Should you pay off debt or save for your retirement? This is an extremely loaded question! As we always know how crucial it is to repay toxic debt, especially credit cards that carry outrageously high interest rates, there is always a dilemma as to whether one should repay their sky-high debt or rather save their dollars for a debt free retirement.
We all are aware of the benefits of getting a large retirement portfolio and if it is big enough, it can easily provide you with a considerable standard of living, that can even be better than what you had when you were working.
But the fact is that not everyone is blessed with a wealthy retirement portfolio that can help you earn dollars that are remotely sufficient. Sometimes it might be better for you to pay off debt as this can get you a bigger bang for your dollars than putting away more money for retirement.
An example to illustrate which option is better for you
Suppose you’re in a position where you own $10,000 that you can use either to repay debt or invest for your retirement. In case you take the decision of investing those dollars in the stock market and you start earning a long term average of about 8%, this will imply an income of about $800 per year.
But instead of investing the money in the stock market, if you can use it to repay your car loan with a per month payment of $300 and an outstanding balance of $10,000, you can easily reduce the annual expense of the car loan by $3600. Although the example of a car loan doesn’t fit in too well as you can repay the car loan with ease, if you can devote your dollars towards debt like mortgage or credit cards, the financial benefit will be more lasting.
Can repaying debt free up income for larger contributions?
If you repay debt before retiring, chances are high that you will be allowed to contribute more towards your retirement account. For instance, in the example mentioned above, when you pay off your auto loan debt instead of investing your dollars, you save $300 every month and this amount can easily be redirected towards your retirement savings and once the money is there in your retirement account, the money will beget more money in the near future. So, the more debt you can eliminate before retiring, the more money will be available for investing in your retirement account.
Paying off debt before retirement also reduces your retirement expenses
Another benefit of paying off your debt obligations is that it is possible to reduce your expenses in retirement. For example if your income requirement for retirement is $4000 among which $1600 is devoted towards your debt obligations; $1000 per month for your mortgage, $300 per month for a car loan payment and another $300 for the credit card payments.
If you can take some rock solid steps to repay these debts off, you can easily reduce your need for income (post retirement) to $2400, which is a reduction of about 40%. Although you will have less amount in your portfolio as you’ve repaid your debts, yet your meed for income will also be less.
In a perfect world, you could easily repay debt obligations and also invest for your retirement at the same time. But as this is not a perfect world, you should concentrate on repaying your debts before saving for retirement to secure a peaceful retired life. Make the required calculations through a debt payoff calculator before taking the plunge.
About the author: Barbara Delinskey is a writer who mainly specializes in finance. She contributes her posts to different financial websites and communities. Some of the topics covered by her are debt consolidation pros and cons, worth of debt settlement as a debt relief option and many more.