Prioritize Savings: Paying Off Debt vs Saving for Retirement

So, you’ve got a little extra cash. What are you going to do with it?

Whether it’s a tax refund, work bonus, stimulus check, or the result of efficient budgeting, if you find yourself with extra money after taking care of your monthly bills — and you want to use the money wisely — your first thought may be to pay off debt. Or, you may think the better choice is to put the money toward retirement. Or, you want to do both.

How to use your money to your financial advantage all depends on your current financial situation, outstanding debts, long-term goals and future retirement needs. Here are a few factors to consider when making this important financial decision.

Should you pay off debt or invest in a retirement account like a 401(k)?

When deciding whether to pay off debt first, consider the amount of debt you’re currently carrying as well as the interest rates of all credit cards, student loans, auto loans, personal loans and other debt.

If you’re juggling multiple credit cards and other high-interest, revolving debt, paying off those accounts should be a priority, especially if they carry large balances and you find yourself struggling to make the payments some months. Consolidating those balances into one loan payment could help you pay off several bills, lower your interest rate and reduce your debts faster.

However, if you carry mostly low-interest debt, and not much of it, then using the money toward retirement could be the better option, especially if your employer offers a matching contribution to your 401(k). If possible, save up to the amount your company will match, to take advantage of the free money they’re offering to contribute to your retirement.

For example, if your employer offers a 100% match up to 4% of your salary and you make $50,000 a year, your company will contribute an extra $2,000 to your 401(k) on top of the $2,000 you invest every year. That’s doubling your money — and it’s an opportunity you should not pass up if possible.

Should you stop contributing to your 401(k) to pay off debt?

If you are in a position to put a little toward debt and a little toward retirement, do so. But if you are considering devoting all of your extra income to paying off debt, and holding off on contributing to your 401(k), Roth IRA or other retirement accounts, you should take into consideration how close you are to retirement age and how much you already have saved for retirement.

A person in her late 20s carrying a significant amount of credit card debt and student loans, may want to focus on paying down her debt so she can free up more of her income later for retirement savings. And, theoretically, she has plenty of time to do so. But a father in his 50s with the same amount of debt may want to direct his extra money to securing his retirement nest egg — and taking advantage of his employer's matching contributions while he can — as he continues to make steady payments on his debts.

Use a ‘pay off debt or save for retirement’ calculator to help

Still unsure whether to use your surplus money to pay off debt or save for retirement? This calculator can help you determine which is the better move for you based on the interest rate you’re earning (or could earn) on your retirement savings versus the interest you’re being charged on your debts.

If you’re among the nearly 25% of Americans who have no retirement savings1 at all, follow these four steps to starting a retirement plan and consider using some of your extra money to start one. Remember, it’s never too late to start, and any amount you contribute can help you get closer to your goals.

The first step is establishing a budget and sticking to it. A budget calculator can help you see where your money is going every month, find areas to cut expenses and get a big picture of how much you can and should be saving every month toward retirement.

So how will you choose to prioritize your savings?

While there’s no one-size-fits-all answer to how you should use extra income, taking your current finances, debt, budget and future retirement needs all into consideration can help you make the decision that works best for you financially, both now and when you reach retirement.

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1. https://www.forbes.com/sites/niallmccarthy/2019/06/03/report-a-quarter-of-americans-have-no-retirement-savings-infographic/?sh=2e9dd7203ebf