Liz Pulliam Weston wrote a nice article recently describing nine money priorities. She lists them from top priority on down:
- Pay your bills
- Save $500
- Start saving for retirement
- Pay off “toxic” debt
- Bolster your emergency fund
- Check out long-term disability insurance
- Enhance your retirement savings
- Start saving for college
- Save for spectacular expenses
I emphasized #3 and #4 because she thinks that starting to save for retirement edges out paying off debt. Sensing backlash, she defends this position:
You may be surprised to see retirement so high on the list. Surely your credit card debt and your kids' college educations are more important.
Except they're not. You have only so many working years to set aside enough cash to last you for the rest of your life, and any delay in getting started will cost you big time. Waiting just five years to begin can reduce your total nest egg by as much as 30%.
Retiring (or not retiring) is about money, not about age. If you reach age 55 (or 65, or 75, or 80) and don't have enough money to support yourself, you won't be able to retire. Fill out an application to hand out yellow smiley stickers while you wear a blue vest. Socking away money at 8% annual return (ha!) does you absolutely no good if you're paying 17.99% APR on a credit card. If the interest you're paying out is outstripping the interest and dividends and appreciation you're getting with your investments, you're falling behind. Filling up a leaky bucket just means you'll be thirsty later.
There are a couple of instances when it might pay to follow this advice:
- You get a match with your 401(k). If you contribute to your 401(k) only to the point for which you get a maximum match from your employer, then this might offset putting off your debt repayment. It's free money. But if your employer doesn't match your contribution, forget contributing until your consumer debt is paid off.
- You have low fixed-rate mortgage debt. This debt is a good inflation hedge. Gosh, if you have a rate under 5%, you're golden. Pay that one off slowly, and put what you want into retirement savings. If there's a chance that your rate will increase, pay it off ASAP before funding retirement.
Otherwise, I really don't seen the merit of saving for retirement until you get rid of the high-APR debt. But maybe it's a psychology thing.
The math tells you that high rate debt should come before retirment savings. Other than an employer match, it’s a slam dunk, even after taxes.
However, this is where the psychology is important. It’s not just about the math. Many people may not get aroud to saving for retirment because “it doesn’t make sense until I pay off the debt.” The problem comes when the debt doesn’t only go down. Debt gets used as an emergency fund, or even just day to day spending. Either way, months and years go by and the debt is still there, AND there’s no retirement savings.
Just as important to the #3 vs #4 debate is #7. Begin retirement savings in #3, such as 3% or whatever the max is to get the employer match. Return at #7 to save as much as you can.
Nice article. While I can’t say that I agree with all of Weston’s priorities, there are a few that I think I’m going to be giving some more thought to. I’m on a new financial plan set up through CheckingFinder.com. It’s actually a trial membership to Dave Ramsey’s MyTotalMoneyMakeover.com, and so far it’s got me headed in the right direction. Just wanted to pass it along. Maybe it will help others as much as it’s helped me.
J Swoboda
In this economy, paying off debt is saving for retirement. The return on investment is positive and guaranteed.
Some great tips. Getting rid of debt as quickly as possible requires motivation and direction. I completely agree that having debt when heading into retirement is a big mistake. Why save it (at a potential lower rate) if you are simply going to have to spend it to pay off debt (at a higher rate) during retirement.
If there’s an employer match then it’s probably arithmetically better to invest for retirement than pay off debt. But psychologically, I can see why starting retirement savings whilst you still have debt is a good idea. It’s getting used to the idea that you invest for retirement, like having a small emergency fund saved up before you focus on debt.
There is one other math factor regarding retirement savings (even without employer matching). You get to take your contribution off your taxes, up to the IRS limit. That is a huge advantage. For example suppose I have $10,000 in debt to a credit card that has a 20% apr. Let me assume I am not currently saving for retirement. Finally, I will assume I am at a 30% marginal tax bracket (combining federal and state income taxes). Option #1 – use my spare $10K to pay off the credit card. Option #2 – use my spare $10K to fund my 401K. If I choose option #2, I then free up $3000 in taxes I avoided, which I can use to reduce the credit card balance to $9000 (i.e., I will assume it grew from $10K to $12K from failing to pay on it until the end of the year). Even with no growth in my 401K account, my net worth using Option #2 is $1000 more than it was using Option #1.
Man, she makes it sounds easy, however at age 53 and laid off, it it is cetainly not that simple. Thanks for positing though.
I totally agree that paying off debt like credit card etc should come first. Having said that its also important that one does not completely neglects the needs for saving for retirement as early as possible in one’s life. The earlier your start more money you will be able to save due to magic of compounding, hence it does require a fine balancing act.
I have a public retirement fund that I no longer pay into, but it is sizable.
If I were to cash it out I’d have to pay 20% tax to Fed. and probably 10% to State. I’d have enough to pay off all our CC debt, our car loan, and have a few thousand left to start a 401 K with my current employer (where I also have a public retirement fund: different state).
Doing this would push us into the 28% tax bracket for 2009.
We’re thinking that the interest we pay on the CC & car loan will be more than what we lose in taxes.
Also the reduction in stress on our lives might help us to live longer (we are 50 & 56) and thus continue working (paying into retirement funds) for another 15 years.
Is this crazy? I don’t see how else we can pay off the CC debt. I work full time, hubby has three part time jobs. We can’t work anymore than we already are!
According to me both are equally important as without clearing debt you can’t relax and saving is also important to secure your future.