Paying off Debt or Saving for Retirement?

Debt or Savings

Debt or Savings

One of the most common challenges for people who are in debt is deciding how much money they should be using to pay down the debt and how much should be allocated for long term financial objectives like saving for retirement.

Saving for a retirement is something that must be done for many decades to have a decent nest egg to retire upon. However if you are in significant debt, is it better to pay down all of the debt first or juggle the two?

First of all, let’s check out some of the advantages to paying down the debt first, then saving for retirement later on.

Advantages of paying off debt first

1) Save money on Interest

Some of the interest rates applied to credit cards and personal loans are very high.  By aggressively paying off your debt you are “saving” money by reducing the amount of interest you would have paid.  In this respect, it’s better to pay down a loan that is charging 16% interest per year than it is putting that money into a savings account that earns 4%.

2) Reducing risk

In the somewhat volatile economy it is often better to carry as small amount of debt as possible.  If you lose your job and have 5 different kinds of loans that need to be serviced, it can be very difficult.  If you only have a couple of loans or just a mortgage, it is mush easier to make ends  meet and obtain refinancing.

3) Extra cash flow

Once you have aggressively paid down some debts, you will find you have additional cash flow.  So if you pay off your car loan a year earlier, you will suddenly have that extra money in your pocket, for you to invest wisely or to treat yourself with.

4) Lower stress

Minimizing debt also makes your financial matters much less stressful.  You are able to relax and enjoy life more, knowing that you don’t have a multitude of different kinds of debts hanging over your head.

5) You look better on paper

When you have a lower debt to income ratio, you are able to obtain better deals on your loans and refinance your loans.  If you are in a lower debt situation, it can actually help you get rid of the debt that is left, and to get better deals.

Advantages of retirement saving

1) Good employers match contributions.

Employers sometimes match any retirement contribution you make from your salary.  So you are getting much more value from your contributions.  If your employer matches $0.60 for every dollar you add to your 401k that is as good as free money!2) Tax advantagesAll contributions to you 401k are tax deferred.  That means you will pay less tax by putting more money into your retirement savings.  When you pay down debt, you are spending money that has already been taxed.3) Stock Market Gains

In the past few decades, the market has consistently been returning gains close to the 10% mark.  If that rate of return is higher than the interest charged on your debt, then it’s a very good idea to keep putting the money into your retirement savings fund.

4) Inflation

Some financial analysts expect the interest rate to increase in the coming years.  That means if your debt has a fixed interest rate, inflation will be on your side.  The money that goes into the retirement fund will scale better with inflation than debt on a fixed interest rate.

Unfortunately there is no simple answer as every financial case is different.  If you are young or old, have a high income to debt or a low one, there are many factors involved in determining how you should split your money between paying down debt and saving.

Hopefully this article has given you some insight into the kind of things that you will need to consider when making the choice between paying off debt and saving!

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