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Which Comes First: Paying Down Debt or Saving for Retirement?

Getting ahead financially requires determining your priorities and setting goals. When you’re focused on paying down debt, it’s tempting to put things like saving for retirement on the back-burner. Dumping your debt as quickly as possible can save you hundreds or even thousands of dollars in interest but you have to figure out whether it’s worth it to delay building your nest egg. If you’re torn between saving for retirement and getting rid of those lingering credit cards or student loans, here are some tips to help you strike the right balance.

Find out now: How much do I need to save for retirement?

Look at the Time Frame

One of the most important things to consider when you’re debating what to tackle first is your overall time frame. If you’ve got decades before you reach retirement age, taking a break from saving (or saving a bit less) to pay off your debt isn’t likely to have as much of a negative impact as it would for someone who’s got less than five years left in the workforce. The closer you are to retirement, the more important it is to make sure you have adequate savings, even if it means you can’t be as intense about paying off your debt.

Weigh Cost vs. Return of Saving

When you’re carrying around a load of high-interest credit card debt, you’re essentially throwing money away each month that you’re still making payments. Even if you’ve got debt with a fairly low rate, like a student loan, you could still end up paying a significant amount in interest if you borrowed heavily while you were in school.

Look at how much each debt is costing you and compare it to what kind of earnings you’re getting from your retirement accounts. If your investments haven’t really taken off yet, putting all your extra dollars towards your debt may yield a bigger return in the short-term.

Take Advantage of Free Money

Stopping contributions to your employer’s retirement plan temporarily while you pay down your debt may seem like a smart move, but you could be missing out on free money in the meantime. If your employer offers a matching contribution, it makes sense to contribute at the least the minimum amount to get the match even if you’re in debt payoff mode.

Related Article: How Does My 401(k) Work?

It might take you a little longer to achieve debt freedom, but the company match may offset the difference when it comes to the interest you’re paying on credit cards or loans. Once you max out your retirement contributions for the year, you can reduce the amount you’re putting in and redirect the money towards your debt.

Don’t Drain Your Nest Egg

If you’re not progressing as quickly as you’d like with paying off debt, you may be tempted to borrow your 401(k) or cash out your IRA to get rid of it once and for all. While it can help you become debt-free that much quicker, there are some problems with going this route.

When you take out a 401(k) loan, you’re basically paying the money back to yourself but you still miss out on any earnings you would have realized if you hadn’t borrowed from your account. If you end up leaving your job, you’ll have to repay the loan in full or risk having to pay taxes and early withdrawal penalty on the money.

Withdrawals from an IRA may also be subject to taxes and a penalty, depending on your age and what type of account you have. Unless you’re experiencing an extreme financial hardship, raiding your retirement savings accounts just to pay off debt just doesn’t add up.

Ultimately, whether you should forgo saving for retirement to rid yourself of expensive debt really depends on your individual circumstances and how comfortable you are with doing so. Once the debt is gone for good, you should have plenty of room in your budget to save but you need to make sure you’re not putting it off too long.

Related Article: 4 Money Moves to Make After Dumping Your Debt

Photo credit: flickr

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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