If you have debt, should you be saving for retirement, paying off debt, or both? The answer is more complicated than you might think.

Paying off Debt vs. Saving for Retirement

There are different kinds of debt and different kinds of retirement plans. In many cases, especially if you have credit card debt, the interest rate is going to be much higher than the return on whatever retirement plan you have set up.

For example, if you have a credit card interest rate of 16%, but your retirement index fund has a projected 8% rate of return, you are losing money by putting money into your retirement savings instead of paying off your debt.

In almost every case, your credit card interest rate will be significantly higher than any return from your retirement savings. The experts will generally tell you to pay down your credit card debt before doing anything else. These are the highest interest loans you have and you will almost never find a return rate that beats it.

Therefore, having credit card debt while putting money into retirement or savings will end up losing you money.

If you have low-interest debt such as a mortgage or student loan, you may want to pay off your debt while saving for retirement at the same time. A maxed out 401(k) match is usually enough of a retirement investment to focus on paying off your debt. If you don’t have a 401(k) match, more careful analysis of interest rate and retirement returns is necessary to make the best financial decision for you and your family. We recommend speaking with a debt specialist to create a customized plan.

What about 401(k) matching?

There is one exception, which is if your employer offers a 401(k) match. If you get a 401(k) match, take advantage of it by putting in as much as you can and receiving the free matching dollars from your employer. If your employer offers a 1:1 match of up to 5% of your salary and you make $80,000 a year, you can contribute $4000 every year and your employer will match it with another $4000.

That’s free money! So, unless you are paying more than $4000 in credit card interest payments a year, you’re better off making the maximum contribution to your 401(k). 401(k) contributions are also pre-tax money, which means you aren’t taxed on it until you withdraw it many years later. This allows you to continue to invest the money for large compound growth. Another great thing about 401(k) matching is that it gets automatically deducted from your paycheck, so once you set it up with HR, you can forget about it. Your contribution plus the employer’s match goes straight into your 401(k).

Keep in mind that if you withdraw 401(k) funds before you are 59 1/2 years old, you will incur severe penalties, such as a 10% early-withdrawal penalty.

The Steps Toward Investing for Retirement

In general, these are the steps you want to follow in order to make the smartest decisions about your money when it comes to debt and retirement:

  1. Set aside at least $1500 in your savings account as an emergency fund.
  2. Ask your HR representative if your employer offers a 401(k) match and contribute the maximum amount to take advantage of the match.
  3. Pay off your credit card debt as soon as possible. This is your highest-interest debt and paying it off will improve your credit score. The average credit card interest rate is about 15% — yours may be a higher.
  4. Pay off any other debt. Use the debt snowball or debt avalanche method to get out of debt. Contact DebtBlue for a free consultation with a debt specialist to make a plan.
  5. Add money to your emergency fund — enough to pay about 3-6 months of expenses, including rent.
  6. Open up a Roth IRA account and contribute as much as possible.
  7. After setting up a 401(k), paying off your debt, and contributing the maximum to your Roth IRA (up to $6,000 for 2019), then go back to your 401(k) and contribute as much as possible.
  8. If there’s still money left over to invest, we recommend setting up non-retirement investment account, but this comes much later and many people never reach this step.

To help you move past the debt payment stage, you may want to consolidate your debts into one single debt or negotiate with creditors to settle for less than the full amount you owe.

It’s time to take action! For personalized debt counseling, contact DebtBlue for your free consultation. Our certified debt specialists will go over your unique situation and come up with a plan to get you out of debt fast!