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Should You Save for Retirement or Pay off Debt?

One of the biggest financial roadblocks that many people face is trying to pay off debt while tackling other financial goals, like saving for retirement. The average adult in America has $29,800 of debt, excluding mortgages. And 15% of Americans believe they’ll never be debt-free.

Given these numbers, it’s more important than ever that people balance paying off debt with saving for retirement. Otherwise, it’s likely that the high rate of people in debt will simply turn into a high rate of people who can’t afford to retire.

Do you have enough in your 401k to retire when you want?

Millions of households use Personal Capital’s free retirement planning tools to see how they can improve their chances of retirement success. You can run different scenarios and get a spending plan to stay on target.

In this article, you’ll learn whether it’s better to pay off debt or save for retirement first, and how to achieve both at the same time.

Is it better to pay off debt or save for retirement?

Personal finance is just that: personal. As a result, there’s no one-size-fits-all approach to saving for retirement while paying off debt. But there are a couple of rules of thumb you can follow, depending on your circumstances.

When you should pay off debt first

Depending on your financial situation, it might make sense to put as much money as you can toward debt before increasing your retirement savings. If you have high-interest debt (generally anything above 9%), it’s worth tackling that as quickly as possible. The interest rate on credit cards often exceeds 20%, as does the rate on high-interest personal loans. This should be your first priority before you increase retirement contributions.

It’s also important to note that debt is a highly emotional topic for many people. If your debt is a serious emotional burden for you, it might make sense to prioritize it, even if it’s not the most financially prudent choice.

When you should save for retirement

There are definitely times when it’s best to prioritize paying off debt, as we discussed above. But there are many other situations when you can redirect some of that money toward retirement savings instead. Here are a few situations when you can save for retirement while you’re still in debt:

  1. Your employer offers a 401k match. About 75% of employers that offer a 401k plan also offer an employer match. If a 401k match is available to you, you don’t want to pass it up. It’s literally free money from your employer, and it can add up considerably over time. If you’re still paying off debt, it’s worth contributing at least up to your employer match, which often equals a few percent of your salary.
    Read More: How Does 401k Matching Work?
  2. You have low-interest debt. While paying interest on debt can feel burdensome, the payoff may be worth it if your money can earn more in the market. According to the Securities and Exchange Commission, the stock market has an average annual return of 10%. When you account for inflation, it’s more like 7%. Either way, the average returns are higher than the interest rates many people pay on their mortgages, student loans, and car loans.
  3. You expect to be in debt for years. In a situation where you have just a small amount of debt you can knock out quickly, you might prefer to go all-in and get rid of it as quickly as possible. But for individuals who expect to be paying off debt for years, it might be best to start saving for retirement as well. Because of compound interest, the longer your money is in the market, the better. It would be a shame to miss out on those early years when your contributions have the chance to grow the most.

Use this calculator to see how much you should be saving.


Tips for saving for retirement while paying off debt

Paying off debt and saving for retirement at the same time can feel overwhelming. Here are a few tips to make the process a bit easier.

1. Review your budget

The more wiggle room you have in your budget, the more quickly you can pay down your debt while still putting money toward retirement each month. 

Personal Capital’s money management tools can help you figure out where your money is going now. Then you can identify areas where you can save to have more money to save and pay off debt.

Mary, who uses the free financial tools, had this to say about the technology in November 2020:

“Coming from a personal history of irresponsible financial choices, Personal Capital has been a really helpful tool in turning things around. I compare my changes to a huge container ship in the ocean: it takes a long time to slow, stop, turn around, and gain speed again.

“Personal Capital has helped with each phase of that transaction, from generating a budget and living within our means, to tracking debt repayment, to generating savings, and most importantly to maintaining accountability and seeing progress.

“Progress is slow; it’s a big ship and can’t turn on a dime. But Personal Capital really lets me see how even small changes have added up. When I interact with Personal Capital regularly, my spending goes down and my savings go up.”

2. Make sure you have an emergency fund

When you’re paying off debt, it can often feel frustrating to push it off any longer. But if you don’t have an emergency fund in place, it’s best to make your minimum debt payments and put extra money toward an emergency fund.

It might seem counterintuitive to save before paying off high-interest debt. But without an emergency fund, any financial emergency just means you’ll have to go even further into debt. And if you have to put unexpected bills on a credit card, you’ll end up paying more for them in the long-run because of the interest charges.

3. Maximize your tax advantages

Saving for retirement comes with certain tax advantages. Contributions to a 401k or traditional IRA are made on a pretax basis, meaning the contribution is removed from your taxable income and thus reduces the taxes you’ll pay for the year. Additionally, the first $2,500 of student loan interest you pay each year is tax-deductible. Depending on your situation, it might make sense to figure out what balance of saving and debt-payoff result in the best tax savings.

4. Set specific goals

It’s easy to say that you want to get out of debt early. But for many people, those words never turn into action. Once you decide to tackle your debt, write down a specific plan. Outline how much extra you’ll put toward debt each month. You can even update your auto-pay so that you’re automatically paying the higher amount.

You can track all of your spending, saving and investing with Personal Capital’s free financial dashboard. Millions of people use this technology to stay on track with their financial goals. You can use the tools to:

  • Organize your spending and set a monthly target
  • Set your retirement goals and ensure you’re on track to meet them
  • Navigate your progress toward paying down debt

Get Your Free Financial Dashboard

Personal Capital compensates Erin Gobler (“Author”) for providing the content contained in this post.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Erin Gobler is a money coach who helps people pay off debt and reach their big financial goals without giving up spending on the things they love.
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