Debt Repayment vs. Retirement Saving

by Wanda Thibodeaux

Being debt-free is a goal rather than a reality for many Americans. At the same time, the need to save for retirement is a pressing issue. Whether you should save for retirement or pay off your debts is a nagging financial question largely because some investments promise such impressive gains. The answer depends on your financial situation and goals, as well as how you feel about your money.

Questions to Consider

Whether you put your money toward retirement, debt or both is a complex issue due to the large number of variables that come into play. To determine whether you should pay down debt, save or throw money into both corners, questions you must consider include how old you currently are, the types of debts you have and the rates of interest they have, whether you have a matching retirement contribution from your employer, whether you can meet basic needs once you make a payment or contribution and what the estimated inflation rate is.

Interest

Mathematically, assuming that your interest rate and retirement investment return rate are the same, paying your debt off first and then concentrating on retirement produces a better result than paying the minimum on the debt, as shown by Trent Hamm of The Simple Dollar website. However, in reality, a person's finances usually are not so simple, with interest and return rates all over the map. In some cases, when you run the numbers, paying down the debt makes more sense. In other instances, putting more toward retirement is the better choice. To make matters more complex, you'll need to reassess your choice from time to time if you have variable interest rates associated with the investment or debt.

Time

Starting your nest egg early gives you an advantage over saving later, simply because you have more time to build up your retirement fund -- the later you start saving, the larger percentage of your income you have to set aside to meet your retirement needs. Additionally, to accommodate rising costs, you must be more aggressive with your investments as you get older. This means that if you focus entirely on debt repayment, it can be very difficult for you to put enough money aside to meet your retirement goals.

Debt Type

Even though your basic debt agreements might mathematically tell you to pay the debt before your retirement, factors outside of the debt agreement sometimes come into play. For example, if you have student loan debt, you may be able to deduct the interest -- up to $2,500 at the time of publication -- on your tax return. This may change the immediacy of paying off the debt.

Psychology

A lot of what you do with your money has nothing to do with numbers. How you feel about your money also matters. For example, if you're a person who is willing to take risks, you might be OK with waiting to save for your retirement and investing in higher-risk investments like stock that might produce a better yield. If you don't like taking risks, you might want to invest in your retirement as soon as possible with lower-risk investments like bonds. In the same way, having debt can be stressful and depressing for some individuals. If you can't stand the thought of owing, you might feel better concentrating on your debt.

Bottom Line

Typically, it is better to focus on debt repayment if your interest rate is high and you feel burdened by the debt you have. It is better to focus on retirement if your debt interest is low and your employer can match your retirement contributions. It is very possible to put money toward both debt and retirement -- many people do this using a 75 debt/25 retirement ratio. It usually is best to start putting money toward your retirement as soon as possible. Because you don't want to be caught short financially during retirement, if you are going to repay debt, it's to your benefit to design your debt repayment strategy based on the funds you'll need to survive later on.

About the Author

Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting. She currently works through her business website, Takingdictation.com, which functions globally and welcomes new clients.

Photo Credits

  • An older man with a cap image by HP_Photo from Fotolia.com