Like most people, you have a limited amount of money and need to decide what to do with it. It can be a tough choice if you have debt you’re trying to pay off, but you’re also eager to start saving for retirement so you have financial security in your years to come.
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.
How to decide if paying off debt or saving for retirement is the smarter choice
When deciding whether it makes sense to pay down debt or focus on saving for retirement, there are a few things to consider. But one of the most important factors is knowing which approach will give you a better return on investment (ROI).
You will always want to pay the minimum balance due on any debts you have incurred. But if you pay extra beyond the required payment instead of directing that money to retirement savings, your return on investment will be equal to the amount of interest saved. If you have 17% credit card debt, you get a pretty high return on investment. But if you have low interest mortgage debt of 3.50% and are able to itemize your deductions and deduct the interest paid on your home loan when you file your taxes, your return on investment is very weak.
If you invest instead of prioritizing debt repayment, on the other hand, your return on investment is the money your investments earn. But you could also get a 401(k) match from your employer, which could provide up to 100% return on investment if your company matches your contributions dollar for dollar. And you could get tax breaks for retirement investments. These tax breaks could include deductions for contributions to a 401(k) or IRA and even the Saver’s Credit which could reduce your tax bill by up to $2,000 if you are eligible and contribute the maximum. .
If you can get a better return on your investment by paying off extra debt—even after taking into account tax savings and 401(k) matching contributions—then you’d be better off putting your extra money into paying off your ready as soon as possible. But if your return on investment is better by investing, you should make minimum payments and invest the rest of your money in retirement savings.
Often, for most people, this leads to a hybrid approach. For example, you can put extra money in your 401(k) until you’ve earned the maximum employer match, then redirect the extra funds to pay off credit cards as soon 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 saving for retirement rather than sending a supplement to a mortgage or to a low interest car loan.
By making a strategic assessment of where your money will best be used, you can decide where exactly your extra money belongs. Remember that you need retirement savings since you cannot live on Social Security alone. So make sure you don’t put off your investments too long for your future years. If your focus is on eliminating your debt first, be aggressive with your extra payments and check that off your list as soon as possible so you can start building a secure future.