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When it comes to managing your money, a few decisions can be as tricky as deciding between paying off debt or saving for retirement. Both are important to your financial well-being, so how do you decide?
There is no single answer for everyone, and the decision will vary based on the individual. In this article, a few financial planners provide their insights, taking into account factors like interest rates, emotional stress, and financial habits, that can help you chart your own course.
Key Takeaways
- If your debt has a very high interest rate, about 8% to 10% or more, paying it off before saving for retirement is generally the better financial move.
- For low-interest debt, particularly if it is tax-deductible, it usually makes more sense to focus on retirement savings, especially if there’s a 401(k) match.
- A balanced approach is usually the best move, and personal stress levels, spending habits, and emotional triggers around money should also factor into the plan.
One of the first questions to ask yourself is, “What kind of debt do I have?” According to Caitlin Harrison, Northeast Planning Associates, “High-interest, non-deductible debt, such as credit card balances, should typically be paid down first,” because erasing interest that compounds quickly, such as 18% or more on credit cards, will provide you with a guaranteed return that you will not get from most investments.
However, it’s not always such a clear-cut decision. “For lower-interest debt like mortgages or student loans, especially when tax-deductible, it may be more advantageous to prioritize retirement savings,” she explains, particularly if your employer offers a retirement plan with matching contributions. These are, essentially, free money.
Harrison stresses the importance of a holistic plan: “A financial plan that considers cash flow, risk tolerance, tax impact, and long-term goals is the best way to determine the right strategy.”
In most cases, combining both strategies—paying down debt while contributing to retirement—is a measured approach that will improve your financial profile.
For Michael Morton, CFP, ChFC, Morton Financial Advice, it comes down to the numbers. “If the interest rate is very high (8% or higher), then paying off the debt makes more sense than saving for retirement,” he says. “If the rate is low (4% or lower), I recommend making regular payments and saving for retirement.”
But what about debt in the middle range? “Many people have debt in the 4% to 8% range. In that case, it becomes largely a matter of personal preference: How much does it keep you awake at night?”
Morton’s approach underlines one of the most important aspects of personal finance—the emotional side. Even if the numbers point to taking a specific approach, peace of mind carries its own value, which can be hard to quantify.
If carrying debt leads to anxiety, that might be enough to pay it down over saving for retirement, even if it’s not the most financially sound path.
Important
If your employer doesn’t offer a 401(k) or similar retirement plan, you can save for retirement on your own via other methods such as a traditional IRA or a Roth IRA.
Eric Roberge, CFP and Founder of Beyond Your Hammock, approaches the strategy from a slightly different perspective; one that doesn’t consider just the numbers, but also the “why” behind the debt.
“If a client has high-interest rate debt of 10% or more, we typically create a plan that prioritizes paying that down as quickly as possible,” he says. But he also looks beyond the surface. If the debt comes from overspending, it might be worth working with a financial therapist.
“Assuming someone has sufficient income…but consistently carries a credit card balance, that indicates there may be some mental blocks or emotionally driven behaviors behind that overspending habit.”
Sometimes, tackling both goals—retirement and debt—at once is ideal. “It’s rare that we’d advise stopping all contributions to retirement accounts,” Roberge notes, especially when those accounts offer tax advantages or an employer match.
Still, if financial stress is affecting your mental health, it may be advisable to temporarily reduce retirement contributions so you have a bit of extra cash to pay down your debt.
The Bottom Line
Deciding between paying off debt and saving for retirement is a tough decision, which will be different for everyone. The right decision primarily depends on interest rates, followed by emotional well-being and your financial situation.
High-interest debt should generally take priority; however, if your debt is more manageable, most advisors recommend you keep saving for retirement, especially if your employer matches your 401(k) contribution.
Generally, the best path will be a balanced approach that helps strengthen your financial profile and gives you peace of mind.
