When should retirement savings be prioritized over debt repayment? | Smart Change: Personal Finance

(Christy Pepper)

Like most people, you have a limited amount of money and you must decide what you are going to do with it. This can be a complicated choice if you have debt you’re trying to pay off, but you’re also eager to start saving for retirement so you can secure financial security in your later years.

So, how should you decide whether to focus on paying off debt or investing for your future? Here’s what you need to know to help you make that tough choice.

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How to decide whether paying down debt or retirement savings is the smartest choice

To determine if paying off debt or focusing on retirement savings makes sense, there are a few things to consider. But one of the most important factors of all is which method will give you a better return on investment (ROI).

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You will always want to pay the minimum outstanding balance on any debts you have incurred. But if you pay an additional amount beyond the required payment instead of directing that money into retirement savings, your investment return will equal the amount of interest saved. If you have 17% credit card debt, you get a very high ROI. But if you have a low interest mortgage debt at 3.50% and you are able to itemize your deductions and deduct the interest paid on your home loan when you file your taxes, your return on your investment is very low.

If you invest rather than prioritizing debt repayment, on the other hand, your ROI is the money your investments make. But you can also get a 401(k) match from your employer, which can provide up to 100% ROI if your company matches your contributions on a dollar-for-dollar basis. And you can qualify for tax breaks for investing in retirement. These tax credits can include deductions for contributions to a 401(k) or IRA and even a savings credit that can cut up to $2,000 off your tax bill if you qualify and contribute the maximum.

If you can get a better ROI from paying extra for debt — even after taking tax savings and matching 401(k) contributions into account — it’s best to set aside your extra money to pay off your loans as soon as possible. But if your ROI is better through investing, you should make the minimum payments and allocate the rest of your money toward retirement savings.

Often, for most people, this leads to a hybrid approach. For example, you can put extra money into your 401(k) until you earn your maximum employer match and you can then forward the extra money to a credit card payment as quickly as possible. Or you could work on paying off your payday loans and credit card debt before investing in an IRA, but then focus on retirement savings rather than sending an extra amount into a mortgage or a low-interest car loan.

By making a strategic assessment about which use of your money will work best for you, you can determine exactly where your extra money belongs. Remember, you need some retirement savings because you can’t live on Social Security on your own. So make sure you don’t put off investing in later years for too long. If you’re focused on getting out of debt first, get serious about your additional payments and clear this task off your list ASAP so you can start building a secure future.

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