Debt Reduction vs. Retirement Savings

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Debt.  Saving.  Retirement.  What should we do?

This topic of retirement savings vs. debt reduction is becoming one of my favorites here on DFA.  Looks like I’m not alone!

Today I received this email from DFA reader Bruce in reference to the family budget spreadsheet I released yesterday.

In the last post I noticed that there was no retirement savings entry in the spreadsheet  you posted.  As the rest of the Budget Spreadsheet was so well thought out , I can only assume that this was by design.  Did you decide that paying off debt was more critical then saving for retirement?

I have been trying to work out what I need to retire, and what will give me the best boost financially, either paying down debt first and then saving for the future, or trying to do both at once.  Any thoughts to share, maybe on a future post?

Thanks in advance

- Bruce

Thanks for the question and great topic Bruce!

I will quickly answer your spreadsheet question, then move on to address the main concern you raise about funding retirement savings or focusing on debt reduction.

While I did not create a dedicated section for retirement savings in the family budget spreadsheet, the amounts can be added to the “Savings” section.  I did this because I, like most American’s, have outstanding debt at a high interest rate, and am not in a situation where I should be contributing to retirement savings.

Should you focus on retirement savings or debt reduction?

Are you like DFA reader Bruce?  You know you have debt, and you know you should be focusing on debt reduction… but at the same time you keep hearing about compound interest and how you should begin your retirement savings as soon as possible.

It can sound confusing… but really it’s not.  A few simple math computations will show us what is best for each or our own individual scenario.  And beyond that, usually we can determine our best plan of action based on a few simple criteria… I have covered these criteria at length in past articles.

Questions to consider…

  1. How much debt do you have, and at what rates? This should be your first concern when attempting to formulate the best retirement savings plan for your unique situation.
  2. How old are you? Even though this question is often given too much attention and focus by retirement planning “specialists”, it is still an important consideration nonetheless.  Just make sure you do not let someone scare you into investing because you are a certain age and have not begun your retirement savings.
  3. Do you have access to a tax sheltered plan? Chances are you do.  If you do not have access to a business 401k plan, a 403b, or an SEP retirement plan, go open a Roth IRA.  Most people are eligible for a Roth IRA and stand to realize huge benefits by getting started with one as soon as your debt amounts allow.
  4. Do you have an employer match? If so, consider all your financial variables before blindly contributing just because everyone says you should.  Is it a fully vested plan from the get go… or do you earn 20% vesting each year?  How stable is your employment… and do you plan on staying with that employer for years?
  5. Can you contribute to retirement savings and still pay for groceries? Don’t contribute to retirement savings if you doing so will hinder your ability to put food on the table.  You have to keep your priorities straight and trust God with the details.

Debt Reduction vs. Retirement Savings archives on DFA

Here are some articles I have written in the past on this exact subject:

Debt Reduction Focus

In a nutshell… it is not in your best interest to concern yourself with retirement savings if:

  1. You still have credit debt or any debt at a high interest rate.
  2. You do not have a fully funded high interest rate savings already set up for emergency situations.

If either or both of these examples hit close to home, then you need to be focusing on debt reduction.

Retirement Savings Focus

You will want to contribute to retirement savings if:

  1. You have no debt.
  2. Your debt is not at a high interest rate.
  3. Your employer matches your retirement savings contributions, you are planning on being employed there long enough to become vested, and you still have enough money for groceries after contributing.

If any or all of these scenarios describe your situation then you should probably consider contributing to your retirement savings.

Balanced 75/25 Method of Debt Reduction and Savings

Long time readers of DFA will instantly recognize this approach!  I will summarize the concept below and customize to today’s topic.  If interested, here is a detailed read on the balanced 75/25 debt reduction and savings method.

The premise here is simple.  If you are not ready to contribute to retirement savings, and are constrained by your financial situation to focus on debt reduction – consider the 75/25 method for a balanced approach to saving while in debt reduction mode.

Some financial experts advise us to save $1,000 then abandon savings and focus solely on debt reduction.  Please remember that many of these concepts were formed at a time when the economy was much stronger than it is now.  Personally… I think the rules have changed.

Consider apportioning 75% of your available money to debt reduction and the other 25% toward an account with a high savings yield.  We did that for months, stopped for one month but felt uncomfortable about not saving at least something, so we resumed putting a portion of our money toward our accounts earning a high savings yield.

High Savings Yield Accounts

If you are in the market for a bank with a good high savings yield, check these out.  I prefer Capital One 360, but any of these are good.

[fintools savings | small]

If you were Bruce… what would you do?



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