Is It Possible to Save for Retirement While Paying Down Debt? (The Answer Is Yes!)

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When you’re managing a lot of debt, it can feel like an isolating experience and an uphill battle. In reality, most Americans have at least some debt, whether it’s a mortgage, student loans, car payments, or credit cards. While debt enables you to pursue important opportunities (like obtaining a degree or buying a home), it also makes it difficult for most Americans to set aside adequate savings for future needs, like retirement.

Millennials have, on average, $125,047 of debt, while Gen Xers top the list at $157,556.1. Not so coincidentally, these two groups of people are at an essential stage in life where they need to start growing their retirement savings — all while continuing to juggle numerous other financial obligations.

If you’re struggling to prioritize paying down debt and saving for retirement, here are a few tips for striking the right balance.

First, Assess Your Outstanding Loans

Before making a debt repayment plan, you’ll need to understand what loans you’re currently paying, what the terms are, and how much the interest rate is. We understand the emotional challenges of facing your debt head-on, but getting a realistic understanding of what you’re paying (especially if payments are set to autopay) can help you build a more effective repayment plan (which we’ll get to shortly).

Common types of loans to look for in your bank statements include:

  • Mortgage
  • Credit card debt
  • Car loans
  • Student loan debt
  • Personal loans
  • Home equity line of credit (HELOC)

Fixed vs. Variable Interest Rates

Look back through the terms of your loans to identify which have fixed interest rates and variable interest rates. This distinction is essential, especially as you build a long-term repayment plan.

Fixed interest rates won’t change over the life of the loan, meaning what you pay during Month 1 will be the same as what you pay on Month 60, and so on.

Variable interest rates fluctuate during the loan’s life. They typically follow an underlying benchmark rate or index. Variable interest rates are a gamble, as they may provide you with a lower initial rate but are liable to rise later.

Next, Evaluate Your Retirement Savings

The next step is to take a peek into your current retirement savings. Review all retirement accounts, including 401(k)s or 403(b)s, IRAs, Roth accounts, and brokerage accounts. Depending on how close you are to retirement, you’ll want to start figuring out just how much you’ll need to maintain your quality of life in the future.

With the help of a financial advisor, you can use your current spending habits and financial obligations to create retirement income projections. From there, you can estimate how much you’ll need to save for each year spent in retirement

Creating (and Sticking to) a Realistic Budget

To optimize your savings strategies and repayment plan, create and follow a budget that reflects your current cash flow and spending habits.

Take a look through your bank statements and credits to first determine what cash is coming in:

  • Paychecks
  • Interest or dividends from investments
  • Contract or freelance work
  • Rental income from investment properties

And then figure out what your fixed expenses are:

  • All debts (including mortgage)
  • Utilities
  • Streaming services
  • Gym or club memberships
  • Subscription services

As well as variable expenses (those that fluctuate month-to-month):

  • Groceries
  • Gas and travel
  • Eating out
  • Medical expenses/appointments
  • Beauty and wellness
  • Miscellaneous items

With an accurate and realistic understanding of what money comes in and goes out, you should be able to find opportunities to reallocate funds (say from eating out often or subscribing to services you don’t use) toward your more important goals (debt repayment and retirement savings).

The Importance of Automation

Speaking of money going in and coming out, this is a great time to reiterate the importance of implementing automation where possible within your financial life. Most financial institutions will allow you to automatically defer a portion of your monthly paycheck to a savings account, whether an emergency fund, retirement savings, or brokerage account.

Along the same lines, setting up autopay on all bills and debt repayments will help you avoid late or missed payment fees. Some lenders even deduct a portion of your interest rate if you turn on their autopay function.

Why You Should Prioritize an Emergency Fund

While this article focuses on balancing debt repayment and retirement savings, establishing and maintaining an emergency fund is worth mentioning.

An emergency fund serves as the primary safety net of your financial life. It can help you cover sudden, unexpected costs, such as broken pipes, a medical emergency, leave from work, car repairs, etc.

Here’s why it’s relevant:

The purpose of an emergency fund is to A.) prevent you from accruing even more debt and B.) prevent you from draining your retirement savings to cover unexpected expenses. 

The general rule of thumb is to save three to six months of expenses in an emergency fund. So, if you haven’t yet prioritized building an emergency fund, including contributions to that account in your monthly budget may be prudent.

Should You Put Off Saving for Retirement to Pay off Debt?

It almost feels like a chicken-or-egg question… but many people wonder if it’s better to focus entirely on paying down debt now or allowing more debt to accrue while they pad their retirement savings.

Everyone’s situation will be different. This is a question for you and your advisor to review and answer. But in the meantime, let’s quickly walk through the costs associated with delaying retirement savings or not paying down debt.

The Cost of Delaying Retirement Savings

Experts recommend starting to save for retirement as early as possible, primarily because of compound interest.

Compound interest is the secret ingredient to growing your savings over time. Here’s how it works:

Say you have $10,000 in an account with an interest rate of 5%, which compounds annually. If you never added another penny to the account, in 10 years, that $10,000 would grow into $16,288. In Year 1, you’d earn $500 in interest (5% of $10,000) for $10,500. But moving forward, you would earn interest on the principal amount ($10,000) and the interest already accrued in the account. So in Year 2, you’d earn $525 in interest (5% of $10,500) for a total of $11,025.

The longer you allow your savings to compound, the more significant the impact of your initial investment.

The Cost of Not Paying Off Debt

Debt accrues interest over time. The longer it goes unpaid, the more interest it accrues. The higher the interest rate, the harder it becomes to pay down the debt faster than the interest accrues.

Keeping your debt high can also impact your credit score, which considers your debt-to-income ratio. If this ratio remains high, it may limit your opportunities to take on new debt, like buying a home (or investment property) or a new car. 

Missed payments can, of course, incur additional penalties and lower your credit score if they go unresolved.

Pick a Debt Repayment Strategy

If you feel like you’re spinning your wheels while trying to pay down debt, here are two standard methods to try:

Snowball Method: While you’ll still pay the minimum amount on all loan payments, focus your extra funds toward the loan with the lowest balance. Once that loan is paid off, use the funds you were putting toward that loan to pay down the next lowest loan—and go on and on up the line. The snowball method does not consider interest rates based purely on loan size. However, it can be more motivating since you see debts paid off faster.

Avalanche Method: Similar to the snowball method, you’ll still focus on paying off one particular loan before moving on to the next. However, the avalanche method requires you to focus on the loan with the highest interest rate before moving down the line. This method may take longer to see a payoff (depending on how big each loan is), but it can help you save on interest in the long run.

We’re Here to Help

The good news is you’re not alone in building a more secure financial future. Our team is here to help you review your current financial obligations, identify opportunities for improvement, and build a plan that addresses your needs today and goals for tomorrow (like retirement). If you’d like to talk more about your unique financial circumstances, don’t hesitate to book a call with our team today.

Sources:1Experian Study: Average U.S. Consumer Debt and Statistics

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