When should you prioritize retirement savings over paying down debt? | Smart Switch: Personal Finance

(christy bieber)

Like most people, you have a limited amount of money and you must decide what to do with it. This can be a difficult choice if you have debt that you’re trying to pay off, but you’re also eager to start saving for retirement for financial security in your later years.

So how should you decide whether to focus on paying down debt or investing for your future? Here’s what you need to know to help you make this difficult decision.

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How to decide if paying off debt or saving for retirement is the smarter choice

To decide if it makes sense to pay down debt or focus on retirement savings, there are a few things to consider. But one of the most important factors of all is which approach will give you the best return on investment (ROI).

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You will always want to pay the minimum balance due on any debt you have incurred. But if you pay more than the required payment instead of putting that money into retirement savings, the return on your investment will be equal to the amount of interest saved. If you have 17% credit card debt, you get a pretty high ROI. But if you have low-interest mortgage debt at 3.50% and you can itemize your deductions and deduct the interest paid on your home loan when you file your taxes, then your ROI is very low.

If you invest instead of prioritizing debt repayment, on the other hand, your ROI is the money your investments make. But you could also get a 401(k) match from your employer, which could give you up to a 100% return on investment if your company matches your contributions dollar-for-dollar. And you may qualify for retirement investment tax breaks. These tax breaks could include deductions for contributions to a 401(k) or IRA and even the Saver’s Credit that could take up to $2,000 off your tax bill if you’re eligible and contribute the maximum.

If you can get a better return on investment by paying more on debt, even after taking into account tax savings and 401(k) matching contributions, then you’d be better off putting your extra money toward paying off your loans sooner rather than later. . But if your ROI is better by investing, you should make minimum payments and put the rest of your money into retirement savings.

Often, for most people, this leads to a hybrid approach. For example, you could put extra money into your 401(k) until you’ve earned the maximum employer match, and then you could redirect the extra funds to pay off credit cards as quickly as possible. Or you could work to pay off your payday loans and credit card debt before investing in an IRA, but then focus on retirement savings instead of sending more to a mortgage or low-cost car loan. interest.

By making a strategic assessment of what use of your money will work best for you, you can decide where exactly your extra money belongs. Remember, you need some retirement savings since you can’t live on Social Security alone. So make sure you don’t put off investing to your later years for too long. If you’re focusing on getting rid of your debt first, be aggressive about your extra payments and cross that task off your list ASAP so you can start building a secure future.

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