How should you go about handling your debt and saving for retirement? Is it even feasible to pay off debt when you don't first have a safety net?
A common issue Americans face is skipping the safety net and paying the debt off first. Why is this an issue? You may find yourself circling back after paying off debt.
Perhaps you're relying on those credit cards. If you pay your credit card off without savings, and an emergency arises, you grab that trusty credit card. Why? Well, you lack in the savings department.
How about those retirement savings of yours? Should you use it to pay your mortgage off, and live mortgage-free? Or maybe you're still dealing with a car payment rather than building your retirement?
Retirement can be both exciting and scary. The loss of a paycheck means you'll need plenty of savings to get by comfortably.
Below we'll go over how you can start building your retirement savings and paying down debt.
Why Pay High-Interest Debt FIRST
Figuring out how to invest in your future to cut your debt can be confusing. Those looking to retire face this challenge every day.
For many, this decision comes in the manner of eliminating mortgage costs or creating a retirement fund. But, when tackling debt, you'll want to pay your high-interest debt down first.
Paying off high interest debt first will save you money on the interest and you can pay your debt off sooner. While financial guru Dave Ramsey suggests paying off small debt balance first as a way to motivate you into paying off more debt, that route can cost you more in interest fees and take longer to pay down.
When you pay off your high interest debt first, you can pay debt down faster and pay less overall.
Pay Off Your Mortgage or Build A Retirement Fund?
Paying into your retirement savings should be a priority before paying your mortgage off early. Why?
You can put those "extra" mortgage payments into your retirement account that can hold bonds and stock investments. But be sure to do this while home interest rates are still low. By doing this, you'll give your money the change to grow over time.
If you're younger than 60, you won't want to withdraw funds from your IRA or 401k to pay off your mortgage. By doing this, you'll find yourself knee-deep in penalties and taxes on the money you withdraw.
If you're older than 60, you can let your money sit in your account and grow. Be sure that your rate of return is much higher than your mortgage's interest rate, though.
Also, you may want to avoid making a large withdrawal to pay off your mortgage for tax reasons. By doing this, you'll end up in a higher tax bracket and paying more than you usually would.
Perhaps you're tempted to severely pay down your mortgage once you reach the end of your terms. But it will benefit you if you do so at the beginning of your mortgage.
Even though you'll make the same equal payment every month, most of the money, in the beginning, go towards your interest. So, when you make your extra payments, in the beginning, you're reducing the principal that you'll be charged on in interest.
The result? You might pay significantly less interest throughout the life of your loan.
The same process can apply to any of your investments. Pay down more of the principal in the early days and save more over time. On the contrary, when you reach the later years, payments will go towards the loan principal.
Paying more towards your loan won't reduce your total interest as quickly. But it will build equity in your home at a faster rate.
So, let's take a look at the key points here:
- If you want to put any extra money towards your mortgage, do so earlier on in the game
- Start saving for retirement early to gain compound interest
- The younger you happen to be, try to focus on your retirement fund over your mortgage
Pay Off Your Other Debts, Before Retirement
Debt comes in many forms. You'll want to retire these debts before you're ready to retire yourself.
Other kinds of debt can include:
- Credit cards
- Car loans
- Personal loans
- Boat loans
Other debts tend to have a much higher interest rate while lacking tax benefits. Not only can costs associated with these debts eat away at your savings, but they can reduce your quality of living.
For instance, let's say you have a $600 car payment each month. In addition to that car payment, you have a $400 credit card bill each month. You're now looking at $1,000 less each month that you have to spend when you retire. By choosing to pay off your debt now, you can enjoy life later.
Credit card debt carries high-interest rates in most cases. You'll want to pay off those credit cards first, even before any of your auto loans. Credit card debt is quite volatile, and it can change abruptly.
Pay Off Your Student Loan Debt Before Retirement
You'll want to be sure not to start any new student loan debt that you won't be able to pay before retirement. People approaching retirement may carry thousands of dollars in student loan debt.
The debt may stem from themselves or their children's educations. Usually, student loan debt can't be discharged. Even if you file bankruptcy.
You may find that a percentage of your Social security payments are garnished if you fall too deep into student loan debt. The interest on student loans isn't tax-deductible, like that of a mortgage.
So, the moral of the story is, take out loans only if you plan to pay them entirely off before retirement.
But maybe this isn't possible for you. Much like a mortgage, be sure to think before you withdraw funds to pay the debt off ultimately. Especially if you're younger than 59 and a half.
But you can use some of your income to help make extra student loan payments before retirement. The average American student takes about 20 years to pay their student loans off. According to financial expert Jordan Sowhanger, "If you are able to allocate even a small amount of funds towards retirement, you should still do so even while you are paying down student loans."
Make sure to take into account the amount of interest you're paying on student loans. We understand that everyone's circumstances financially will differ. Ultimately, you'll have to do what makes sense for you and your family.
401K Contributions - Go for It!
So how should you go about contributing towards your 401k? We say, go for it!
Especially if your employer is planning on matching! When employers match 401k contributions, it means they're contributing to your retirement savings.
Your employers matching contributions can depend on a variety of different ways.
Most often, employers can match a percentage of your contributions, up to a certain point. Sometimes employers will match your contributions to a specific dollar amount. Regardless of how much you decide to contribute.
According to financial planner Monica Sipes, "A buy-one-get-one-free deal is how I think of it. The match is something that's considered in your overall compensation, so by not taking advantage of it, you're not getting a full freight of what your employer was expecting to pay you."
Clearly, there are incredible benefits of a 401k when saving for retirement. Maybe you can only contribute a small part of your check to your 401k. Even so, you'll be in a much better position doing that than doing nothing at all.
Deciding how to plan on your retirement can be a challenge. Although, if you make sacrifices earlier on, you can prevent making those sacrifices later in life. Paying down your highest debts, tackling credit card debt, contributing to a 401k, and paying down mortgages, can reduce a world of stress. Also, having a savings account to protect you when the credit cards and other debt is paid is a great way to prevent going into further debt.
David Haass is the COO of Elite Insurance Partners & MedicareFAQ. A visionary with experience propelling innovation in the Insurance field, he is highly regarded for driving industry standards in client experience and cutting-edge technologies. Mr. Haass is an active contributor on the Forbes Financial Council, recognized for building brand trust and establishing strong customer relations, motivated by a genuine desire to demystify health insurance options.
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