78% of Americans said they were concerned about not saving enough money for retirement, in a 2018 study conducted by the Northeastern Mutual Planning and Progress. Conventional wisdom advises focusing on saving for retirement right from when you are young, either through a 401(k), IRA or any other convenient plan. But a critical dilemma to consider is whether you should delay these contributions or investments to clear your debts. Since massive debts, including student loans, burden many people, it can be hard to make financial progress. So when is the right time to prioritize clearing your debt?
When settling debts should come first
Let us say that you are earning $40,000 per year but have $70,000 worth of loans. Such a situation could mean that you are approaching bankruptcy, which is disruptive, and can leave you with little freedom and affect your employment. In this case, it would be more prudent to put a stop to other obligations and prioritize paying your debt. Think of it as a move to channel all your resources and effort into dealing with the biggest blockage to growth and happy retirement. After clearing these debts successfully, you can now focus your full energy on savings and investments, which will place you in a better financial point after retirement.
The opportunity cost of paying your debt first
There is a negative side to committing to pay debts without saving for retirement. Assume it will take you 5 years to completely get rid of your loans. During this time, you would have saved $5,000 per year plus your employer’s addition (50% of your contribution). If you invest this money in stock, giving an average annual return of 10%, you would have more than $48,000 at the end of these 5 years. This is the opportunity cost of choosing to clear debt first, which is a steep mountain to climb. The same goes for freelancers seeking a retirement plan that works best for them. Also, the IRS puts a limit on how much you can contribute to tax-advantaged retirement accounts yearly, and if you miss out on it, you will not enjoy the chance again. This and the fact that you lose time to grow financially is enough incentive to make you reconsider your options.
Pay loans and save for retirement if you can
If your monthly income puts you in a position to pay the debt and still invest for retirement, you should do so. But this arrangement could also work for those whose income does not give them much space. In such a case, you can go ahead and do both while giving one more weight. For example, focus on paying your student loan while saving minimally. Inc advises that regardless of your financial situation, you should contribute a certain percentage of your income, aiming to generate maximum employer match on your 401(k) or whichever plan you are using. Additionally, there are available loan-payoff-calculators that can help you to determine how best you can settle your loans while still growing your nest egg.
One of the biggest financial challenges is that many vital commitments compete for limited income. While delaying retirement investments is a bad idea, sometimes you can forego it and focus on clearing your debt. Everybody’s situation is unique depending on their type of loan, payment terms, and age, amongst other factors. As such, it is essential to consult a professional financial adviser, who will guide into selecting the plan that works best for you.