When it comes to paying off debt or saving for retirement, a lot of people are confused as to the right path to take. Paying off your debt is a put idea and saving up for your retirement is also necessary, but the question should be, “Which of these two options should come first.

This article is gear at helping you make the right decision, this will be done by providing you with the needed information on both options. In the end, whichever option you choose will be the right one for you. As you go through the article, look out for the following points.

• What is Debt?
• What is Retirement?
• Should You Pay Off Debt or Save for Retirement?
• Is It Better to Pay Off Debt or Invest?
• Is It Better to Pay Off Debt or Invest in 401(k)?
• Paying off Mortgage vs Investing Calculator
• Should You be Debt Free Before Retirement?
• How to Pay Off Debt Before Retirement
• How to Pay Off Debt in Retirement
• Should You Use a 401(k) Loan to Pay Off Debt?
• How to Get Out of Debt Without Money
• How to Protect Your 401(k) in A Recession
• How Much Debt is Too Much
• At What Age Should You be Debt Free

What is Debt?

Simply put, Debt is what someone owes to someone else. Usually, debt is in the form of money, but it can also be items, services, favors, or other things. Thus if you make an agreement to give or do something for someone else, you now owe a debt. An example of debt is what you owe on your mortgage and car loan. What about retirement.

What is Retirement?

Retirement means to withdraw from one’s position or occupation or from active working life. You can achieve retirement when you have sources of income that do not have to be earned by working.

Now that we know the meaning of the two words we are focusing on in this article, let’s look at another important point.

Should You Pay Off Debt or Save for Retirement?

When this question arises most times, the straight forward answer will be to settle your debt before saving for retirement, and it really makes sense. Look at it this way, you want to save for retirement, but you’re still getting billed each month for old debts. Can you really justify starting a retirement fund when you have credit card bills, student loans and a mortgage to pay off?

Read Also: How Much Do You Need to Put in Your 401(k)?

However, there is another angle you need to consider. Your age changes the priority level of a retirement fund. Your income and spending trends dictate how much you can afford to put toward savings or debt each month. Your total amount of debt can help you estimate monthly payments and how long it’ll take to pay your debt entirely. And if you’re planning any life events like buying a house, your credit and spending priorities will change.

Some situations might make it compulsory for you to save for your retirement instead to paying off your debt. Some of them are listed below.

• If you’re older and nearing retirement, it might be in your best interest to make a retirement fund your top financial priority.
• If your employer is willing to match your 401(k) contributions, it may be worth it to take this free money, which can make up for the interest you’ll accumulate on unpaid debts.
• If you’re in debt because of a mortgage rather than credit cards, paying down your mortgage may not be a priority. Paying off a credit card creates available credit at your disposal. If necessary, you can use your credit card again to borrow money. But paying a mortgage does not free up additional credit. Further, a mortgage carries a lower interest rate than a credit card, reducing its need for immediacy.
• If your debt is reasonably small, you could continue making the minimum payment and setting aside some money for retirement. With only a small balance remaining on your debts, you’ll be able to wipe it out fairly soon anyway.
• If you feel more comfortable with cash on hand, then you should consider starting a retirement fund sooner rather than later.

On the other hand, if you are younger or don’t receive retirement savings benefits from their employers, it might make more sense to focus more on paying off your debt. Here are some situations.

• Less debt means lower monthly payments. If you work toward paying off debts and don’t accrue further debt, your expenses should decrease each month. This is a wise move if you’re looking to free up cash in the near future.
• A lower amount of debt can boost your credit score. If you’re planning on buying a home or car, this could make you eligible for better interest rates when you take out a new loan.
• Lower balances equate to less interest. Paying a little extra now will save money in interest long-term.

In the end, you need to consider your circumstances and decide on which option suits you better. Another decision you might have to make is deciding whether to pay off debt or invest your money.

Is It Better to Pay Off Debt or Invest?

Since we already know what debt is, let’s try to understand what investing entails and how to go about it.

Investing is the act of setting aside money that will, itself, earn a profit and grow. Investing is not the same thing as is pure savings, where the money is set aside for future use. When you invest, you expect the money to return some income and increase the original amount.

Investing provides the peace of mind that you will have funds available to endure a future financial milestone. Retirement, business projects, and paying for the college education of a child are examples of such financial milestones.

If you have extra cash in hand, deciding whether to pay off debt or invest might be a bit difficult. The reason is that both options sound reasonable at first until you sit down to deliberate on them.

Whether you pay off your debt or invest your money, you have a lot of advantages attached to them. For example, paying off your debt means reduced stress, lower risks, and a greater ability to withstand personal emergencies, recessions, and depressions. Investing means building a reserve that can protect you and your family, provide you with passive income, and allow you to retire comfortably. 

But before you decide where you are going to focus on, here are some things you need to put in place,

• Make sure you have enough cash saved
• Make at least the minimum payment on all your debts
• Take maximum advantage of your company’s 401(k) match, if available

“If you haven’t met one of those requirements, focus on that before tackling anything else,” says Kara. “Only once you’ve met that baseline does the ‘payoff debt versus investing’ decision come into play.”

When making your decision also, there are two things you need to pay attention to, your debt’s after-tax interest rate and the rate of return on the investment.

If you discover that the potential returns on your investment is higher than your debt’s interest rate, you should prioritize investing.

What does this decision look like in real life? It depends on what type of debt you have. Here are the average interest rates for the most common types of debt and investments:

Student Loans: The interest rate on your student loans could vary from 2% to more than 10% depending on what type of loan — federal or private — they are, whether they’re from undergrad or grad school, and what year you opened them.

Like mortgage interest, student loan interest may be tax-deductible (up to a point). Before you calculate your after-tax interest rate, you first need to find out if you’re eligible for the deduction. If your modified adjusted gross income is more than $80,000/year as a single filer or more than $165,000/year as a joint filer, you won’t qualify to deduct your loan interest. If you make less than that, up to $2,500 of your interest could be tax-deductible.

Loans with a fixed interest rate lower than 6% may be worth keeping given their after-tax interest rate could be lower than the rate you could earn on a diversified portfolio. For someone who qualifies to deduct their interest and has a tax rate of 25%, the after-tax rate on a 6% student loan would be 4.5% (6% x (1 – 25%)). However, if you don’t qualify for the tax deduction, you are likely wise to prioritize paying down your loans. Even if you don’t decide to tackle paying down your loans, you may benefit from refinancing your student loans.

You will discover that even if your expected return on the investment you’re considering is much higher than your loan’s interest rate, market risks in the near-term make this impossible to guarantee. But the money you’ll save by putting the money toward your loan — thereby avoiding extra interest — is guaranteed.

Is It Better to Pay Off Debt or Invest in 401(k)?

One point you might have picked from this article so far is that paying off your debt is very important if you want to achieve financial freedom, it should come first before investing. However when it comes to paying off debt or investing in 401(k), You need a deep thought on it.

There’s no perfect answer to this question that applies to all. In general, mortgage debt will be with you for a long time and is generally very low-interest rate debt. Vehicle loan debt may also fall into this category.

Yet, when it comes to a consumer debt or student loan debt, you will thank yourself if you make the required lifestyle changes to get these financial obligations paid off aggressively. It’s difficult to meet other goals such as saving for retirement and buying a home while you are saddled with excess debt.

Paying off Mortgage vs Investing Calculator

When you receive some extra money it may be difficult to determine whether you should invest the funds or use them to pay towards liabilities. Financial theory recommends that if your after-tax return on investments is greater than your after-tax cost of debt then you should invest. Use this calculator to help analyze your situation.

Should You be Debt Free Before Retirement?

It is important to note that when it comes to debt, controlling it at every stage of life is compulsory. So whether you are still young or approaching retirement, ensure to be debt-free.

But a flat statement about eliminating all debt in retirement may be too simplistic. That’s because the amount of debt you can comfortably handle is very individual and depends on your bigger financial picture.

So, if you’re convinced that being debt-free in retirement will give you the greatest sense of security, then that should be your focus. Get rid of consumer debt first. Make additional payments on your mortgage, as you’re able. And give yourself a realistic retirement timetable—one that will allow you enough time to plan and save for a comfortable future.

How to Pay Off Debt Before Retirement

Now that you have decided to pay off your debt before retirement, have it in mind that you have made a very good decision. This is because retirement should come after these four steps.

1. Save a $1,000 baby emergency fund.
2. Pay off all your debt except your mortgage using the debt snowball method.
3. Save an emergency fund equal to three to six months of expenses.
4. Invest 15% of your income in tax-advantaged retirement accounts.

For example, your baby emergency fund allows you to focus on paying off debt. If you have an unexpected expense, your emergency fund will cover it, and you avoid sinking further into the hole

Then, once you’re debt-free, you can concentrate on saving up a fully-funded emergency fund instead of making payments. Finally, you’ll be able to use your income—your most powerful wealth-building tool—to make real progress on your retirement nest egg.

How to Pay Off Debt in Retirement

Everyone wishes for a debt-free retirement, but sometimes, because of some situations beyond your control, this might not be possible. The good news is, all hope is not lost, you can still pay off your debt while in retirement.

It wouldn’t be easy to achieve this though. Like Katie Ross, education and development manager for American Consumer Credit Counseling, a national financial education nonprofit said, “It can be difficult to pay off debt after retiring, especially if you are on a fixed income. But that doesn’t mean it is impossible. Here are some tips to help.

Take a Moment to Access Your Financial Situation

Thinking about your debt might leave you feeling tense and unable to make sound decisions. The first thing to do will be to take a deep breath and think about what the current financial situations is.

Ask yourself “what’s the worst that can happen” and keep reminding yourself that learning how to deal with debts is important but not worth making yourself sick. The best way of dealing with debt is to approach the situation calmly and without panic. Don’t be tempted by payday loans, car title loans, or get talked into co-signing a mortgage. Only do things that are going to have a positive impact on your financial situation. Financial moves made under duress tend to be less than ideal.

Consider Downsizing

One way you can downsize is by sell your home and move to a less expensive one — or rent if you’re carrying a mortgage into retirement. Not only will you reduce your monthly mortgage payments, but you will likely spend less on other bills like lawn care, heating and air conditioning

If the furniture you now own won’t fit in the new space, you could sell it and use the proceeds to pay off other debts faster.

Use a Debt-Busting App

There are also helpful apps for your phone or tablet that can help you manage debt. Three that cost less than $1 to download:

• Debt Payoff Planner: The free app is compatible with Android and iOS. You enter your debts, put in your monthly payment budget and then see how long it will take to be debt-free.
• Debt Manager: This app, available on iOS, lets you make a list of your debts and prioritize them. After paying off one debt, the app transfers the amount you’ve been paying to the next one in line.
• Debt Book: With this graphic-laden Android app, you enter your debts and track your payment progress.

Try Automatic Debt Payment

Many banks let you set up automatic, recurring debt payments to be made every month. Start by setting the payments to at least the minimum amount due each month. Then, use a calculator like the one at NerdWallet.com to see how long it will take to get rid of the debt. After that, increase your monthly amount to pay off balances faster.

Look for Ways to Increase Your Income

After you have applied all these tips, a method that will yield instant results is to look for ways to make more money. Considering that you are retired, this might not be easy for you especially if you are looking to get a job. But the internet is filled with different ways you can make money no matter your age or circumstances.

For example, if you love pets, you can sign up to be a pet sitter at Rover.com. Another option: put your expertise to work by teaching or giving lessons at TakeLessons.com. If you’re crafty, you might set up a shop on Etsy.com to sell items you make.

Or look into consulting work in the industry you formerly worked in. You might even find your previous employer could use the expertise of people with years of experience, like you.

Should You Use a 401(k) Loan to Pay Off Debt?

A 401(k) plans allow users to borrow up to half their retirement account balance for a maximum of five years. The limit is $50,000. About 1 in 5 plan holders have a 401(k) loan, according to Fidelity Investments, a large retirement plan administrator.

However, a 401k loan should be your last means of solution, you shouldn’t see it as a means to raise money. It is only when other options are exhausted, a 401(k) loan might be an acceptable choice for paying off toxic high-interest debt, when paired with a disciplined financial plan. Consider this.

Let’s say you withdraw from your 401(k) earnings to pay off your credit cards. A few years later your credit cards have rebuilt themselves and you think again about your 401(k) money just sitting there. You take another withdrawal. A year later, you take out money for a home down payment. Before you know it, you’re 65 with little saved for retirement.

While withdrawing from your 401(k) can be one option, you will want to consider your long-term goals. Your 401(k) may or may not be better off collecting dust now but treat the decision to withdraw money as if your future financial health depends on it. Because it does.

How to Get Out of Debt Without Money

Is it really possible to get out of your debt without paying it? Well, the answer is not so straightforward, some factors will need to come into play for that to happen. Before you stop paying, make sure you know the limitations and the long-term ramifications of doing so. Here are some situations to consider.

Student Loans

There are many options available to you when it comes to student loans. However, your loan, job status and sometimes the school you attended all determine what you’re eligible for. Some of these may apply to you.

Public Service Loan Forgiveness: Available for those who work in the public sector, like employees at the federal, state, and local level, and for those who work for a nonprofit organization. After you’ve made 120 qualifying payments while working full time for a qualifying employer, the rest of your Direct Loans will be forgiven.

Teacher Loan Forgiveness: Open to teachers who work five consecutive years at a low-income elementary or secondary school and to those who work at an educational service agency. You might qualify for forgiveness of up to $17,500 of your Direct Loans or Stafford Loans.

Perkins Loan Cancellation: Teachers, firefighters, law enforcement officers and others are eligible for Perkins Loan cancellation or discharge. Cancellation can happen over the course of five years, while discharge could happen in the event of bankruptcy, death or disability.

Closed school discharge: If your school closed while you were attending (or soon after you withdrew), you may qualify to have your federal student loans discharged.

Discharge options: You could get your loans discharged in the event of death, permanent disability or — very rarely — bankruptcy.

Credit Card Debt

If you have more credit card debt than you can handle, there are a few steps you can take; however, you may want to consider the repercussions.

If you stop paying your credit card bill, it gets turned into collections and your credit score tanks. But there’s a statute of limitations for how long creditors can sue you for outstanding credit card debt, which varies from three to 10 years in most states. You could skip payments, but you might be liable for them later. Even at that point, if you are sued for outstanding payment, you most likely wouldn’t win the case.

Another route is debt settlement, which is when you settle your debt with the current lender (or collection agency, if it’s reached that point) for less than what you owe. You may not be responsible for your entire credit card debt, but you’d still pay some of it.

File For Bankruptcy

This option should be your last resort. Filing for bankruptcy may sound like you’re starting over, but depending on the route you go, you may still be on the hook for some of your outstanding debt.

In a Chapter 7 bankruptcy filing, some of your assets are sold off to pay back debt, meaning you could lose your home and personal property. A few months after filing, your remaining debt will be discharged — although Chapter 7 typically won’t cover things like student loan debt or child support.

In a Chapter 13 filing, you get set up on a court-ordered repayment plan. Any remaining debt after a certain time has passed, like five years, might be discharged. This process means you’ll spend even longer paying off your debt, and you’ll also have a bankruptcy filing on your credit report.

Depending on the type of bankruptcy you file, a bankruptcy filing could stay on your credit report for up to 10 years, which is why it’s important to carefully weigh your options and your outstanding debt. Debt collectors can’t attempt to collect a debt that was discharged in bankruptcy, and they can’t continue collection activity while the bankruptcy case is pending — but the filing itself will have long-term effects on your financial health.

How to Protect Your 401(k) in A Recession

Whenever a recession being talked about. a lot of investors usually panic and they start to think of the possible way to secure their investments. The same can be said about your (401k) investment. When you hear a report from an economist about a future recession, what should you do to protect your investment? Here are some tips

Avoid early withdrawals

Early withdrawals are a killer for a successful retirement, so you need to do everything you can to avoid them. That goes double when the market is down since you suffer not only from having a lower balance in the account but also from selling and not enjoying the future rebound. On top of all of that, the IRS may hit you with an early withdrawal penalty.

One alternative is to take a loan from your 401(k), if the administrator offers it, and not all do. You’ll have to pay back the loan, but at least you can avoid the income tax and a penalty on the withdrawal. A loan is generally not a great solution, because it may limit future contributions that you otherwise would have made and you’re repaying the loan with after-tax money from your paycheck.

The best solution is to avoid taking out any money if you can help it at all. Your 401(k) account is about the last thing you should tap for money, especially for any expense that you can delay.

Pay attention to asset allocation.

When the stock market becomes more volatile, investors may have thoughts like, “Should I move my 401(k) to bonds?” This could offer a sense of security in the near term, but it’s important to avoid becoming shortsighted. Richter says it’s better to ensure that a retirement portfolio is invested in a way that doesn’t necessitate sudden changes if a slowdown occurs.

“A plan participant should avoid the temptation to attempt to time the market,” he says. Those closer to retirement should be focused on minimizing volatility, while younger workers can look for opportunities to grow their portfolios. “The investors who have allocated properly should be able to ride out the waves of a recession without losing sleep,” Richter says.

Continue to Contribute into Your 401(k) Investment

How much to put in a 401(k) during a recession is something workers may struggle with if they’re concerned about a declining stock market. Charlotte Geletka, managing partner at Silver Penny Financial, says investors shouldn’t be put off by gloom-and-doom financial headlines. “When the stock market is down is the best time to invest in your 401(k),” she says.

That’s because elective salary deferrals can stretch further when stock prices drop. Re-evaluating current contribution rates and potentially increasing that rate are strategic moves to consider when the economy seems to be in a slump. Sticking to a long-term retirement investment approach that includes consistent contributions can help balance out down periods over time.

Avoid taking a loan from your plan

Loans can be just as detrimental as withdrawals when the economy begins to lose steam. “Investors should be especially careful about taking 401(k) loans in a contracting economic environment where their job might be at risk,” says Chad Parks, founder and CEO of Ubiquity Retirement + Savings.

“If you don’t have the money to repay the loan, you could be at risk for a huge tax liability and a penalty charge, just when you can least afford it.” Loans can also be problematic if the plan bars workers from making new contributions while the balance is outstanding. The value of existing assets in the plan may shrink and savers aren’t able to offset that with new investments.

Does Borrowing From Your 401(k) Affect Your Credit Score?

If your 401(k) plan permits, you’re allowed to borrow up to $50,000 or half your vested account balance, whichever is smaller, for any reason you want. This might sound like a great time to take a vacation, but borrowing from your 401(k) affects your financial outlook, even though it has no impact on your credit score.

No Negative Impact

With a traditional loan, each lender you approach pulls your credit report, which results in an inquiry on your credit report. Then, after you take out the loan, it shows up as debt, which can lower your credit score. When you take out a 401(k) loan, you’re borrowing your own money, so there’s no lender to pull your credit score. When the plan disburses the loan funds to you, it doesn’t show up on your credit report, so it won’t add to your debt. Plus, it isn’t considered long-term debt, so it doesn’t hurt your chances of being approved for a mortgage.

No Benefits Either

Because the loan isn’t reported on your credit score, paying it on time according to the loan terms doesn’t improve your credit score. When you have a loan that is reported to the credit bureaus, each on-time payment builds your payment history, which bolsters your credit score.

How Much Debt is Too Much

You might be struggling with different kinds of debt, like a mortgage, an auto loan, a student loan, or even a credit card balance. Soon you will realize that having too much debt can cause an unhealthy financial life. Even if you can afford the monthly payments, your debt may still affect your ability to meet other financial and life goals. If you fear you might have too much debt, there’s a way to see exactly where you stand. But how do you know when your debt is too much? Below is an example.

For example, you may have too much debt if you have to use your credit card to pay for ordinary expenses, you frequently run out of money before your next paycheck, or you don’t have enough money to build an emergency fund or save for retirement. These are signs that you’re spending too much of your income on debt payments.

Rather than guessing, you can calculate your level of indebtedness relative to your income. One of the easiest ways to calculate your debt load is by figuring out your ​debt-to-income ratio. This number compares your monthly debt payments to your monthly income.

You can calculate your debt-to-income ratio in two different ways. You can include all your debt or only your non-mortgage debt. Leaving out your mortgage allows you to measure only the amount of consumer debt you’re carrying.

Carrying high amounts of consumer debt, like credit cards, personal loans, auto loans, and medical bills causes more financial problems if you fall behind. On the other hand, if you want a total picture of your debt, include all your debt including your mortgage.

For example, assume your monthly income is $3,000. Let’s also say you spend $300 on credit card payments and $450 on an auto loan. Your ratio calculation would be $750 / $3,000 = 0.25. Then multiply by 100 for a debt-income-ratio of 25%. In this example, you spend a quarter of your income on consumer debt. Consider it this way: for every $1 you earn, you’re spending 25 cents on debt, leaving you with 75 cents for savings, non-debt expenses, and other financial goals.

If you determine that you have too much debt, you can put together a plan to lower your debt. Not only will that make your finances easier to manage, but it will also improve your credit too.

At What Age Should You be Debt Free

The truth is that nobody wants to be in debt, but sometimes, some circumstances beyond your control might arise and the only option will be to get a loan. However, early payment is necessary to be debt-free.

There has been a lot of discussions as to which age is ideal for you to be debt-free. Kevin O’Leary had some points to make on this subject.

“The reason I say 45 is the turning point, or in your 40s, is because think about a career: Most careers start in early 20s and end in the mid-60s,” O’Leary says. “So, when you’re 45 years old, the game is more than half over, and you better be out of debt, because you’re going to use the rest of the innings in that game to accrue capital.”

In addition, It can be difficult to get out of debt quickly. The average person should be debt-free by the age of 58 unless you choose to extend your payments. Otherwise, you could potentially be making payments for another two decades before you become debt-free.

Now, if you were to use a more disciplined budget and well-planned payments, you could be done by age 39.

Disadvantages of Paying Off Your Mortgage

You may even be tempted to pay off your mortgage early if you’re fortunate enough to have the cash lying around. However, paying off a mortgage early isn’t always the smartest decision, and there’s a reason mortgage are referred to as “good debt.” So if you’re thinking of paying off your mortgage early, here are three reasons to reconsider.

Less liquidity

By keeping your mortgage, and the cash you might have used to retire it, you’re creating a better personal balance sheet. Yes, it will be one with another liability (your mortgage) but also one with more in assets (cash). By eliminating your mortgage with the cash, you also limit your ability to address an unexpected expense or investment opportunity.

It won’t provide income

When you invest your money in stocks and bonds, you have the potential to secure an income stream via dividends, interest payments, and capital gains. Paying off your mortgage, however, won’t provide you with income. Instead, it will leave you with limited cash left over to invest. If you put all your money into your home, it could take years for it to grow in value, and paying off your mortgage could limit your ability to generate income for things like college, retirement, or other short- and long-term goals.

Inflation hedge

You’ll be making payments on your current mortgage in future dollars, which will actually cost you less in real dollars in the years ahead. So, for example, if there’s an annual inflation rate of just 2 percent during the next 15 years, the last payment of $1,000 on a new 15-year fixed-rate mortgage will only “cost” $743 in today’s dollars.

Conclusion

If you’re under 35, the time to deal with a debt problem is now. Having a well-funded retirement plan will be of no benefit if it is offset by an equally high level of debt.

If you are deep in debt, seriously consider your situation and your options, as well as the implications for your future.