Ask the Readers: Pay Down Debt or Save for Retirement?

We had a lot of debt and considered dropping our 10% savings to our 401K to pay down the debt but when we called to do that our HR person said that it wouldn’t be wise because our income would not increase much. It was just enough of a deduction before taxes that plunked us in a lower tax bracket, couple that with what we were receiving matching funds on 6% of the 10% that it was worth saving. We plugged away with the debt and finally got rid of it and our retirement grew to a decent amount.

I would do both. Since Roth IRAs are harder to tap into, you don’t need to be successful in getting out of debt to have some retirement savings.

If Sara can find a card with a good balance transfer offer, then I would contribute even more than $100 towards the IRA. Otherwise you’ll only contribute $1200 this year, and you’ll never be able to make up the other $3800.

Also, for this year at least, consider a Traditional IRA so that you get some immediate tax savings, which can be used to pay down your debt when you get next April’s tax refund.

Assuming a 12 month 0% balance transfer and contributing $300 to each, we get:

1. $3600 applied to debt, $5400 remaining

2. $3600 tax deduction from IRA contributions, assuming 25% tax bracket, reduces taxes by $900

3. $900 refund applied to debt, $4500 remaining

Then do another balance transfer or just focus all $600 on it for 8 months.

I’ve never had any significant debt (except my mortgage). Obviously, high interest debt has to be paid down.

Most people get a psychological benefit from an emergency fund when they have debt. I’m not really one of those people so much, and probably would just hammer on the credit card debt, paying as much as I could and as early in the month as I could afford it.

For the most part, I’ve chosen not to prepay my mortgage, but rather to focus on my IRA and 403(b) contributions (I do not get a match).

However, this year I decided to start some small prepayment on my mortgage in order to get it paid off at age 59, 5 years after my earliest retirement date (i.e. I’m on track to be able to collect my pension at age 54). I might retire early, depending on the state of health care in 20 years (i.e. I might have to keep working if some version of Hillarycare is not in place).

I am doing something modified…I’m paying off all of my high interest debts *first* and then when I get it down to my college loans (which I have a low rate on), *then* I’ll start to put some more toward my retirement. At long last, though, (and I’ve been an idiot for missing this), I do now make sure I put enough into my company’s 401K to qualify for my employer’s match. I followed JD’s ‘math theory’ as above…it just didn’t make sense to be putting money away at 6-8% when I still had some debts in the 13-21% range.

I ran different scenarios over at the Debt Payoff Calculator at Bankrate to double-check my ‘gut instinct’ on this: http://www.bankrate.com/brm/calculators/creditcards/debt_payoff_calculator.asp
I experimented with putting in different ‘accelerated payment’ amounts (the additional amount I wish to pay each month, to more quickly payoff my debts). Say, if I said I had $500 total a month to throw at my situation, I might run different calculations for $300 to debt/$200 savings, $400/$100 savings, or the whole $500 toward debt. This was beneficial to me because then I could see what could be paid and by when…and timing and a ‘finish date’ is a big goal and motivator for me. Even after I get my high interest date paid (this August), I still only plan on contributing about $200/month to retirement and that still allows an accelerated payoff on college loans. I’m tired of having this ‘weight’ looming over me…it’s *that* important that I get out from under it ASAP.

I’ve got 10 years on Sara, am not married, and have been hit with substantial medical bills in recent years (now paid). To me, it made sense to get the debt finally paid (or at least until I just get down to my college loans only), before throwing anything into retirement savings. I know that’s not a plan for everyone my age, but I think getting the high interest debts out of the way makes the process easier for me.

To each their own, though, to each their own. And best of luck to Sara and family…everybody has to do it their own way to fit their own specific goals, their own specific needs.

I am trunk on the Dave Ramsey coolaide. I would say get on the baby steps. Get your $1000 emergency fund then on to Step 2. Pay off the debt via the snowball. Then you can start saving.

As usual, I agree with J.D. and think that as long as you have a plan to pay off the debt in a few years or less, you should find a way to contribute to both the debt and retirement. But if adding to the retirement account means it will take you 15 years to pay off that debt, then you should certainly focus on the debt.

The power of compounding is just too much to pass up at a young age to completely ignore it. For example, let’s say you take $1,000 and apply it towards retirement instead of the debt. Sure, at 18%, you’re “losing” $180. But, take that same $1,000 and invest it, averaging 8% returns over the next 30 years, and it turns into about $10,000.

Being relatively young, you have the luxury of saving less, and let time and compounding do the work for you. But if you wait a few years, you’ll just have to contribute more to make up the difference that even a few thousand dollars makes over the course of 30 or more years.

So, strike a balance so that you can still pay your debt off in a short amount of time while also getting into the habit of saving for retirement. Also, as someone mentioned, you might not want to abandon the traditional IRA idea either, since the tax savings could negate the interest you would have otherwise paid.

Do you have “emergency fund” money? Money that you don’t anticipate spending, but its on-hand, liquid, and safe and sound if you need it? If so, I would put *that* into a Roth. Since you can withdraw contributions (but not earnings) penalty-free, you still have it. But if you don’t, you’ve taken advantage of the Roth tax benefits. (Of course, given the situation I would keep that Roth money in low-risk investments until you have developed an external emergency fund.)

I agree with Frugal Dad – if you can wipe out the debt in less than 18 months (which it appears she can), attack the debt and get it out of the way. Then start plowing the $600/month into the Roth.

This really depends on the type of person Sara is. Are she and her husband REALLY going to never run a balance on those cards? Have they stopped using them?

If they are fully committed to not using them, I would put that extra 600 a month on the card. And not use the card! But if they aren’t intense about it, I would split it, maybe 200 to the IRA and 400 to the card.

Don’t forget that the current IRA limit is $5000/year. So even if she wanted to, she couldn’t put $600/month into an IRA, at the most she could put in $416 on average per month. Granted, considering that it is already May, it would be possible to do that for this year.

Since there is no retirement savings plan at your company, I can’t give you my first recommendation, which would be to always contribute to retirement savings if there is a dollar match (especially if the match is a 1:1; 100% returns are pretty hard to pass up ).

Since that’s not an option for you, if you can pay off your total debt in 18 months or less, I would go psycho on the debt and do everything you can to clear it out. Sell stuff, take a second job if it makes sense, do something that will help get you focused and into the zone to pay of your debts, using the Debt Snowball or another method that allows you to get “medievel” on it. Once you have done that, then get serious about plugging into the ROTH.

Alternately, if it will take more than 18 months, or if you want to allow yourself a bit of a planned staging, determine a minimum amount that you will put into the ROTH, even if it’s as little as $50.00 a month. Put everything else towards slaying the debt. Each time you knock a debt payment out of your life, roll that payment into your debt snowball, plus roll a little more into the ROTH. Each time you ratchet up the snowball, the level of ROTH IRA contribution will increase, until you either clear out the debt or max out the ROTH IRA. Once the debt is out of the way, plow as much as you can into the ROTH and other vehicles to reach your “magic number” (I like Dave Ramsey’s 15%, but if you want to do more, by all means, do more ).

Personally, I’m working on both (and doing both slowly, because I’m a single mom and lower enlisted in the military, I don’t have much other option), but if I had to pick, I’d pay down debt first. Debt causes a lot of stress in life, and stress is detrimental to your health, which could raise health care costs.
Think about it.

Personally, I don’t believe retirement savings count as an investment from a Ramsey/debt/retirement perspective.

Let me elaborate on my opinion: If you have $600 to ‘throw at something’ after the budget is done but are not already contributing to your retirement, then in my opinion, you don’t really have $600 to throw at something. You have $600 less whatever you *should have already been contributing* to your retirement.

In other words. Your retirement savings should be coming off the top line of your budget, not the bottom line. It should be your number one priority every single month. That is the only reliable way you are *ever* going to save enough. Optimally, it shouldn’t even be a factor in your budget at all, and you should consider your pay to be what you are making now minus a small retirement contribution, because having it as a line item in your budget implies that if you are having a tough month, you can forgo saving for retirement that one month.

Just remember: somebody will lend you money for anything else in life, but not for retirement.

A little bit of both makes the mind feel at ease. Not to time the market, but you also need to consider where the market is right now… dropped a lot… not a bad time to be investing heavily.

But, paying off debt should be first in the long run. Maybe a 75%/25% split.

I’d buckle down hard and do both. But I think I’d put the retirement planning ahead of the debt payment – you can’t catch up on retirement later in life. You’ve got to stop using those cards first though. You guys sound like a big candidate for Dave Ramsey. You really should go to the library and get a copy of The Total Money Makeover. Good luck – its a rough road, but you can make it!

I’m going to disagree with just about everyone here: max out the Roth first, then pay down debt.

The reason is this: once the opportunity to put money in the Roth goes away (once the tax year ends), it’s gone. Never again can you put that $4,000 into an account that grows taxfree. Never again.

Beyond that, if she has $600/month to spare, that’s $7,200 per year. Only $4,000 of that can go into her IRA per year, leaving a nice $3,200 per year to throw at debt. There will inevitably be windfalls along the way that can be thrown at the debt as well. Ignoring interest for a moment (both on the debt and on the IRA) that means she’ll have paid off the debt in three years and will have $12,000 in her IRA. If she pays off the debt first before funding her IRA, she’ll pay off the debt two years sooner, but will end up with only $8,000 in her IRA, despite the fact that she will have more money to invest than that – but she will have lost the opportunity to invest for her 2008 IRA. Gone, never to come again.

Looking at interest again, that $4,000 she couldn’t invest because she was so focused on debt will cause lost interest for decades. At 8%, she would have $8,000 in 9 years (37). In another 9 years (46), it would be $16,000. At 55, when she can start withdrawing earnings, she’ll have $32,000 – $28,000 more than her original investment. Spending an extra two years paying down a high interest loan has got to be worth an additional $28,000 in retirement.

Hi. I think I am closest to agreeing with #32 — even when one has a large debt and is focussing on reduction, you still have to spend money in other ways, on food and rent etc, so debt reduction isn’t the only line in your budget. If you think of “retirement savings” as just another line on the budget, it doesn’t mean that you’re choosing it over debt reduction, it just means that you see it as a legitimate item, like the food bill and utilities etc. It is, like the food bill and utilities, somewhat elastic — and maybe it’s only $25 or $50/month, but “retirement savings” can still be part of what you’re doing with your income each month.
I’m going to be “retiring” in July 1, but I’m planning to continue to, as I earn free-lance money or other income, to continue to put some money each month into savings…

I agree with J.D. – put a little into savings/retirement and a little to the debt.

Here’s what I would suggest doing – it’s a modified version of what we’re doing.

1. Find a 0% transfer and move the CC debt there.

2. Calculate the monthly payment required to pay off the debt before the 0% runs out.

3. Pay that amount and put the rest in savings/retirement. Always keep in mind that the sum of $600 is coming out and going to one of these two places – and nowhere else. Treat it like a fixed bill.

4. Add any extra income you’ve received during the month or any extra funds in the budget (“leftovers”) to the next debt payment (or go ahead and pay it).

5. Adjust the monthly payments remaining and the amount going to savings to equal $600 again – the future debt payments will go down and amount going to savings will go up.

6. Rinse and repeat every month. The monthly debt payments will dwindle down and the savings will get bigger each month. Eventually, all $600 will go toward the savings.

I said it was modified from what we’re actually doing.. We were recently married and my wonderful husband brought along $8000 in credit card debt (0% thank goodness!) and $22000 in an HELOC (variable), which he’d only been paying the interest on. I had no debt other than a little bit for the wedding (0%) that was paid off quickly. In addition, there was no emergency fund or any other savings. We combined incomes and bills, as there was no way he could have paid it off on his income alone. He saw bills as a chore and I was already meticulous in tracking my own bills and spending, so it was decided that I would take over the finances.

I have a set amount that goes to savings and another set amount that goes to debt each month. I use a similar method as described above to determine what goes where. Each month, the “leftovers” get split between debt and savings. The extra amount going to debt goes to the CC, and then the remaining payments are adjusted. Using a similar sliding scale, as each monthly CC payment gets lower, the HELOC payment gets bigger. By the end of the year (when the CC is paid off), all of it will be going to the HELOC, plus half of any “leftovers.”

I use MS Money to plan out future budgets and payments. The way I figure out how much is “leftover” is by looking ahead to the next month’s budget and pulling whatever is over a given buffer ($1000 in our case).

My husband and I have found this method to be successful. We were originally going to put all the extras into debt payment, but that made me really depressed. It was hard to handle everything going to a debt that I had nothing to do with. That may sound selfish, but it was a tough situation. I described it as paying for an invisible car that was misplaced. That’s when we decided a 50/50 savings/debt option was better. That way, we’re still tackling the debt plus putting money away for the e-fund, vacations, and house projects. True, we could pay it all off quicker, but we’d be miserable. It’s nice knowing that every dollar less that gets spent each month will help us in two ways – by reducing debt and being a little bit closer to our next vacation.

By reading this post, I have another question now.
Does anyone know, we should invest for retirement or save for down payment for a house?
My husband and I are trying to save up to 20% down payment for the house right now. So we don’t need to pay for PMI.
But it is impossible to be done if we do both at the same time.
So I am wondering, if there is any good ideas out there.

@Mrs ThePoint-I’m in the same boat. I want to start saving money for a down payment. I’m paying down debt and funded a emergency fund.

According to the “Wealthy Barber”, IDEALLY we should take care of our present and our future. HOWEVER, he does state later in the book that as long as we are securing our future (retirement), having some debt or having less than savvy spending habits is “ok”. Personally, I think it depends on your situation. My husband and I have a lot of debt. But we also have just 14 years until retirement. We try to do a little of both, pay off debt and save for retirement. As we reduce our debt, the plan is to put more in retirement savings.

You do have until April 15th of 2009 to fund your IRA contribution for 2008.