It's a catch-22: You feel that you should focus on paying down debt, but you also want to save for retirement. It may be comforting to know you're not alone.
According to an Employee Benefit Research Institute survey, 18% of today's workers describe their debt level as a major problem, while 41% say it's a minor problem. And workers who say that debt is a problem are also more likely to feel stressed about their retirement savings prospects.1 Perhaps it's no surprise, then, that the largest proportion (21%) of those who have taken a loan from their employer-sponsored retirement plans have done so to pay off debt.2 Borrowing from a plan can have negative consequences on retirement preparedness down the road. Loan limits and other restrictions generally apply as well.
The key in managing both debt repayment and retirement savings is to understand a few basic financial concepts that will help you develop a strategy to tackle both.
Are you eligible for an employer match?
If you have the opportunity to save for retirement via an employer-sponsored plan that matches a portion of your contributions, the debt-versus-savings decision can take a different turn.
Let's say your company matches 50% of your contributions up to 6% of your salary. Suddenly, instead of saving 6% of your salary for retirement, you’re saving 9% -- for free! That much of a financial boost to your retirement savings accounts can add up significantly over years. That's why it may make sense to save at least enough to get any employer match before focusing on debt.
And don't forget the potential tax benefits of retirement plan contributions. If you contribute pre-tax dollars to your plan account, you're immediately deferring anywhere from 10% to 39.6% in taxes, depending on your federal tax rate. If you're making after-tax Roth contributions, you're creating a source of tax-free retirement income.3
Consider the types of debt
Your decision can also be influenced by the type of debt you have. For example, if you itemize deductions on your federal tax return, the interest you pay on a mortgage is generally deductible — so even if you could pay off your mortgage, you may not want to. Let's say you're paying 6% on your mortgage and 18% on your credit card debt, and your employer matches 50% of your retirement account contributions. You might consider directing some of your available resources to paying off the credit card debt and some toward your retirement account in order to get the full company match, while continuing to pay the mortgage to receive the tax deduction for the interest.
There's another good reason to explore ways to address both debt repayment and retirement savings at once. Time is your best ally when saving for retirement. If you say to yourself, "I'll wait to start saving until my debts are completely paid off," you run the risk of never getting to that point. Postponing saving also reduces the number of years you have left to save for retirement.
It might also be easier to address both goals if you can cut your interest payments by refinancing debt. For example, you might be able to consolidate multiple credit card payments by rolling them over to a new credit card or a debt consolidation loan that has a lower interest rate.
Bear in mind that even if you decide to focus on retirement savings, you should make sure that you're able to make at least the minimum monthly payments on your debt. Failure to do so can result in penalties and increased interest rates, which would defeat the overall purpose of your debt repayment/retirement savings strategy.
1 Employee Benefit Research Institute, 2017 Retirement Confidence Survey
2Employee Benefit Research Institute, 2016 Retirement Confidence Survey
3 Distributions from pre-tax accounts will be taxed at ordinary income tax rates. Early distributions from pre-tax accounts and nonqualified distributions of earnings from Roth accounts will be subject to ordinary income taxes and a 10% penalty tax, unless an exception applies. Employer contributions will always be placed in a pre-tax account, regardless of whether they match pre-tax or Roth employee contributions.
Need more insight? Let us be your guide.
Our national network of experienced financial advisors can help you create a personalized plan to help you identify financial goals and get you where you want to go in life.Find an Advisor
Saving for retirement can be tough. Employer-sponsored 401(k) retirement plans can offer a good opportunity to save, with employer contributions jumping from 3.9% of employee salaries in 2015 to 4.7% in 2016. Are you taking full advantage of your workplace retirement benefits?Read More
This information is prepared by an independent third party, Broadridge Investor Communication Solutions, Inc. and is provided for informational and educational purposes only. Waddell & Reed believes the information has been obtained from sources considered to be reliable, but does not guarantee the accuracy of the information provided. This information is not meant to be a complete summary or statement of all available data necessary for making financial or investment decisions and does not constitute a recommendation.
Please note that the information provided may include references to concepts that have legal, accounting and tax implications. It is not to be construed as legal, accounting or tax advice, and is provided as general information to you to assist in understanding the issues discussed. Neither Waddell & Reed, Inc., nor its Financial Advisors give tax, legal, or accounting advice.
This information is not meant as financial or investment advice pertaining to your personal situation. The selection of appropriate investment, insurance or planning options and/or strategies should be made on an individual basis after consultation with appropriate legal, tax and financial advisors. Nothing contained herein is intended as a solicitation or an offer to buy or sell any product or service mentioned and they may not be suitable for all investors. Securities offered through Waddell & Reed, Inc., Member FINRA/SIPC, are not insured by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financial institution, and are subject to risks, including the possible loss of principal. Insurance products are offered through insurance companies with which Waddell & Reed has sales arrangements. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.
Securities offered through Waddell & Reed, Inc., Member FINRA/SIPC, are not insured by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financial institution, and are subject to risks, including the possible loss of principal. Insurance products are offered through insurance companies with which Waddell & Reed has sales arrangements. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.