Pay Off Debt or Save for Retirement?

When Phil Risher graduated from college, he had $30,000 in student loans. He wanted to get serious about paying them off, which meant putting every extra penny toward the loan balances. But he didn’t forgo savings entirely—he still contributed 3% of his income toward retirement.

“My employer matched me dollar for dollar up to 3 percent,” says Risher, 26, who lives in the Washington, D.C., area and runs the website YoungAdultSurvivalGuide.com. That means that if 3% of his income amounts to $2,000, and he puts that into his company-sponsored retirement account, his employer also puts $2,000 in. “It is a nice perk, and I would highly recommend that everyone consider at least doing this, at the minimum,” he says.

For Risher, prioritizing student loans over retirement made sense, and he managed to pay off his debt in 12 months, while making $48,000 as a customer service executive. He broke his debt down into payments of $2,500 a month and lived off the rest of his income: $500 a month.

“I moved into my dad’s basement,” Risher says. “I negotiated a ‘contract’ with them, that instead of paying rent, I would make sure the grass was cut, gutters clean and [act as] an on-call babysitter for my younger siblings.”

Once he paid off the balance, he bumped his retirement savings to 15%. But balancing paying down debt and saving for retirement can cause real confusion, especially when debt levels are high. What’s the best approach, and how do you cover all your bases on a limited income? Here are some strategies if:

You have student loan debt

Your approach to student loans will depend on a variety of factors such as the type of loans and the interest rates you’re being charged. In general, you may want to put money where you are most likely to achieve the best results. If you’re paying off a student loan charging you 4.45% in interest (the fixed rate for Stafford loans for the 2017-2018 school year), you essentially earn 4.45% for every dollar you put toward that loan balance. 

On the flip side, many financial professionals generally estimate that you may earn an average of between 6% and 8% on retirement savings, over the long term. That means you might be better off putting as much as you can toward retirement and making minimum payments on your student loans.

If your student loan interest rates are 6% or higher, consider that you can get a tax deduction for student loan interest, depending on your income level. If you’re in the 25% tax bracket, that means a loan charging you 6% interest is really like 4.5% after the tax break—so it may make sense to focus on retirement first. Once you’re saving at least 10% of your earnings toward retirement, you can start making extra payments on other loans.

If you’re paying higher interest than that—on private student loans, for instance — you may want to look into student loan refinancing, which can consolidate your debt and lower your overall interest rate. But be cautious: Refinancing federal loans removes all the flexible repayment options that come with federal borrowing.

You have credit card debt

The same logic applies to credit card debt—the amount you should throw toward this versus retirement savings depends on how much you’re paying in interest. But because the average credit card interest rate is about 15%, it generally makes sense to be aggressive about paying down those balances ahead of retirement savings.

There is an exception to consider: If you’re getting a 401(k) match from your employer, that’s like achieving a 100% return on the money you contribute. Make sure you’re putting at least enough away to get that match before turning your attention to credit card debt.

“If there’s a match, I would definitely recommend taking advantage of the match,” says Howard Pressman, a certified financial planner with Egan, Berger & Weiner in Vienna, Virginia. “The future compounding growth of their contributions, as well as the match, can make a big difference over time.”

The caveat: If you’re putting less than 10% into retirement funds so you can focus on debt, you should be attacking your debt with gusto so you can get back to your savings goals. The sooner you start saving, the longer your money has to grow.

You have a mortgage

With 30-year fixed mortgage rates at 4.78% (as of September 2018) and income tax breaks sometimes available for mortgage interest, it often works to your advantage to max out your retirement savings before putting any extra money toward your home debt. Having a mortgage — and making on-time payments over time — s good for your credit, and the money you contribute toward retirement will likely do far more for your financial security than paying off your home early. That said, make sure you have a plan to pay off your home loan before retirement. Ideally, you should be entering retirement without mortgage debt weighing you down.

Kate Ashford is a freelance journalist who writes about personal finance, work and consumer trends. She has written for BBC, Forbes, LearnVest, Money, Real Simple and Parents, among others.

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