Opinion: Should You Save For Retirement or Pay Off Debt First?

Sally Aquire

growing savings Should you save for the future or throw every extra cent at your debts to pay them off quicker? This debate is one that pops up all the time and causes a lot of confusion. Some personal finance experts advocate combining debt reduction and saving for retirement, but what if your money doesn’t stretch that far? Here at Money Crashers, we sway towards paying down debt first, and then use that extra money towards funding your retirement accounts.

The reasoning behind this approach is pretty simple: when you no longer have to allocate a set amount of money for debt repayments each month, you’ll have more money to use for funding your retirement, and you don’t have split priorities to carefully juggle. If you’ve only got so much money to spare once you’ve met your essential monthly bills and budgeted for semi-regular and occasional expenses, dividing what’s left between retirement funds and paying off debts can mean that there’s not much going in either fund. As far as your debts go, you’re extending the time that it’ll take to fully pay them off and as a result, you’ll be paying more interest. It’s not uncommon for credit cards to have interest rates of 18% or higher, which is obviously a big expense on top of the actual debt that you’ve racked up.

Even if you don’t have credit card debts, you may have student loans, car loans, or home equity loans. The interest rates on these may not be as high as on credit cards, but it still makes sense to get them paid off as soon as you can and free up your monthly income. Your monthly income is your most important weapon to help you build wealth, and you can’t save aggressively for retirement if you’ve got thousands of dollars going out the door every month to a bunch of banks.

How about once your debt is payed off? Well, if a good portion of your income has been used to fund your debt repayments each month, then you’re used to this and won’t miss the money if it’s then used to fund your retirement savings instead. After all, that money hasn’t really been “your’s” for a while, because it’s been going straight to creditors, so adopting the mindset that it’s still not “your’s” now that you’re debt-free makes it easier to start building retirement savings as soon as possible.

Do you disagree? Do you have an argument for saving for retirement right away? We want to hear it.

Categories: Credit and Debt, Goals, Investing, Retirement, Spending and Saving

Sally Aquire
Sally is a UK-based freelance writer. As well as personal finance, she also writes on health & beauty and lifestyle topics. When she's not writing, she enjoys reading, shopping, hanging out with friends and generally making the most of her downtime!

Learn more About Money Crashers - including co-founders Andrew Schrage and Gyutae Park.

Comments

Elizabeth I

My only thought regarding saving for retirement first would be if your student loans were consolidated at an extremely low rate and you were able to deduct student loan interest on your tax return.
http://quitbeinglazy.com Mike Lutter

You need to be maxing out your 401k match. That goes without saying. Taking that few percent and throwing to debt is leaving free money on the table. Always save the most you can on your 401k.

Next, your IRA accounts have a definite max you can apply in any one year. At age 49 and below that is only $5k. The younger you are the more powerful money saved is to you. Admittedly, if you pay the 5k you might not have much left over to put towards debt, but you will never be able to contribute that $5k again. And there isn’t much opportunity in later years to “catch up”.

It’s a bit of a juggling act, but you really need to both save and pay down debt. You should max your retirement contributions, and still have a good plan to pay off your debts.
http://madsaver.com Mac

No matter what, I make sure each year that a set percentage of money from my paycheck is invested into our company’s 401k. I don’t even think about that money and don’t consider it part of my paycheck. So ignoring that investment, I think it’s most important to pay down debts, especially credit cards. There’s no point in investing in something that will earn you 5%, when you’re losing 20% each month in credit card interest.
Chris

Saving and paying off debt should occur no matter what. Like others, i allocate some of my paycheck to my 401k, and don’t even consider it part of our budget for expenses. What’s left goes into expenses and debt. If you had to choose one over the other, then debt should go first; the interest on debt is so much higher than what you could *potentially* earn from savings that you’d be paying that off for a very long time.
http://www.adamgainer.com Adam Gainer

I am currently in the process of doing both. I recently graduated college and finally have a “real job” (Salary and benefits). I owe probably close to 6k in loans(student loans / private). I currently live with family so don’t have that much in the way of expense but I do have to pay for basics (car, phone, insurance).

I’m using the 60/20/20 rule. I save off 20% into an “emergency” / investment fund. Then use the the rest to spend on my “bills” ( I include the loan payments in this category). After I pay off my loan debt I’m going to take the money I’ve been paying in loans and take half of it straight to savings 401k. I’d like to be able to contribute more now but I think that while I’m saving up I’ll be able to turn my emergency / savings money into CD’s and invest into my company’s 401k.

fortunately I stayed away from credit cards and don’t have any credit card debt. It makes me want to cry when I looked at my student loan payment schedule and it has it schedule out for 7 years and I would end up paying another 3k in interest payments. I’d rather keep that 3k and get it locked into a CD where I get to get paid for my money.
http://www.moneyobedience.com/blog/ ctreit

I think the choice is not that clear cut since it depends on a lot of different things. For example, if your employer matches your 401k contributions you have to look beyond actual percentage rates. If the employer matches your contributions dollar for dollar, it would even make sense to add to retirement savings rather than to pay off a credit card with an 18% interest rate. Having said that, we need to add the psychological set-up, too. If your credit card balance gives you sleepless nights, it may be better to forgo a 1 for 1 match and pay off the credit card instead. In such a case the objectively “right” thing to do may not really be the right thing for such an individual.
Em D.

I agree with the general idea- though it depends on your interest rates and whether your retirement is being matched by your employer. I suppose if you’re hard core you should sit down and do projections for your debt and savings calculating over the next x number of years what the net result is and figure out the right balance. Sounds like the word problem from hell. Putting off debt will just cause it to grow on the other hand retirement investments at a younger age will go much further.
http://www.bucksomeboomer.com Bucksome Boomer

I cut back my 401K contributions in the past year to concentrate on debt elimination. Once all non-mortgage debt is paid (12/11 is plan) then I’ll max out retirement savings.
- TheMadTurtle
  
  Why just the “non-mortgage” debt? I’ve been crunching numbers and doing some thinking recently about applying a theory like this to our mortgage (which is our only debt). The amount of money to be saved by making extra principle payments each month is staggering.
  - John Moser
    
    That’s because the principle/interest model is an abstraction. “Interest” payments are “escrow”, i.e. your money goes into an account and is then applied to your next payment–meanwhile you pay interest on your balance. Your mortgage and car loans grow in balance each day. A “principle” payment pays on the balance immediately, so that part of the money stops accruing interest! That’s why mortgages are “front loaded”: they’re savings accounts, the bank puts money in your hands and you pay interest on it. You know how if you put $100,000 in a bank savings account you make a lot more interest every month than if you put in $10? That’s what happens with a loan! You have to pay interest on $100,000 at first, and eventually you pay interest on $10; your first payment goes 99% to interest because you’re doing even monthly payments and you accrue a TON of interest, almost as much as your payment, at first.
gina

I believe that if your company is matching your 401k, you really have to try to put money into retirement before paying off your debts. That is, unless you have VERY high interest rate debt, or if the debt is so large that you may worry about not being able to pay your bills each month.
- http://www.bucksomeboomer.com Bucksome Boomer
  
  Gina, the match is low at my company (10 cents on the dollar up to 8%)that it seemed like I wasn’t losing money compared to paying interest.
  
  It’s only for a couple of years and then big time retirement savings will start.
http://toxic-shock.blogspot.com Atom Shock

The sooner the better. The earlier you start saving, the more money you’ll have for retirement. Don’t put off maxing out your 401k match to pay off debt. You could be debt free with little to no savings and not be able to retire.
- John Moser
  
  Across 8 years of 401(k) matching I have $0 from my employers, as I’ve been moved between contracts or moved to another company for bigger salary and more valuable opportunities (like, moving from $40k to $60k) before the 3-5 year vesting period was up. The 401(k) funds always under-perform compared to a frigging savings account.
Winston C

Well, it depends on a lot of things. What kinds of debt are we talking about? Student loans? Credit cards? Mortgages? Business loans? What about age? How close you are to retirement? And a lot of people mentioned a very good point about company matching 401 (k) contributions. To me, if the company that I work at offers matching 401(k), then I will put in the max amount. Then I will pay off the debt, of course the ones with the high interests first.
- John Moser
  
  Company match has never kept up with my debt interest paid. I used to be 19% APR credit card and 10.71% car loan; now I’m 9.99% credit card and 1.99% car loan, and taking a 2.875% mortgage.
  
  My 401(k) can’t kept up with my ability in the stock market; the funds are VERY slow except in an opportunistic market (like after August 8, 2010, when the US Debt downgrade to AA sharply depressed the market artificially–buy everything, sell after doubling in a few months).
  
  Once I took a loan for $13000 at 1.99% APR refinancing a car with a $10,000 balance on it and in 1 month made enough money on the $3000 to fully offset the interest paid on the car over 5 years. On purpose. I was spending 6-8 hours a day studying the market and making 1% per day. It wasn’t easy, and one week I lost 9% in one day and had to struggle to get back above my baseline.
  
  On top of all that, I’ve never been vested–2-4 years in I switch companies, especially as a government contractor being passed around between contractors with a 3 year vesting period, so if you’re popped onto another contract for the same position your employer keeps all the 401(k) match they were supposed to give you.
  
  Imaginary 50% and 100% matches don’t keep up with real 10% and 20% interest.
Kayembee

My situation is pretty ugly. I am about $450,000 in debt which includes mortgage, credit cards, car, student loan, medical bills and equity loan. I am single, 56 and have no money set aside for retirement. Can’t sell my house because it is $100,000 upside down. So right now I am focused solely on getting out of debt. Only then would I be able to think about saving any money for retirement. I believe I can pay off everything but mortgage, equity and school loan in the next three years. If I take that money and apply it to the mortgage, equity and school loan I can everything paid off in 10 years which means I’d be 66 and much too late to start saving anything. I think that I will have to do so sort of work until I die. I also believe if I sell my house, I can use that money to live on till I die. It’s all pretty sad but that is my situation. Retirement looks impossible for me.
- John Moser
  
  Pay off the mortgage and don’t imagine you’re rich and can buy expensive cars and travel all the time. You’ll find you can live on $400 or so a month. How soon can you retire?
http://pulse.yahoo.com/_3O6VM7MCLFKPWXTVH2PM667ZXU MellowGuy

Payoff high interest loans first. Home loans can wait, but don’t get a home loan unless you have 20% down.

401Ks are good if you have matching funds, and definitely take advantage of Roth accounts. You will want to have as much as possible in a Roth account when you retire.

It is important to have a regular investment account where you can sell off assets if you need the money without penalty. Stocks are about the only way to get a good return in the long run, unless you can start your own business. This may mean doing with making heavy contributions to a 401k in a person’s early year.
- John Moser
  
  The stock market operates by taking money from idiots. If you’re not a shrewd investor with a sharp grasp of the market able to make constant returns (the ups and downs exist, but the ups are bigger than the downs and you hedge when you’re unsure), you shouldn’t be in the market. If you ARE in the market, you’re funding my retirement. I don’t play anymore because it’s a lot of work and I have a job already.

Opinion: Should You Save For Retirement or Pay Off Debt First?

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