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Save for retirement or pay down debt?

You'd like to pay off your high-interest plastic, but you also need to save for retirement. Which should you do first?

By Stacy Johnson Aug 13, 2012 10:13AM

This post comes from Angela Colley at partner site Money Talks News.

 

Money Talks News on MSN MoneyAccording to the most recent report from the Federal Reserve, credit card debt stands at $864 billion, which equals an average of $7,226 per U.S. household. (The average for households that have debt is actually much higher since more than half don't carry a balance from month to month.)

 

If your household is one of those that is struggling with credit card debt, you know how important it is to reduce those balances. But you also know it's not the only priority you have. Saving for retirement is also a critical goal. So, when you find yourself with an extra dollar or two, where should it go -- to reducing debt or increasing retirement savings?

 

That's a question we heard when we took our camera to the streets to talk to people about their money concerns.  Check out the answer in the video below, then read on for details.

Deciding what to pay first

Whatever your goals, you obviously want to get the biggest bang for your buck. Compared with the rate of return on a typical savings account, CD, or stock investment, you'll get a much higher rate of return by paying off your credit cards first.

 

Image: Worried Man (© Corbis)It's useful to use a credit card calculator, like this one from the Federal Reserve or this one from MSN Money, to see what can happen when you pay extra on a credit card balance. For example, plug in a balance of $7,000 and an interest rate of 13%, and you'll find that by paying only a 2% minimum monthly payment, it will take 24 years to pay off the card, and cost more than $7,500 in interest.

 

But instead of paying the minimum 2% payment -- $140 a month to start -- suppose you jacked the payment up to a flat $300 every month. You'll pay the card off in two years and pay $1,100 in interest. Which means you'll keep $6,400 that otherwise would have gone to the bank.

 

The exception

As Stacy said in the video, paying off a high-interest debt is like earning that interest risk-free and tax-free, which is tough to beat. So the rule is to pay off that kind of debt as soon as possible. But as with most rules, there's an exception.

 

Many 401ks and other types of retirement plans offer a company match up to a certain amount, typically 50% of whatever you contribute, capped at 6% of your annual salary. For instance, if you earn $50,000 annually and contribute $3,000 (6%) to your retirement plan, the company will contribute $1,500.

 

That's like earning a risk-free return on your investment of 50%.

 

So, if your company matches your 401k contributions, make sure you're contributing enough to get every free penny being offered by your plan. After that, put any extra income you have left into paying off your debt. Once your debt is wiped out, you can start contributing more to your 401k or look into other investment options.

 

Getting it done

Now that you know what to pay and when, you'll need to come up with the cash.

First, talk to your HR department, find out what your company matches in 401k or retirement contributions, and set up the appropriate automatic deposit into a retirement account. 

 

Then follow these steps to find the money to pay off those credit cards:

  • Create a simple budget. Don't let the word "budget" freak you out. All it means is keeping track of the money you have coming in and going out. There are apps and websites that can help you do it almost automatically and plenty of how-to articles that can help.
  • When you see where your money's going, you'll know how much you have left over to apply to credit card debt. Stay motivated by plugging your new payments into a debt payoff calculator to see how much faster you'll be debt-free.
  • Not finding extra money in your budget? There are loads of ways you can save without sacrificing your quality of life, from cutting the cable to raising insurance deductibles.  Check out "25 simple ways to save an extra $1,000" for more ideas.

More on Money Talks News and MSN Money:

5Comments
Aug 13, 2012 12:38PM
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Saving for retirement will be pointless if you first don't learn to live within your means.
Aug 14, 2012 1:02AM
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I have a finance question:  How do I get the government to pay for my retirement AND pay off my debt so I can buy a brand new full size truck and a boat to pull behind it?  Oh yeah, I also go on regular shopping sprees and I eat out every night, so I can't afford to do both, or either, really.  Might as well reward myself for getting an entry level job after earning my liberal arts degree, amiright?

(this post was written as a joke)
Aug 18, 2012 9:25PM
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One important piece to stress here - 401k and emergency fund come first and with equal emphasis.  Why an emergency fund?  Two reasons, really - it keeps you from needing to rack up a credit card balance again (once you finally pay the one you have down) AND one of the most important reasons to have an emergency fund - so you never never never need to withdraw, take a loan or reduce your contributions to a 401k (or IRA) due to an emergency.  One of the biggest issues with 401ks, second to not participating in the plan in the first place (that's another topic) is tapping the account for nonretirement needs.  Never touch it and help yourself to stay away by having an emergency fund. I can't believe how many people think these funds are available..for things like buying a first home, a wedding - 401k loans should be considered as only a very last resort. Also, if you change employers and need to move a small 401k, do no less than a trustee to trustee transfer - don't take two steps back by withdrawing.  Messing with your 401k causes future damage, compounded damage.
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