Making Sensible Decisions: Paying Off Debt vs. Saving for Retirement
Trying to decide whether you should pay off some bills, or set aside more savings for your retirement? You’re not alone. The choice is a tough one, and there are several factors you may want to consider. For instance:
Rate of return vs. interest rates
A lot of people compare the amount they’ll earn on their investments, against the amount of interest they’re paying on their debt. In other words, if your debt interest rate (say at 18%) is greater than the rate you’d earn back on any investments (for instance, an estimated 8%), you should pay your debt off first.
Investment earnings are never guaranteed, but your credit card interest will remain the same unless you can take advantage of a special offer to get your rate down. Plus, credit card interest isn’t deductible from your taxes. To make more from investing, in this scenario, you’d have to earn an after-tax return of more than 18% — and that’s a tall order.
What about employer matching?
Many employers match as much as 50% of the money you contribute to your 401(k) or similar savings plan. If that’s the case, this free, 50% return on your money makes your choice harder. For this reason, most financial experts would say you should always contribute at least as much your employer matches — even before you pay off debt completely.
All or nothing isn’t necessarily the answer
The best approach might be a blend of paying and investing.
Why? Because inevitably when you plan to pay off a large debt, and then start saving, life gets in the way. Some people never end up saving anything, because they never reach the point of having zero debt.
So, how can you do it? Start with investing in your employer-matched retirement account if at all possible. When you invest in that, you’ll be paying yourself first, while likely earning a better total return than you could on anything else. And once you get used to this money being taken out of your paycheck automatically, you might not even notice it’s missing.
With the income that remains, try to make credit card payments that are equal to or ideally a little more than your monthly minimum. By paying more than the minimum, you’ll pay less in total interest by the time it’s paid off, because you’ll pay it off more quickly.
And while everyone would love to pay their car or mortgage off faster, too, keep in mind this debt generally has a much lower interest rate than that of the credit card bills you have. Plus, mortgage interest is deductible from your tax return.
Another approach is to consolidate debt. Sometimes putting all your credit card bills into a single debt consolidation loan — or transferring all balances to a single, low-rate card — can save a lot in interest.
Other things to think about
Talk to a financial adviser about the best approach for your circumstances. When you do, ask about these topics, too:
Automatic withdrawals — Whether for your retirement savings, or your debt payments, automatic deductions from your bank account can help ensure that you don’t accidentally spend money you’ve allocated toward your goals.
Emergency funds — Determine how much you should have in a simple checking or savings account, just in case you lose your job or have a medical emergency. Some employer-sponsored retirement plans will allow withdrawals instances like these – but depending on your age and other factors, you may incur penalties.
Other account limits — Just in case you do need to borrow from your retirement plan, make sure you know all the costs. You may have to repay it more quickly than a personal loan from a bank or family member, for instance. And of course, your amount of earnings will be reduced after withdrawing some of your invested money.
Whatever you do, get started now. Whether you’re paying off bills, saving for the distant future, or both, time is on your side. The earlier you save, the more you’ll have when you retire. And the more you pay toward your debt right now, the less you’ll pay over time.
These are tough decisions, so feel free to contact us or stop by your local Horizon Bank branch for some Sensible Advice. Our financial advisers will be happy to discuss your options and help you make a plan that works for you.