Managing Your Household Debt
The challenge of paying down debt while saving for the future can be daunting—especially in today's weak economic environment. For many, paying off debt is easier and more emotionally satisfying than building up savings. That's because debt obligations can be whittled down in concrete chunks, while savings goals are more ambiguous and can change as easily as changing one's mind about how much to save. And of course, contributions put into regular savings can be taken out and spent on a whim.
A large percentage of those polled in "The African American Financial Experience" study admitted to putting off long-range goals in favor of addressing immediate needs such as day-to-day expenses, emergencies, and, to a significant degree, credit debt.
But is paying off debt always a good idea? While the urgency associated with addressing short-term financial needs makes this practice understandable, it may not always be the best approach for everyone. Rather, it's recommended that you take a bold, hard look at your individual situation—with the help of a qualified financial professional—and take steps to ensure that you meet your long-term objectives.
Options to Consider
In many cases, routinely saving and funding your retirement even while paying off debt is the smartest choice.
Consider these options:
- Even if you have high interest loans or credit card debt, you may want to make it a priority to contribute to your 401(k). Put in at least the highest amount your employer will match. You'll receive a 100% return on your investment, and the sooner you contribute, the longer your money will have to compound.
- Do the math: Compare the interest you'd receive in savings (e.g., stocks, bonds, mutual funds), to the interest you'd pay in debt (e.g., credit cards, high interest loans). If the interest you'd make on your savings is higher, then consider putting as much as you can into savings and doing it as soon as possible.
- Think twice (and then think again) before tapping into your retirement savings to meet immediate cash flow needs, pay off debt, or cover emergencies. The penalty for early distribution from a 401(k) is sizable. The withdrawal amount is generally included as part of your taxable income plus a 10% additional tax penalty fee applies if you are under age 59 1/2 unless an exception applies. If the tax hit exceeds the interest penalty on your debt, it's a bad deal for you.
So don't let the seeming urgency of current debt cause you to shortchange your future. Give your long-term financial goals their due. Find a balance and take an approach that considers both your immediate needs and your long-term goals. You can decrease debt while saving for the future.
The Prudential Insurance Company of America, Newark, NJ