Getting (and staying) out of debt and saving regularly for retirement are some of the most important personal financial habits that everyone should be doing, but having a finite income with conflicting financial priorities understandably complicates matters. If you have student loans, a running balance on your credit cards, or other outstanding debts in the 4+ figures range, how should you balance your debt repayment plan (short-term goal) with your retirement savings plan (long-term goal)? What is the best way to save for retirement when you are in debt?
Best Way to Save for Retirement When You Are in Debt
The answer to this ultimately depends on the amount of debt and the interest rate you’re paying. Still, a generally good idea for most people’s situations would be to simultaneously repay debts while saving for retirement instead of dedicating 100% of your discretionary income to one or the other.
To achieve the best results for your wallet and portfolio, here are some important considerations to make when navigating the debt versus retirement conundrum and the best way to save for retirement when you are in debt.
Talk to a Financial Professional
First of all, you should speak to an experienced financial planner or counselor before proceeding with an actual repayment/savings plan. Many banks and credit unions offer their members low/no-cost financial professional consultations, so contact your institution to see what options exist for you.
Before meeting with them, create a brief report of all the relevant information you’ll need, including current balances (retirement accounts, credit cards, loans, etc.), interest rates you’re paying on the debt(s), your current income, and budget, rates of return you’ve gotten on your retirement portfolio so far, and retirement goals (age, target income range, lifestyle needs).
Compounding Interest Comparisons
Compound interest is important to investors because it allows investors to increase their money over the long term. Compound interest refers to earning money from both your initial investment and the reinvested interest of that money.
Now it’s time to do some math. Fortunately, several compounding interest calculators are available to help you calculate figures such as current/ongoing contributions, estimated rates of return, savings timeframes, and compound frequency (annual, monthly, daily). This step is critically important to understand how much your retirement investments may be worth several years from now.
On the surface, throwing $500 at a credit card with 18% APR may seem like a better option than investing that $500 into a retirement account that’s currently earning 6% in annual returns. However, a compounding interest calculator could demonstrate that you’d be much better off investing most of the money into retirement because it’ll be worth significantly more in a couple of decades when you’re ready to leave the workforce.
Consider a 0% Balance Transfer
If you have a good or excellent credit score, then you may qualify for a special 0% interest balance transfer offer for a credit card. In these cases, you’re effectively paying no interest on transferred balances for the duration stated in your offer agreement (typically 6-18 months). If you’ve been struggling to repay high-interest debt, then calculate how much interest you’re paying each month and compare that amount with the balance transfer fee (oftentimes 2-4% of the transferred amount).
A word of caution on balance transfers: if you don’t repay off the transferred amount before the 0% rate expires, you may be hit with a very high-interest rate on the remaining amount (or in some cases, you may have to pay interest on the entire amount if it’s not fully paid off before the offer expires – be sure to thoroughly read the contract to understand what you’re getting into before opting for a 0% balance transfer).
Take Advantage of Employer Matching
Does your employer offer a percentage match on your 401k Retirement Plan contributions? Many employers offer 3-6% matching contributions based on the overall amount you put towards retirement each year. This is essentially free money – designed to incentivize employees to save more for retirement – so if you’re not taking advantage of employer-matched contributions yet, then you should prioritize retirement saving over debt repayments (unless your debt is exceptionally high-interest or within 6-12 months of being fully paid off – in these cases, the snowball method might work well for you).
Being in debt can be a stressful experience, especially with fears of not having enough saved for retirement hovering in the back of your mind along the way. Rather than taking an all-or-nothing approach by solely repaying debts and promising yourself to save for retirement “when I’m debt-free,” a balanced approach that maximizes your long-term retirement account returns while remaining mindful of the short-term pressure of debt accruing interest is the best option.
To optimize your strategy of repaying debt while saving for retirement, consider setting aside a specific amount every month for both goals and gradually increase your retirement savings allocation over time as the debt load decreases. For best results, speak with a financial expert to clearly define and execute your goals in ways that make the most sense – and cents – for your unique situation.
