There’s an age-old dilemma: Do you pay down debt or save for retirement with your excess dollars? Paying down debt can be appealing–it feels safe and secure. However, putting off saving limits the growth of your assets.
Most experts we’ve consulted agree that you should never leave money on the table. If your employer offers a match on your 401(k), take full advantage of that first. A 50% match is a 50% automatic return!
After maximizing your match, high-interest debt should be paid off next. For example, if you are making only the minimum payment on a $5,000 credit card at 12% interest, it will take almost 13 years to settle. However, by paying an extra $100 per month, that $5,000 will be paid off in just under two years. So what qualifies as “high-interest debt”? Conveniently, the experts do not agree, but anything over 10% is worth a closer look.
Beyond these two scenarios, it is less about the numbers and more about what’s most important to you.
- By investing more into retirement now, there are potential tax advantages (subject to IRS guidelines). Also, the earlier you contribute, the greater the benefit to your nest egg. For example, if you invest $100 per month at 8%, it would yield $7,600 in five years; in 20 years, $60,000.
- There are also benefits that come with paying down a low-interest loan. For example, apply that $100 extra monthly payment to a 30-year, $180,000 mortgage, at a 5% interest rate. At the end of five years you’d end up with $6,800 in additional equity. At the end of 20, you’d have an additional $41,100 – not as much as investing, but still significant.
Maxing out the 401(k) match and paying down high interest credit card debt are clear winners. But when left with the choice of paying down low interest debt or increasing your retirement contribution, what makes you sleep best at night just may be the best way to go.