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Making smart financial decisions can often seem like a trap. You know that you should save for retirement, but it is difficult to save when you are in debt. But put your limited money in debt and you're wasting valuable time saving for retirement.
Saving for retirement and paying off debt are two important financial priorities, but there is no simple answer to which one is the most important. As in most financial decisions, it depends on the situation.
Sometimes it is better to repay the most expensive types of debt first, because you can pay more interest than income on your investments. Other times, it is wiser to dedicate more funds to retirement and continue to make minimum payments on debt, even if it takes longer to repay. The solution that suits you will depend on several factors. It is therefore important to look at the bigger picture to determine which option will give the best results in the long run.
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When to give priority to the debt rather than the savings
Not all debts are created equal and some types are more damaging than others. High interest debts, such as credit card debt, can be extremely toxic. Even if you make regular minimum payments, because of the very high interest rates, your balance may simply increase plus it takes time to pay off the debt. Even relatively modest balances can take years (not counting accumulating hundreds or thousands of dollars in interest payments), and taking the time to pay off this type of debt can sometimes do more harm than good.
For example, if you have thousands of dollars in credit card debt and you pay an 18% interest rate, place money in a retirement account with a 7% rate of return. % may not be as beneficial as it seems. If you pay more interest than you save on your savings, you do not really succeed.
That said, if you have a 401 (k) that offers matching contributions to the employer, it's a good idea to contribute enough to your retirement fund to win the full match, regardless of the amount of your debt. These matching contributions are essentially free money and can potentially double your savings, so make the most of it.
Focusing first on your higher interest rate debt is also good if your retirement fund is relatively healthy. Although it's never a bad idea to save consistently, if you have a solid nest egg, you may be able to afford to ask for a break to save long enough to pay off your rate-conscious debt. high interest.
When to give priority to saving rather than to debt
Types of low interest rate debt, such as mortgages or student loans, are not as damaging or expensive. It is therefore not so crucial to repay them as quickly as possible. Although you still need to make the minimum payment on all your debts, try to save the rest of your money for retirement.
Saving for retirement as soon as possible has a key benefit: your savings grow much faster when you start early, thanks to compound interest. For example, suppose your goal is to save $ 500,000 by age 65. If you start saving at age 25, you will need to save just over $ 200 a month to achieve this goal, assuming an annual rate of 7%. return on your investments. But if you had to wait until age 35 to start saving, you would need to save about $ 450 a month to achieve the same goal.
By taking a time out to focus on debt, you lose your most valuable asset: time. If you focus on paying off less expensive debts before you save for retirement, it will be even harder for you to catch up on your savings.
Saving for retirement should normally be your main financial goal, unless you are struggling with thousands of dollars in high interest rate debt that earns interest every day. If this is the case, pay your most expensive debt as quickly as possible and then spend the rest of your savings on retirement.
Balancing retirement and debt
Ideally, you should aim to save for retirement while settling your debts. You may need a little more time to pay off your debts if you dedicate some of your savings to retirement, but it will also be easier to establish a solid retirement fund if you save. regularly.
If you are struggling with high interest rate credit card debt, one way to ease the burden is to take advantage of balance transfer cards. The best balance transfer cards allow you to transfer your credit card balance to a new card with a 0% introductory period before and up to 21 months. In other words, you can convert your existing debt into interest-free debt for a given period of time. This allows you to quickly reduce your debt and potentially save thousands of dollars in interest.
At the same time, try to earn at least a little for retirement. Saving even a small sum each month is better than nothing, and if you can take advantage of employer contributions matching 401 (k) dues, you'll be even better fit.
Managing money can sometimes be difficult, especially when you have competing financial priorities and you have very little money. By strategically defining your priority, you can potentially save money and prepare for long-term financial success.
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