Paying Down Debt vs. Saving for Retirement

Here is one we hear all the time – “How can I save for retirement with all of these monthly debt payments?”  For what is seemingly a simple question, the answer can actually be somewhat complicated.  Striking the right balance between debt payments and savings contributions will vary with each household and the solution is more than just a mathematical calculation.

Ideally, we would like to pay down debt and save for retirement simultaneously, but for those struggling to make payments, we must first prioritize paying off the outstanding debts  (  Once you have built at least a small emergency fund that will help avoid any further debt, here are a couple of scenarios where it may be more prudent to pay off debt before saving for retirement:

  • High-interest rate consumer debt – a threatening obstacle for many, carrying large balances on credit cards or other high-interest loans can be detrimental to your future financial freedom.  Minimizing the amount of interest paid each month can eventually lead to better cash flow and is likely to save you the most money in the end.
  • Feeling overwhelmed – if outstanding debts are negatively affecting your mental health, it may be best to pay them off first before saving.  Eliminating the fear of how the bills will get paid can greatly reduce stress, particularly if debt payments stretch your budget beyond a comfortable level.

Hopefully, it’s not an either/or dilemma when it comes to debt reduction and saving for retirement but there are times when one should be prioritized over the other.  Let’s take a look at a few situations, in which it may make sense to save for retirement before paying down your debts:

  • Employer match on 401(k) or similar plan – regardless of outstanding debt, this is a benefit that everyone with the opportunity should take advantage of.  Most companies that offer a 401(k) also match employee contributions up to a percentage of your salary.  It is important to make room in your budget for this item, ideally contributing enough to at least get all the matching 401(k) dollars that your employer offers.
  • Outstanding debts are considered “good debts” – if your only debt is a mortgage, there may be advantages to saving your extra cash for retirement versus paying off the balance.  For starters, you would retain the tax deductibility of your mortgage payments (at least for now) while also taking advantage of the tax deferral on retirement contributions.  Also, if you delay saving for retirement in order to pay off your mortgage, you are losing what many refer to as the eighth wonder of the world…compounding returns on your investments.

If you are fortunate enough to have extra cash after the bills are paid, deciding on what to do with it can be challenging.  Sure, carrying debt can be costly; nevertheless, having inadequate savings could extinguish your hopes for retirement.  Here are a few things to consider when deciding on what to do with your free cash flow:

  • Have you built an adequate (3-6 months living expenses) emergency fund?
  • Have you paid off your high-interest debt?
  • Are you at least getting the full match on your 401(k) or similar plan?
  • If eligible, (phased out at $199,000 MFJ for 2018) are you contributing to a Roth IRA?
  • Are you saving 10-15% of gross income toward retirement?

And last but not least, are you rewarding yourself for the hard work?  If you are being faithful to your budget, it’s important to occasionally spend money on something that’s not strictly a necessity.  We don’t want people to resent their budget, if you’ve met a goal, reward yourself, just don’t blow it out of the water.

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