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.