The Great Debate: Paying Off Debt or Saving for Retirement


The topic of retirement has had its fair share of press recently, thanks in part to National Save for Retirement Week and an onslaught of news reports talking about the increasing age of retirement. Now more than ever, it appears that saving for retirement is as important as, if not more important than, any other financial goal.

But what if you’re knee-deep in debt?

Paying off debt isn’t easy to accomplish. During a debt payoff journey you may battle emotional setbacks, high interest rates, and typically a much longer payoff plan than you’d prefer. With those kinds of challenges, the idea of adding anything else to the plate could seem ludicrous. But choosing not to save for retirement could be just as financially damaging as incurring debt (and could even lead to future debt). Hence the great debate: pay off debt or save for retirement?

The Argument for Saving for Retirement

There are many reasons to start saving for retirement early, though not all obvious:

  • Once you retire, it may be harder to find a full-time job if you ever need to re-enter the workforce.
  • Due to ageism in the workplace, you could be forced to retire earlier than you expected.
  • Medical reasons could lead you to an early retirement – or medical costs later on in retirement could be more than you expect.
  • The cost of living goes up every year. So even the most frugal of retirements could end up in a more expensive lifestyle than planned – even if you plan to scale back.
  • Medical advances lead to longer, healthier lives. That’s great news! But it could also lead to many more years in retirement and thus many more years to fund.

Now that you know why it’s important to save for retirement, it’s important to discuss why you need to start saving sooner rather than later. You might think that you can reach other goals first and then double down on retirement savings later. But the sad truth is doubling down probably won’t equal more money in your pocket when you hit retirement. In fact, it might not even equal the amount of savings you would have had.

Compound interest – both friend and enemy.

In debt, compound interest works against you. In retirement savings, compound interest works for you. By saving a little each month and putting into a 401(k) or Roth IRA, your money is invested and earns interest over time. That’s why it’s more important to start saving a little bit early on rather than more later.

The Argument for Debt Payoff

Debt costs a lot of money. Debt also denies you money that could otherwise have been saved and could prevent you from lifestyle changes such as moving to a new place, changing careers, or taking risks. Therefore, paying off debt opens the door to greater financial security and potentially more opportunities.

Whether you choose to pay your debt off with the debt snowball method, the debt avalanche method, or something else, one key factor is that you need to pay over the minimum payments. Otherwise, you’ll never make any real progress on paying your debt off faster.

But what if you are living paycheck to paycheck? Most likely any extra you can make will go straight to debt payoff (even if it’s just a few dollars a month). And even if you’re not living paycheck to paycheck, you may only want to focus your extra money to debt payoff because of the high cost of interest – especially if the interest is higher than what your retirement accounts will yield in the same period. Either way it’s the same: having a tunnel vision to apply any and all extra funds to debt and debt alone.

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The Balance

Believe it or not, the answer to the great debate of saving for retirement or paying off debt doesn’t have to be one or the other. It is possible to strike a balance. The first and most important step of this balance is to stop accruing debt. That is at least one thing that doesn’t impede on either your goal of retirement savings for paying off debt – in fact, it helps both of these goals.

It’s especially important to avoid accruing new debt as your retirement draws near. Taking on debt later in your career means you’ll have less time to pay it off and less years of higher earning potential to help. While not all debt can be avoided (such as paying for an emergency that an emergency fund or insurance couldn’t cover), you can at least stay away from the type of debt accrued from lifestyle inflation or a desire to purchase before you have the full price saved in cash. (If you feel that your current debt level is too high to ever pay off, then you should talk to a financial counselor or bankruptcy attorney for advice.)

Another way to strike a balance is to use the retirement resources that are available to you already – such as a 401(k) employer match. Any money you allocate to your 401(k) via your employer is taken out pre-tax and comes right out of your paycheck – so you won’t even miss it. And if your employer matches a certain level of contributions, that gives you a chance to double your savings at no cost to yourself. It also allows you to save for retirement in a way that doesn’t require you to take money away from your debt payoff plan.

Finally, you can also strike a balance between these goals by using the principles of the debt snowball and avalanche methods. For both, once one debt account is paid off you would allocate whatever you were paying on that account to the new target account on top of the minimum payment. But what if you took some small portion of that amount, even as low as 10%, and allocated it to a retirement plan? And then for each account that’s paid off, you could take the same small portion of that payment and add it to your retirement contributions, while still continuing the avalanche or snowball to debt payoff. Also, see our post Is It Better to Invest or Pay Off Debt for a detailed look at the tradeoffs of each choice.

In today’s hectic world filled with longer work hours, more expenses, and a down economy which leads to lower earnings, reaching even one financial goal can be a major challenge. However, striking a balance between paying off debt (improving your present situation) and saving for retirement (preparing for a stronger future) is imperative. A little creativity and knowledge can go a long way to making sure that you can strike this balance!

Image Credit: red11group

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