and investments to help you come up with an action plan for tackling your debts as well as maximizing your retirement savings.
Overwhelming debt can impact your ability to save for retirement. Ideally, you should be able to do both simultaneously, but if the budget is tight, prioritizing one over the other requires some careful consideration and a closer look at your budget.
If you are unable to make more than the minimum payment each month, it may be time to seek debt relief. TurboDebt can help you find the right debt relief option based on your financial situation. Connect with us today for a free consultation. Read our reviews to see how our debt relief services have helped thousands of clients.