One question I hear quite often from readers who are getting out of debt: “Which should I do first, save for retirement or pay off debt?” It’s a common question that leaves a lot of people confused. There is plenty information available on the subject. But no clear consensus about the best way to proceed when you’re concerned about both paying down debt and saving for the future.
Paying Off Debt or Saving For Retirement, Which is More Important?
Paying off debt and saving for retirement are extremely important to managing your financial health, now and over the long term. But is one more important than the other?
I don’t necessarily think so.
Here’s why both are extremely important:
- Paying Off Debt- Getting out of debt is probably the most important thing you can do financially. The longer you stay in debt, the more interest you pay, the less freedom you have, and the less money you have to put toward more important things like saving for retirement. Debt is always a drag on your finances and makes you poorer. The longer you have debt, the more you are held back financially.
- Saving For Retirement- You can’t work forever. At some point in your later years you’re probably not going to be producing an income. That’s why it’s important to save and invest when you’re young, invest that money, and let it grow exponentially over time. This is how you become financially secure and have the ability to finance your life when you no longer produce an income to support yourself. If you don’t do this you will have to rely on government support which is minimal at best (if it’s available at all).
Now that we know that saving and paying off debt are both extremely important to your financial health, let’s do a comparison.
First, let’s take a look at the advantages of paying off debt first, then saving for retirement.
What If I Pay Off Debt First?
When I talk about paying off debt first, I’m specifically talking about consumer debt. Consumer debt consists of debt on things such as vehicles, credit cards, student loans, etc. Basically, consumer debt is most every debt you have except for your house.
So for this discussion, when I talk about paying off debt, I’m talking about paying off everything but the house.
So what are the advantages of paying off debt first, then saving for the future? Here are the 3 main advantages I can think of:
- Your Behavior Changes- Getting out of debt means living your financial life in a different way than you once did. You have to fundamentally change the way you behave with money to get out of debt. Then your new habits will serve you well going forward. Changing behavior means you will never have to go back into debt again!
- You Have More to Save and Invest For Retirement- When you have changed your money behaviors and you’re completely out of debt, you automatically have more money to send into your retirement accounts. Those retirement accounts can build very quickly and will make your future bright!
- It’s a Better Investment- Most consumer debt has a high interest rate. Usually the rate is equal to or higher than what you could make by investing that money instead. No matter the interest rate, paying off debt before investing has the advantage of getting rid of the serious drag that paying interest has on your financial situation. Paying interest is always worse than earning interest.
What If I Save For Retirement Before Paying Off Debt?
Some financial gurus recommend continuing to send money to retirement accounts while you’re paying off debt. You can do that if you choose, but there are good and bad consequences to doing both at the same time.
- If Your Employer Matches Your Contributions- There’s nothing better than free money! If your employer matches contributions to your retirement account, you should take advantage of that. Contribute to your retirement account up to the maximum amount your employer will match. Then use the rest of your money to pay off debt as fast as you can.
- It Takes Longer to Pay Off Debt- The longer you take, the more you pay in interest and fees. Unless your employer matches contributions, I believe it’s best to pay off debt instead of investing for retirement. The faster you pay off debt, the less money you waste. Then once you’re out of debt, then you can aggressively contribute toward savings and retirement plans.
- It’s Harder to Change Behavior- Dividing your attention between paying off debt and saving for retirement makes it harder to be completely effective at either one. Trying to do both at the same time runs the risk of not fully developing the new financial habits it takes to get out of debt. Becoming too focused on retirement contributions may keep you from ever getting out of debt.
Which Should I Do First, Save or Invest For Retirement?
As a general rule I believe it’s best to make a get out of debt plan and pay off all consumer debt before saving money for later. That way you’re sure to have the right financial habits in place that allow you to save as much as possible for your future without wasting money on debt payments in the present.
Saving and Investing Are Dependent on Developing Good Habits
Saving money for retirement and getting out of debt are two of the most important things you can do financially. How much you can save for your future is directly related to how much debt you have now.
This is why we read so many reports about the dismal state of retirement saving in this country and the huge numbers of people living paycheck to paycheck. The average Joe spends more than he makes, doesn’t save for retirement, and doesn’t make an effort to turn those things around.
But when you finally decide to make a change and treat your finances with respect, the turnaround will be dramatic! That means developing good habits like getting mad and naked, doing a budget, and deciding you will never go back into debt.
So if you want to be rich in retirement, change your habits now. It will pay off bigtime for your future!
Question: Do you think you should pay off debt or save for retirement first? Leave a comment and let me know what you think.