Should You Pay Off Debt or Save for Retirement First?

Whether to pay off debt or save for retirement first is one of the most common money decisions people face. Your interest rates, how close you are to retirement, and how much you owe all shape which goal deserves your money first. A few clear factors could help you build a plan that moves both goals forward, even if you focus on one first.

Should You Pay Off Debt or Save for Retirement? Factors to Consider

No rule says you have to choose debt over retirement or vice versa. It's up to you to decide which one is better for you. These factors could influence which way you lean.

• Age. The sooner you start to save for retirement, the longer your money grows. If you're closer to retirement, you may feel more pressure to save as much as possible.

• Interest rates. High-interest debt is expensive, and the longer you let it hang around, the more it costs you. If rates drop, that could be a good time to refinance or consolidate debts to save on interest.

• Stress/emotions. Your viewpoint about debt and saving also comes into play. You might feel driven to get rid of your debt ASAP if your balances cause stress. Likewise, you may feel anxious that you're not where you should be with your retirement goals.

If you're a numbers person, do the math. Calculate how long it'll take you to pay off your debts, and the interest you'll pay if you make only minimum payments. Then, do the same calculations again, using the highest amount you could afford to pay toward your debt if you pause retirement savings for now.

That demonstrates how much interest (and time) you could save by choosing debt payoff over retirement savings.

The last step is to compare the result to how much you could expect to earn over the same time period by saving for retirement instead.

The Priority Order for Debt Payoff and Retirement Savings

This order helps you decide where to send extra money first, whether you're paying down debt, saving for retirement, or both.

1. Capture your employer match. If your employer offers to match part of what you put into a retirement plan, contribute enough to get the full match first. It's money added on top of what you save, and part of your retirement benefit goes unused if you skip it.

2. Build a small emergency fund. Set aside some savings next, even before you pay down debt aggressively. One to three months of essential expenses is a common target. Even a smaller cushion helps you avoid new debt when an unexpected cost comes up.

3. Pay down high-interest debt. Put extra money toward your highest-interest unsecured debt next, generally credit cards or personal loans. These balances usually cost more to carry than low-interest debt. A faster payoff on high-interest debt could save you money over time.

4. Balance retirement and low-interest debt. Once your highest-interest balances are gone, split any extra money between your retirement account and remaining low-interest debt, like a mortgage or federal student loan. Low-interest debt typically costs less to carry, so there's less urgency to pay it off ahead of schedule.

Revisit this order any time your income, your debt, or your retirement benefits change.

When It Makes Sense to Pay Off Debt First

For some people, the cost of the debt is greater than the retirement earning potential in the same window of time. Sometimes it's better to tackle debt before you save for retirement. You might decide to do that if you:

• Mostly owe unsecured debt, meaning debt that isn't backed by collateral, like credit cards or personal loans

• Have room in your budget to aggressively pay down debt

• Want to minimize what you pay in interest

A debt snowball or debt avalanche strategy could help you pay off debt faster. With the debt snowball, you pay off your debts from the lowest balance to the highest. The quick payoffs on the lowest balances help keep you motivated. You throw all the extra cash you have at the smallest debt, then once it's paid off, roll that amount over to the next smallest debt. You do that over and over until all the debt is gone.

The debt avalanche works the same way, with one change. You pay off debts from the highest interest rate to the lowest. This payoff method could be faster and you save the most money on interest.

For both strategies, make minimum payments on all of your debts except the one that gets the extra cash. Learn how credit card companies set minimum payments.

When It Makes Sense to Save for Retirement

Retirement is years away, until suddenly, it isn't. If you wait to save, you could shortchange your goals. You might choose to save for retirement before you pay off all your debt if you:

• Have less time to save and need to play catch-up

• Only owe a small amount of debt

• Mostly owe low-interest debt like a mortgage or a home equity line of credit (HELOC)

When you retire, you want as little money stress as possible. For some, that means zero debt and less in savings. For others, it's a little debt and enough money to live on.

Aside from retirement, think about other savings goals. A rainy-day fund, generally enough to cover one to three months of essential expenses, could help you avoid having to use a loan or credit card to cover unexpected expenses. If you don't have emergency savings, you might put that goal at the top of your list, then think about debt and retirement.

How to Balance Debt and Retirement Savings

It's entirely possible to pay down debt and save for retirement at the same time. You just need a good plan. Here are a few tips to help you keep both goals in sight.

• Get on a budget. A budget is your plan for how you spend the money you bring in each month. It's a way to take control of your money, since you decide how much to commit to debt vs. retirement savings.

• Save automatically. Not everyone has a retirement plan at work. If you do, use it. For example, if your job offers a 401(k) and your company matches contributions, take advantage. An employer match is basically free money that gets added to your nest egg. Even if you contribute the smallest amount allowed for your plan, that's still money you could save on autopilot.

• Consider debt consolidation. If you find a lower interest rate on a personal loan or HELOC than what you pay on your debts now, consolidation could help you pay off your debts faster. Get a few rate quotes to estimate how much you could save on interest.

• Avoid early retirement withdrawals. Leave your retirement savings alone while you pay down debt. An early withdrawal from a 401(k) or IRA often comes with taxes and penalties, and it could set back your long-term savings goals.

Making the Best Decision for Your Future

Whether you pay down debt, save for retirement, or do a little of both, the choice is yours. At the end of the day, you have to feel good about the decisions you make with your money.

And it's okay to ask for help if you need it. Debt relief may help you find solutions to improve your financial situation. For example, debt settlement could help you settle debt for less than what you owe.

Talk to a debt expert about your options if you're unsure how to balance your money goals. A credit counselor or Debt Consultant could lay out different paths and help you weigh the pros and cons.

Debt settlement may negatively impact your credit.