Mindful Money: Debt and retirement

By Mir
August 26, 2008

I got to thinking the other day when I posted about IRA contributions, and I realized we’ve never really hashed out the whole matter of paying down debt vs. saving for retirement, here.

And lord knows that many, many people—who are actually, you know, financial experts and not just incurable tightwards such as myself—have discussed this in greater detail, but I’m going to take a stab at the Want Not summary of this issue. Just for fun. And because, if nothing else, I hope it will motivate anyone who has questions or concerns in this area to do the research and commit to a plan.

So I’m going to give you a few general tips and hopefully somewhere in there we’ll hit upon something good. Heh.

The first thing to keep in mind is that you cannot catch up on compound savings. Simply put, delaying contributions to your retirement fund results in an earnings loss you can never reasonably hope to obtain later. Here, take a look at this chart. You’ll need to put in almost three times as much money every year if you start contributing at age 35 to match the target number you’d hit if you started contributing 10 years earlier. While more money is better, obviously, earlier contributions of smaller amounts trump later contributions of larger amounts in the end. This means that it’s vitally important to contribute to your retirement as early as possible, and with regularity, even if the amount is small.

The second thing to keep in mind is that not all debt is created equal. Credit card debt is bad—it’s (usually) high interest, it’s not tax-deductible, and you probably don’t have any equity to show for it, either. A mortgage, on the other hand, is (hopefully!) at a reasonable interest rate, gives you a nice tax break (unless you’re incredibly wealthy, in which case what are you doing here?), and represents the biggest chunk of equity most of us own. Student loans also have tax-deductible interest and very low rates.

Don’t be in a hurry to pay down so-called “good debt.” You need to get rid of the “bad debt” as quickly as possible, but mortgages and student loans—what’s your rush? Many people believe in trying to pay off their mortgages before their kids get to college, by the way. There are countless financial aid opportunities for students, including low-interest loans which may be a better deal than re-mortgaging your house to pay their tuition, so don’t blindly set this as a goal—it doesn’t make sense. On the other hand, it does makes sense to try to plan to have your house paid off before you retire, obviously.

Okay, so, ideally you have no debt and lots of money put away for retirement. Right? Right! In reality, very few people can do this. Nearly everyone has debt of some kind. So how do you balance the two? Do you pay down debt and ignore your retirement? Do you put money towards retirement and struggle along with the debt?

You have to put money towards both. The proportions will depend on your available income and your particular set of circumstances, but the important takeaway here is that even if you have a mountain of bad debt that you’re trying to eradicate, you must still put some money towards retirement. It doesn’t have to be a lot. It just needs to be something—both to build the habit and because every dollar helps, the earlier you can invest it.

Let’s take a moment, here, to address something else. There’s a variety of IRA products out there, and I’m not a financial consultant so I’m not going to tell you which one makes sense for you, but if you have an employer that offers a company match on a 401k plan, get it. Maybe your company will match the first 6% you put in, but you’ve decided that money is too tight right now and you’re only going to set aside 3%. In this scenario, you are effectively throwing away 3% of your salary, because you’re missing out on the match. Find another way to scrape by, but do not turn down even a penny of corporate match. It’s free money.

Look; I know this stuff is hard. I know that paying down debt and planning for retirement and having an adequate emergency savings fund starts sounding like a very tall order when things are tight. I get it. Start small—if you can only afford to put $10/month aside to start, then do that.

The most important part is sitting down and looking at all of your finances and figuring out the plan. Too many people are too scared of how awful they think it’ll be, and then they do nothing, and then—surprise—it really does end up being awful. There’s nothing wrong with taking baby steps, and I promise, it gets easier.


  1. ok, the fact that you called it an “emergency savings FUN” cracked me up!

    I was thinking about my answer in the comments to the IRA posting and realized I had automatically assumed it was BAD debt, since that’s what I’m dealing with. Thank you for addressing the difference between good and bad debt. And for the kick to actually do something with my old state retirement somewhere that’ll do me some good!

  2. I can appreciate the low cost of “good debt,” like a mortgage, whose interest is tax-deductible (for now). However, should that mortgage interest deduction change OR should you have a higher interest rate mortgage (higher than 6.5%, IMHO), adding some additional principal to the payment each month seems like a good idea. There are lots of mortgage calculators on the web to check this out.

    However, assume a $200k mortgage (amount borrowed) at 7%, for 30 years. The basic principal and interest is $1330 per month. Adding 1/12 of that payment each month (one extra payment each year), $111, moves the payoff date up 6 years

    Adding 1/6 of the payment each month (two extra payments each year), $222, moves the payoff date up 10 years.

    The total interest expense for the original mortgage is $279k (almost 1.5 times the value of the mortgage). The total interest expense for the 20 year version (by sending that extra principal each month) is $172, for a savings of $107k (rounded) in interest.

    $107k. At a cost of $2664 per year ($53k spread over 20 years) in extra principal contributions.

    Astounding numbers, although tax brackets, mortgage size, and interest rate all determine the real effect of the $107k. If you’re in a low tax bracket, though, it’s hard to see that the tax benefits of spending that extra $107k outweigh the benefits of having that $107k, if you can spare the extra principal each year.

  3. Great advice. I wish I had started before my late 20’s on my retirement fund, but can’t go back (and it would be waaaaaay back) and now contribute every month through my employer’s matching plan. Another thing we do is put money away in a 529 plan for our children’s college expenses. Pretty sure most states offer these, but maybe call it something a little different and may have different tax advantages. But I got it through my local State Farm agent, it’s also offered through some banks around here. A tip from my agent: get one plan and change beneficiaries as they each enter college – saves on monthly fees for 3 plans! (cuz, I have 3 kids)

  4. Thanks for this great reminder, Mir!

  5. Sounds like you might have listened to Dave Ramsey??? We did his Financial Peace Class last year- it was AWESOME and I highly recommend it to anyone and everyone! Thanks for the great advice!

    -From a new reader 🙂

  6. Heh, I think Dave Ramsey makes some good points, but unlike him, I happen to believe in the judicious use of credit cards, which is where our beliefs diverge.

  7. We’re currently on the “Ramsey plan” to get out of debt a lot quicker than we were on our own (read=not getting out at all!). I read your post on using credit cards. You should really read the statistics Dave has on cards. You spend 17% more when you don’t use cash, very very very few people redeem their miles/reward points,etc. on and on. He really does make a pretty good point for not needing them. I know there are some (VERY few) who can use credit cards wisely, but I bet even those people spend more than they would if they only used cash. Just sayin’! 🙂
    Love your site btw…thanks so much for all the work you do to bring us bargains!

  8. Again, Ramsey and I differ on this. And he’s a big famous financial expert and I’m just some mom with a blog—I get that. However, I have successfully used credit cards for years, have never carried a balance, have made a ton of money off of the rewards… then again, I fall into that (apparently small) percentage of people who doesn’t overspend just because it’s not cash. If you can’t manage a credit card, don’t use one. Obviously. 🙂

  9. As usual, this is a great, thought provoking post.

    I especially appreciate your making the point that even if you can only start by saving $10/month, you should! Sometimes charts like Clark Howard’s can be intimidating if you aren’t starting until you are older — who can really afford to save $6000/month???

    Saving a smaller amount will help, even if it doesn’t get you all the way to financial security. And after a year of saving $10/month, try to step it up to $11 or $12.

    Also, I loved the idea of matching a teen’s savings in an IRA! What a great way to help them get on solid financial footing and in the habit of saving. Even if you can’t match their savings dollar for dollar, doing some kind of 25-50% match would probably be almost as motivating for most kids.

  10. I also believe that credit cards can be used responsibly. I just transfered my old student loan debt that I was paying 8% on to a 0% balance transfer card with no transfer fee saving me up to 400.00 a year on interest. I actually should have done this sooner. The loan will be paid off in 3 yrs rather than 7+ on the student loan. My husband and I will also take advantage of the 0 payments, 0% interest for a year on big purchases. We keep the money in the bank collect interest and pay it off right before the year is up. This also helps our credit rating and allows us to pay lower interest on things, like the car that I am paying 1% on. Play the credit card game right and it can work in your favor.

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