Should You Pay Off Debt or Save For Retirement?

by Jessica Sommerfield · 8 comments

One financial decision many people struggle with is whether to focus their energy and resources on paying off debt (which frees more of your income) or investing in retirement (which secures your financial future). With more than 43 million Americans responsible for $1.6 trillion dollars in student loan debt, getting free of debt burdens should be a high priority.

At the same time, the guarantee of Social Security benefits are questionable for many in my age bracket, making it imperative to invest in personal retirement accounts and other savings options. Both are equally important, so which should you tackle first? The answer depends largely on your unique situation.

Here are a few areas to examine as you consider which of these wise financial moves should be your first priority.

#1: Re-negotiate your student loan payments.

If you’re having difficulty making the minimum payment on your student loans, your primary focus should be on negotiating an affordable payment plan.

Thanks to the College Cost Reduction and Access Act of 2007 (CCRAA), many former students qualify for payments based on income, which can bring their monthly payments to as low as 10% of their total income. This can significantly reduce loan payments and enable you to not only pay off debt but have more income to invest in retirement.

#2: Re-finance if it makes financial sense.

If you’re still struggling to see how you can afford to invest because of other debt such as your mortgage, other loans, or credit cards, consider if refinancing is right for you. I know interest rates are high but it may still make sense depending on how much interest you are paying with your other loans. Talk to a trusted financial advisor about your debt consolidation and refinancing options.

Look at your debt as a whole. At the end of the day, if you can come away with a lower payment and interest rate, it will free even more of your budget for investment options.

#3: Invest what you can, now.

Even though student loans and other debt may be weighing heavily on you, the truth is that the earlier you invest (ideally, in your twenties), the more you’ll take advantage of the compounded interest that comes with long-term investments.

Understandably, you might not be in a place to invest much if you’re still plugging away at debt, getting established in your career, or raising a family. But even a little can make a huge difference. One of the easy investments you should take advantage of is your employer-offered 401k plan.

Your 401k may not have the sexiest investment options available. Still, if your employer is offering matching funds, you’ll do yourself a huge favor by saving the maximum matched amount since it will be automatically doubled. It’s essentially free money for your retirement! Automatic payroll deductions make it even easier to budget this investment because you won’t have to think about it.

#4: Increase your investments as income increases.

Don’t just start a 401k or retirement account and forget about it. As you pay off more debt and your financial situation improves, increase your deductions or contributions and branch out into other options.

The wisest course of action is to focus more on stocks when you’re further away from retirement. As you get older, transfer riskier investments into more secure sources of income, such as certificates of deposits or bonds.

To put it in a nutshell, don’t let debt keep you from investing. No matter how much money you owe, there are steps to reduce your payments and make them more manageable so you can afford to invest. Even if you make small steps at first, your future will thank you for it.

Are you paying off debt or saving for retirement? What’s your strategy for these financial goals?

Editor's Note: I've begun tracking my assets through Personal Capital. I'm only using the free service so far and I no longer have to log into all the different accounts just to pull the numbers. And with a single screen showing all my assets, it's much easier to figure out when I need to rebalance or where I stand on the path to financial independence.

They developed this pretty nifty 401K Fee Analyzer that will show you whether you are paying too much in fees, as well as an Investment Checkup tool to help determine whether your asset allocation fits your risk profile. The platform literally takes a few minutes to sign up and it's free to use by following this link here. For those trying to build wealth, Personal Capital is worth a look.

Money Saving Tip: An incredibly effective way to save more is to reduce your monthly Internet and TV costs. Click here for the current AT&T DSL and U-VERSE promotion codes and promos and see if you can save more money every month from now on.

{ read the comments below or add one }

  • sianas says:

    I think what we should do in retirement is to pay the debt first, and why? debt is a burden that always haunt us. Investment or effort that we build will not run smoothly in result of debts that we have not yet paid. Because debt is an obligation that we have to pay the debt to the people has given us.

  • HTL says:

    I am approaching this by trying my best paying off my debt (mortgage+autoloans) first. It is very challenging and I have to constantly remind myself and keep myself on track. I hope to pay off my mortgage in 3 years and I am counting month after month…

  • Bob Cunningham says:

    Good info… I see lots of comments focusing on debt reduction as the better strategy, and good points all, but the specific numbers matter – how much debt, what interest rate, income/cash-flow vs. spending. There is no right answer fits all here. Generally, however, high interest debt like credit cards, which commonly have APRs of more than 20%, should be top priority. Low interest debt, like mortgage, car loans, and student loans, can be paid off strategically at the same time you put money away for retirement savings. NEVER under-estimate the power of compound interest, for or against you.

  • David says:

    Questioning the guarantee of social security benefits for your age bracket too easily plays into the narrative that there is some insurmountable problem with making the system work, and too readily erodes support for the program, letting Congress off the hook for making it work. Why not question another obligation, that the U.S. will pay its bond debt? Nevertheless additional savings are essential for a comfortable retirement.

  • Rob says:

    One should pay off debits with high interest first before one invests. A guaranteed reduction in ~6% interest every year is a better return than a potential gain of ~4-8%.

  • Cyrus says:

    I believe someone should be debt-free except for a mortgage before they start investing. If they are trying to invest while paying down a bunch of consumer debt, they likely aren’t going to be able to do much of either. There is a power to focus, in any part of our lives for that matter but particularly in your finances, that is more effective than any supposed mathematical gains you get by trying to split your money among 10 different goals.

    As financial guru Dave Ramsey likes to say: “Your most powerful wealth-building tool is your income, and if it’s all going out the door in payments, it’s very difficult to become wealthy.” To quote another source, a Forbes 400 study asked the people on their list what is the most important key to building wealth. 75% of them said it was getting out of debt and staying out of debt.

    Focus ALL of your income and more on paying off ALL of your consumer debts as fast as possible, including but not limited to: student loans, cars you couldn’t afford (or sell them), all credit card balances (and close the accounts), and loans to friends or family. After doing that and building a healthy 3-6 month emergency fund, investing 10-15% of your income in retirement accounts every month (which is what most financial expert say you should do) should be no problem.

    • Kim says:

      I have to respectfully disagree. If you invest $150 a month for 40 years, that grows to 1 million dollars with compounded interest. Start that at 18-20 and you can have the million by 58-60. However, if you wait to pay off college debt and other important debt, you could easily have to wait until you are 30+ making the million dollar retirement 70+.

      Compounded interest is very important but only really works if you start young. Therefore, I believe it is better to start saying a little young than saving more when you are older.

    • Cyrus says:

      Kim, when I advocate for people to be debt free before they invest, I don’t mean wait 10 years as you alluded to. If it really takes 10 years to pay off consumer debt, you usually either have an income problem or aren’t cutting your lifestyle enough to achieve the goal. For most people it takes 2-4 years to become debt free, which means there is still plenty of time for compounding returns to be substantial.

      Also, in your example, you are assuming someone only invests $150 a month for 40 years. If you are debt free, you should be able to easily save $500-1000 a month depending on your income, and can easily make up for any lost time due to delaying investing. Most financial advisors recommend 15% of your household income going towards retirement. It’s pretty hard to do that when you have large debt payments.

      One last point that most people don’t factor in when they borrow money to invest or neglect to pay down debt and invest instead (mathematically the same): Debt = Risk. More debt equals more risk and less debt or no debt equals less risk. There is a mathematical representation for risk (the beta) that when factored into comparing your 10% average return on your mutual fund versus the 5% interest paid on your student loans, the “spread” is largely negated.

Leave a Comment