Like most people, you have a limited amount of money and you must decide what to do with it. This can be a complicated decision if you have debt that you want to pay off, but you also really want to save for retirement so that you are financially secure in your later years.
So how should you decide whether to focus on paying off debt or investing in your future? Here’s what you need to know to make that tough decision.
Here’s how to decide whether paying off debt or saving for retirement is the wisest choice
There are a few things to consider when deciding whether to pay down debt or focus on saving for retirement. However, one of the most important factors is which approach gives you a better return on investment (ROI).
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You will always want to pay the minimum balance due on any debt you have incurred. However, if you pay extra over and above the required payment instead of putting that money into retirement savings, your return on investment will be equal to the amount of interest saved. If you have 17% credit card debt, you get a pretty high ROI. But if you have a low-interest 3.50% mortgage debt and are able to itemize your deductions and deduct the interest you paid on your home loan on your tax return, then your ROI is very low.
On the other hand, if you invest instead of prioritizing paying off debt, your ROI is the money your investments bring in. However, you could also get a 401(k) match from your employer, which could offer up to a 100% return on investment if your company matches your contributions on a dollar-for-dollar basis. And you might qualify for tax breaks on retirement savings. Those tax breaks could include deductions for contributions to a 401(k) or IRA and even the savings loan, which could cut your tax bill by up to $2,000 if you’re eligible and contribute the maximum.
If you can get a better ROI by paying off additional debt — even after accounting for tax savings and 401(k) matching contributions — then you’d better be investing your extra money toward paying off your loans as soon as possible. But if your ROI from investing is better, you should make minimum payments and invest the rest of your money in retirement savings.
For most people, this often leads to a hybrid approach. For example, you could put extra money into your 401(k) until you’ve earned the maximum employer match, and then divert extra money to pay off credit cards as soon as possible. Or you could work on paying off your payday loans and credit card debt before investing in an IRA, but then focus on saving for retirement rather than putting extra funds into a mortgage or low-interest car loan.
By strategically assessing which use of your money will pay off best for you, you can decide where exactly your extra money goes. Remember that since you can’t live on Social Security alone, you’ll need some retirement savings. So make sure you don’t put off investing for your later years too long. If you’re focused on getting rid of your debt first, be aggressive with your additional payments and get that task off your list as soon as possible so you can start building a secure future.
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