Pay off debt or put money into a 401(k)? For people who have debt but are still concerned about retirement savings, this is a crucial decision to consider. When thinking about this, there are a lot of factors to take into account, like how much money to put toward debt vs retirement and when
In this article, we’ll lay out some information to help you understand what’s involved in making this decision. We’ll look at your mind and your money. And we’ll investigate how to decide whether to contribute to your 401(k), pay off debt—or do both.
In the face of economic uncertainty many individuals are grappling with the dilemma of whether to prioritize debt repayment or retirement savings. While both are crucial for financial well-being the decision of which to prioritize can be a complex one, fraught with emotional and financial considerations.
The Allure of Debt-Free Living
The allure of debt-free living is undeniable. The burden of high-interest debt can weigh heavily on both our finances and our mental well-being. The prospect of eliminating that burden can be incredibly enticing offering a sense of freedom and control over our financial future.
The Importance of Retirement Savings
However, the importance of retirement savings cannot be overstated. Our money has more time to grow thanks to compound interest if we start saving early. This can have a big impact on how much money we have saved for retirement, guaranteeing a comfortable and secure future.
Finding the Right Balance
As with most financial decisions, the answer to the question of how to strike the right balance between paying off debt and saving for retirement is that it depends. There is no one-size-fits-all answer, and the optimal strategy will change based on the specifics of each case.
Factors to Consider
Several factors should be considered when making this decision:
- The Type of Debt: Not all debts are created equal. High-interest debt, such as credit card debt, should be prioritized for repayment as it can quickly snowball and eat away at your financial progress. Lower-interest debt, such as student loans or mortgages, may be less urgent to pay off.
- Your Financial Situation: Your overall financial situation plays a crucial role in this decision. If you have a stable income and a healthy emergency fund, you may be able to afford to prioritize debt repayment. However, if you are living paycheck to paycheck or have limited savings, it may be wiser to continue contributing to your retirement savings.
- Your Risk Tolerance: Your risk tolerance also comes into play. If you are comfortable with taking on some risk, you may be willing to pause your retirement contributions to focus on debt repayment. However, if you are risk-averse, you may prefer to prioritize retirement savings even if it means carrying some debt.
Making an Informed Decision
The choice to stop making contributions to your 401(k) in order to pay off debt is ultimately a personal one. There is no right or wrong response, and the optimal course of action will depend on your unique situation. But if you carefully weigh the previously listed considerations, you can decide in a way that suits your risk tolerance and financial objectives.
Additional Considerations
Here are some additional considerations that may be helpful:
- Speak to a financial advisor: A financial advisor can help you assess your financial situation and develop a personalized plan that takes into account your individual needs and goals.
- Explore other debt repayment options: There are a variety of debt repayment options available, such as debt consolidation loans or balance transfers. These options may help you reduce your interest rate and pay off your debt faster.
- Don’t forget about your emergency fund: It’s important to maintain an emergency fund to cover unexpected expenses. This will help you avoid going into debt if you face a financial emergency.
The decision of whether to stop contributing to your 401(k) to pay off debt is a complex one. By carefully considering your individual circumstances and exploring all of your options, you can make an informed decision that aligns with your financial goals and sets you on the path to a secure and prosperous future.
Life choices: Debt vs. 401(k)
The reality is that many people with outstanding debt don’t have the funds to completely pay off their debt immediately. In many cases, they may even have a negative net worth. Here’s where your mind comes in.
Before you move forward in your financial life, you need to make some important decisions. You have limited income and vast financial wants and needs. You need a job to generate income, and you also need to pay for things like rent, food, insurance, transportation, and debt repayment. The remainder of your spending is discretionary.
How you allocate your money now can influence the rest of your financial life. Your habits, when practiced over time, can become permanent. For example, using credit to continuously finance your “wants” can become a habit and result in a tight financial future. Now is the time to ask yourself some questions:
- To strengthen your financial situation in the long run, are you prepared to give up some short-term desires?
- In order to reduce debt and save for the future, are you able to set and maintain goals related to budgeting, spending, and saving?
You might need to cut back on your current spending in order to have more money for debt repayment if your goal is to improve your long-term financial situation. That implies that in order to increase your chances of paying off debt and setting money aside for the future, you must develop goal-setting, budgeting, and spending discipline skills. This is where the hard decisions come, and you’ll need to learn to say “no” to yourself. Develop self-discipline now, and it will be simpler to pay off debt and save for retirement.
Debt and retirement facts
Let’s look at the facts. According to the SSA, the average monthly Social Security benefit was $1,703.98 in July 2023. Very few people can live on Social Security alone, so it’s often on the individual to shore up their finances for retirement.
Paying off debt, whether it be credit card debt, student loan debt, or something else entirely, has an impact on your capacity to save for retirement. The interest rate you pay on your debt is frequently greater than the rate of return on your retirement savings. If, for instance, you choose to invest rather than pay down your debt and you assume a 7% interest rate on your investments and your debt interest rates are higher than 7%, you run the risk of losing money.
For example, let’s say that Julian has a credit card debt of $20,000. He will be paying that debt with an average interest rate of 2018 for the time being. If he invests that money rather than using it to pay off his debt and instead receives a return of 7% on average for his investment dollars, he will lose money in 2011(18-7=11) because he chose to invest rather than use it to pay off his debt. Keep in mind that, in contrast to the obvious advantages of paying off debt, investment returns are not assured and that there is always a risk associated with making investments, including loss.
Should I Really Stop My 401(k) Contribution While Paying Debt?
FAQ
Should I stop my 401k contributions to pay off debt?
Should I take out my 401k to pay off debt?
Should you stop investing to pay off debt?
Should I stop putting money into my 401k?
Should you pay off debt before investing in a 401(k)?
Others may prefer to pay off any and all debt as quickly as possible, before saving for retirement. If you have low-interest rate loans and expect higher returns on the investments in your 401 (k), it may be a good strategy to contribute to your 401 (k) while chipping away at your debt—making sure to prioritize paying off high-interest rate debt.
Should I withdraw money from my 401(k)?
Before withdrawing money from your 401 (k), there are some pros and cons to consider. May pay off debt sooner: In some cases, you may pay off debt earlier than you expected. By putting your 401 (k) withdrawal toward your existing debt, you may be able to pay off your account in full.
Should a 401(k) be used to pay off credit card debt?
Allan Roth, founder of Wealth Logic in Colorado Springs, Colorado, said that for people over 59½ and in a low tax bracket, a 401 (k) withdrawal to pay off credit card debt may make sense because these people are avoiding the 10% penalty and not subject to a huge levy. “Certainly the math can make it worth it,” Roth said.
Should you use a Roth 401(k) to pay off debt?
With a Roth 401 (k), you would have the full $45,000 to pay off your debts. Of course, with either type of 401 (k), you would have that much less money saved for retirement. Should You Use a 401 (k) to Pay Off Debt? In some cases, it could be beneficial to cash out a portion of your 401 (k) to pay off a loan (or credit card) with high rates.