One of the most frequently asked finance questions people have is whether they should be paying off their debts or saving more towards their retirement. There really isn’t a one-size fits all solution that will work in every situation, but there are some things to consider to help you decide whether it makes more sense to pay off your credit cards, student loans and other debts or start putting more aside for when you retire.

Put More Into Retirement Accounts

If you’re lucky enough to work for a company that offers a 401K plan with a matching contribution – you would be crazy not to take advantage of the program. Each time the employer matches your contribution (or even if they only match a percentage of your contribution), that’s free money for you.

There are a number of benefits for saving with a 401K account, which makes it one of the favored options for retirement planning by many people.

Tax advantages include:

  • Reduction in tax liability since contributions to a 401K plan are not taxed

  • Tax deferred investment income

  • Compounded interest (the earlier you save, the more you’ll have upon retirement)

If your employer doesn’t offer a 401K plan, or you are self employed, you may want to consider a Roth IRA which has a number of tax advantages as well as some distinct advantages over the 401K plan (primarily the ability to withdraw the money before you are 59 and a half, penalty free, in certain situations).

Pay Off Existing Debt

Many people who have debt to worry about are often concerned that by contributing more to their retirement accounts it will make it that much more difficult to pay off their existing debts. One of the easiest ways to answer the question of whether or not you should contribute more to a retirement or pay off your bills is this: if contributing to a 401K or other type of retirement account is not going to leave you enough money to pay your bills each month, you obviously are not in the position to contribute to a retirement account, yet!

On the other hand, it’s very easy to always say you don’t have enough money to save, so be sure to be honest with yourself regarding how much money you earn each month and how much money you are currently paying out for bills and living expenses. If there is more money than you owe; immediately set up an automatic savings option so that it comes out of your pay without you having to do anything. (if you don’t see the money, you won’t miss it as much!)

In most cases, it doesn’t make sense to skip paying into a 401K or other retirement account in order to pay your car loan or mortgage faster. This type of debt is often a fixed, low interest, and for most people- will be paid off before you are ready to retire. On the other hand, if you take and apply all of your money to these bills now, when you are ready to retire you may not have enough saved to stop working.

If most of your debt is high interest accounts, like credit cards or personal loans for example, you’ll want to pay these off as quickly as possible – even if it means reducing your retirement savings temporarily while you attack the high interest debt. If you paid only the minimum on a credit card that you over-spent on, you could still be paying that $4000 debt in 20 years time (and paying thousands in interest!) The faster you pay off high interest credit card accounts, the more money you save on interest and the more you will be able to contribute to your retirement account.

If your cash flow doesn’t allow you to pay more on high interest accounts because you are contributing to a retirement plan it is probably better to reduce or skip the retirement contributions for two or three years to get your debt paid off- and then put all of that money into your 401K or other savings plan once you are debt free.



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