The question of how one invests in a retirement account while carrying a debt burden is becoming more common. According to a survey by Fidelity Investments, almost half of all baby boomers will retire with debt. Today, the average American carries $15,000 in credit card debt alone. While saving towards your future does become more complex with debt, knowing what you’re retirement needs are and understanding the nuances of your debt profile can help you to create an optimized savings plan that is right for you.
What is your Retirement Objective?
Without knowing your retirement needs, it will be difficult for you determine if you should pay off existing debt or invest your capital in a retirement plan. One of the biggest risks investors face is running out of money in retirement. To minimize this risk, there are a number of factors that you should consider when developing a retirement plan.
Starting with crucial questions related to life expectancy (how long will your retirement investments need to last?) and minimum cash distributions (how much will you need to withdraw each year during retirement?) is a good place to start.
The more thought and attention you give to your retirement needs, the better prepared you’ll be to plan for the future.
Debt vs Retirement: What Should you Consider?
While you should discuss your individual retirement goals with a financial advisor, there are some fundamental considerations related to the structure and cost of your debt that can further inform your decision to pay off debt vs invest in retirement.
Interest Rates: The cost of carrying debt is an important consideration when determining your ability to contribute towards retirement. If you’re carrying high balance, high-interest rate debt, the monthly cost of that debt will be high and it may be prudent to pay down that debt as soon as possible.
Taxable Income: Contributing towards tax-advantaged retirement accounts such as 401(k)s and IRAs allows you to enjoy tax deferred to tax-free growth on your investments. As a result, it may be more advantageous to contribute towards a retirement account in lieu of paying down debt. To get a sense of what this will look like for you, you’ll need to consider your proposed yearly retirement investment and compare that to your yearly cost of carrying debt.
Priority Debt: Paying down credit card debt and other high-interest revolving debt should take priority over mortgage debt. Paying down credit card debt creates available credit for you to use in the future and lowers your overall interest profile. If your debt is only comprised of a low-interest mortgage, making contributions to a retirement account can take priority over debt reduction.
Age: The closer you are to retirement age, the more crucial it is for you to make contributions to your retirement fund.
Contribution Matching: In addition to the tax advantages of retirement contributions, many employers offer 401(k) matching. If your employer offers a matching program, depending on your income, those matched contributions could make up for the interest you’d otherwise accumulate on your standing debt.
Along with these considerations, it’s important to know that help is available should you need it. Don’t be afraid to reach out to legitimate credit counselors and financial advisors and form a plan before it’s too late.
Actionable Ways to Contribute to Both Debt & Retirement
Bonuses & Unexpected Cash: Next time you unexpectedly receive a bit of additional cash, split it down the middle. Put half of it towards your debt and the other half into a retirement account.
Slash Current Expenses: If you’re in debt, you’re probably very aware of your unnecessary expenditures, but dig even deeper. Even cutting an additional $50 per month can help reduce debt and boost retirement accounts.
Find a Side Job: While working a side job is not glamorous, it can rapidly move the needle on your current debt and allow you to contribute to a retirement fund sooner.
Contributing to retirement when you’re in debt is difficult. But it is possible. Keep hustling so you can retire and live better well into old age.
Not Sure How to Start Investing?
I opened up my first investment account back in 2012 after paying off a lot of debt. That account was with Betterment. Since then, I haven’t looked back. I love the simplicity and ease of use they provide. I think their system is good for any type of investor. If you want to get into investing, check out Betterment.