Saving money and paying off debt are both very important goals. Here are some questions that you should consider before making a decision.
28
March
2011

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Saving money and paying off debt are both very important goals. They’re also steps that you require taking in order to reach a bigger goal, that of living financially free during retirement. But what if you have credit card debt, mortgage debt and you also make contributions towards your 401(k) account? Which should be your priority? Should you continue making contributions towards your 401(k) account or repay your liabilities? In fact, this is one of the most common questions that the financial advisors face from their clients. So, if you’re dilly-dallying between reducing your debts and tucking aside dollars in your retirement account, read on the concerns of this article.

Debt reduction or retirement savings?

Are you someone who has debt and who knows that he should be focusing on debt reduction but at the same time keeps hearing about compound interest and how one should begin his retirement savings as soon as possible? Well, most Americans owe an overwhelmingly large amount of debt on hence they get confused about whether to repay debt or plan their retirement.

It can sound confusing but actually it’s not as a few simple calculations will tell you what is best for each individual scenario. Here are some questions that you should consider before making a decision.

How much debt do you have and what are the interest rates?

While attempting to analyze the best retirement savings plan for your unique financial situation, you should first ask yourself how much debt you have and what are the interest rates that are being charged per account.

What is your age?

Even though most retirement analysts and financial planners give too much attention and focus to this question, yet it’s still an important consideration. Just keep in mind that anyone shouldn’t scare you into investing simply because you’re at a certain age and you’ve still not begun your retirement savings.

Do you already have access to a tax-sheltered plan?

There are high chances that you do! If you still don’t have access to a business 401(k) plan, an SEP retirement plan or a 403(b) plan, open a Roth IRA. Most individuals are eligible for a Roth IRA and they stand to realize huge benefits by getting started.

Do you have an employer match?

If answered yes, you should consider your financial assets before you blindly contribute just because someone said you should. Is this going to be a fully vested plan or do you earn 20% vesting every year? Is your employment stable? Do you plan to stay with that employer for some more years?

Can you tuck aside money and still pay for groceries?

The basic necessities of life are the most important things that should be given priority. Don’t contribute to retirement savings  if you think that doing so will bar your chances of shopping for groceries.

Should you pay off debt or save money?

Debts can mar your retirement goals and can spoil your plans of spending your golden years in peace. If you want to stay debt free during retirement, you have to sacrifice repaying your debt. How do you know whether this is the right step to take at a moment when you’re already drowning in high interest debt?

Concentrating wholly towards your debt - The problem with it

If you’re someone who can pay off your debt first and halt your savings goal, then you will actually have nothing to fall back on when an emergency situation arises. Unfortunately, you can count on a particular type of expense when you don’t expect it at all. When you face an emergency and you start using your cards to fund it, you will soon fall deep into debt and find it tough to get out of the same. When you delay your retirement savings, you will soon have a negative impact on your credit score. The longer you wait to start off with saving money, the more money you will put aside each month to achieve your retirement goal. On the other hand, if you can start saving earlier, you can get more years to earn interest rates.

Only continuing with saving money - The problem with it

On the other hand, if you’re saving money and you don’t want to focus on paying down debt, you will waste money unnecessarily on paying the interest rates. The interest rates on credit cards are way higher than that you yield on your savings accounts. Hence, if you keep on saving money while not paying down debt, you will spend more money than what you earn on your investment. The other problem with saving first is that you will enter retirement with debt.

Instances when saving money can be more important than paying off debt

If you don’t have an emergency fund or liquid cash which you can access during an emergency, take time to build one then. Now you must be wondering what is an ‘ideal’ emergency fund. Well, the ideal emergency fund is 6-12 months of living expenses but this can take several years to boost your savings account. If your employer offers matched contributions to your 401(k) plan, don’t make the mistake of turning down free money as there are tax benefits to retirement savings. The money that you contribute to your retirement fund is usually excluded from your taxable income, resulting in lighter tax burden.

From a financial point of view, if the interest rate that you’re paying on your debt is lower than that what you’re earning on your savings or investment, you’d rather get a high return by saving rather than by paying off debt. If you owe debt on low interest rate student loans, you can continue with saving money rather than paying off debt.

Ultimately, you require finding a balance between the amount you spend on savings and debt each month. It isn’t wise to put off either in lieu of the other and hence you should try to come up with some effective way of splitting money between the two options. If you have an extra amount of $2000 every month, you can put $1000 towards your debt and $1000 towards your savings account.

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