Should You Pay Off Debt or Save for Retirement?

Chances are, you've consulted a map or used a guide to reach a desired destination. A solid financial plan acts like a map in much the same way: a means of reaching your larger financial goals with a step-by-step plan for controlling your income, expenses and investments.

A comprehensive financial plan will thoughtfully address both your short- and long-term goals, which may beg the question: Should I pay off debt now, or save for retirement?

Of course, when it comes to a financial plan, there's no one-size-fits-all solution. The right answer for you will depend on several factors we'll examine in this article.

Benefits of Paying Off Debt

There are plenty of good reasons — besides the obvious legal obligations — to pay off debt, including the greater financial security, flexibility and financial independence that being debt-free provides. Here are a few more benefits of paying off debt.

Reduced stress

Virtually no one avoids carrying some debt during their lifetime, but two out of three U.S. adults say money is a significant source of stress in their lives.¹

Carrying debt that feels unmanageable or overwhelming often means carrying extra stress along with it, particularly if that debt causes you to make choices between which bills get paid, or worry about covering basic expenses. Long-term chronic debt stress has been linked to increased instances of depression, anxiety, migraines, elevated blood pressure, heart problems and even suicide.¹

If financial stress is compromising you physically or mentally, talk to your doctor first about strategies for protecting your health. Next, speak with a trained professional, such as a credit counselor, to help you assess your specific financial situation and formulate a debt management plan.¹ Simply having a road map in place to address debt can dramatically reduce levels of stress and anxiety.

Read Related: 18 Easy and Instant Stress Relief Techniques

Reduced interest payments

Paying off debt as quickly as possible — particularly high-interest debt such as credit cards or personal loans — means you'll save money over time and pay less in interest as your debt decreases.²

Use an online debt calculator to find out how much you could save in interest payments and how quickly you could pay off a specific debt if you paid more than the required minimum amount each month. You can use an online calculator for almost any debt — from credit cards to auto, mortgage or student loans.³

Some loans may come with fees or surcharges for an early payoff, so be sure you're familiar with any restrictions associated with the debt you're planning to pay off.

Improved credit score

The amount of debt you owe relative to the total amount of credit you've been given is called your credit utilization ratio.³ In other words, your credit utilization ratio indicates how much of your credit line you are using at any given time.

When you pay off debt, you reduce your credit utilization ratio, which may improve your credit score, giving you access to more favorable interest rates in the future.³

The FICO credit model generally encourages consumers to keep their credit utilization ratio around 30% or less. As an example, a consumer with a $1,000 line of credit should keep their balance at or below $300.³

Read Related: What Is a Good Credit Score?

Benefits of Saving for Retirement

Ideally, saving for retirement is a marathon that starts decades before you're ready to stop working, ensuring you have enough personal savings to enjoy a long and comfortable retirement. Here are a few advantages of saving now for retirement.

Long-term financial security

Social Security replaces only about 40% of a worker's wages after retirement, and most financial experts agree retirees will need approximately 70% of their annual income earned while working to maintain a similar lifestyle in retirement.⁴

While relying on Social Security alone to provide for your needs in retirement is not a viable option for most Americans, personal retirement savings can offer more long-term security and the opportunity to create the kind of retirement you want. In addition, saving for retirement provides certain tax benefits both now and when you're ready to tap into those retirement funds down the road.⁴

Compound interest

The earlier you start saving, the more time your money has to grow, and with the added power of compound interest, or “earning interest on interest," your nest egg grows even faster.⁵

Compound interest is the interest on savings calculated on both the principal and the accumulated interest. Because compound interest includes accumulated interest, the paid interest continues to grow over time.

For example, a $10,000 investment (the principal) at 5% (the interest rate) compounded annually will earn $500 in interest in the first year. In year two, the account (now $10,500) will earn $525 in interest (0.05 x 10,500 = 525), bringing the account to $11,025. At this rate of 5% compounded annually, after 40 years the account will be worth over $40,000, having accrued more than $30,000 of interest over time.⁵

Employer matching 401(k) contributions

A company 401(k) retirement plan is one of the easiest ways to save for retirement as you can earmark a portion of each paycheck to go to your 401(k) account, resulting in a consistent deposit schedule.⁶

If your employer offers a 401(k) match benefit, meaning that when you contribute to your 401(k) account they do too, you're receiving “free money" from your employer. It's a smart move to take advantage of this benefit to maximize your 401(k)'s power.⁶

Employers may match 401(k) contributions 100%, 50% or partially match up to a certain percentage, like 6% or 8%, of your pre-tax contributions. Your plan will outline the specific terms and conditions.

Read Related: The Basics of Retirement Accounts

Pay Off Debt vs. Saving for Retirement: What to Consider

So, should you pay off debt or save for retirement first? The answer is … it depends.

One school of thought advocates paying off all debt as quickly as possible in order to maximize investing and saving opportunities. Another school of thought adheres to a “pay yourself first" philosophy, pointing out that not all debt is created equal.⁷

There's no right or wrong answer, but consider the following factors when evaluating your strategy:

Interest rates and type of debt

Interest rates vary significantly on different types of debt. Low-interest mortgages and student loans, for example, are “cheap financing" compared to the double-digit rates typical for credit cards or personal loans.⁸

Most financial experts would agree it's a wise move to prioritize paying down high-interest credit card balances while allowing low-interest debt like a mortgage or student loan to be paid over time, or paid off after more pressing financial milestones have been met.⁹ You may also be able to take a tax deduction on interest paid on mortgages and student loans, making these loans even more affordable.⁷

Your age and timeline for retirement

The advantage of time and compound interest when it comes to saving can't be overstated. The longer you have to save and invest, the better. If you have 20 or 30 years before retirement, you might focus on funneling extra money to high-yield savings accounts, or tax-advantaged accounts like 401(k)s or traditional IRAs, Roth IRAs or HSAs (health savings accounts).⁸

If you're closer to retirement, you might prioritize paying down debt to improve your cash flow and shore up your existing savings.⁸

Read Related: What Is Full Retirement Age and Why It's Important

Your personal financial goals⁷

Your financial goals are unique to you. Being completely debt-free — including mortgage-free — might be a top priority if you're seeking the peace of mind and sense of freedom it provides.

On the other hand, you might be comfortable with the conventional wisdom that recommends paying off high-interest debt first, then focusing on a balanced plan of saving and investing while allowing low-interest loans to be paid over time.

Neither approach is right nor wrong, and a financial plan that works for you accommodates your psychological well-being as much as your budget's bottom line.

Strategies for Balancing Debt and Retirement Savings

Paying down debt or saving for retirement are personal decisions and part of your larger financial strategy. Most financial experts agree that the reality is not an either/or choice, but more often a balanced approach to doing both.

Prioritize paying off high-interest debt

Making minimum payments on high-interest credit cards or personal loans is like being trapped in a financial headlock. Prioritize getting out from under these debts and tackle them with either the debt avalanche or debt snowball method.

With the debt snowball approach, you'll focus on paying off the card with the smallest balance first, then move on to pay off the next highest card balance, and so on. The psychological boost from paying off cards one by one creates a motivating “snowball effect."²

Deploying the debt avalanche approach means targeting the debt with the highest interest rate first, then moving on to pay off debts with the next lowest interest rate, causing the high-interest debt to crash like an avalanche.²

Both methods have their pros and cons, but both ultimately create a solid path to repayment, which frees up more money for investment as your debt decreases.

Update your household budget

Review your most recent household expenses, including all bills, bank statements, loan balances and credit cards. Use an expense tracker to track how you're really spending your money and make adjustments according to your saving goals.⁸

Extra funds can be earmarked for either debt repayment or boosting retirement accounts, or divided between both.

Maximize employer 401(k) matching

You already know to take full advantage of a company matching program if you have one.

If your company matches up to a certain percentage — 3% to 6%, for example — ensure you're working toward increasing your contributions to your retirement fund to get the maximum match from your employer.⁹

Be aware of your employer's vesting schedule, or the amount of time you must work for your employer in order to keep the matching contributions. You may want to time your retirement date to coincide with the vesting schedule. Once the matching contributions are fully vested, they're yours to keep.⁶

Use a windfall to pay off debt and save for retirement

Whether it's a tax refund, work bonus, stimulus check or a lucky lottery ticket, sometimes life hands you a financial windfall.

While it might not be the most exciting option, you could make a significant reduction in your debt depending on the size of the windfall. Likewise, it's a good idea to earmark a portion of those funds for a retirement account like a traditional IRA or Roth IRA. Annual IRA and Roth IRA contributions cannot exceed $6,000 per year if you're under the age of 50, and $7,000 if you're 50 or older.¹⁰

Consult the professionals

An experienced professional financial advisor can offer the sound advice you need to maneuver through life events such as marriage, planning for children, elder care, property ownership, new business ventures, divorce, medical issues and of course, retirement.¹¹

Professional advice can be particularly important as you approach milestones like retirement, an event with a definitive date in which your investment accounts must shift focus from growth to distributing funds.¹¹

Similarly, you may benefit from debt counseling to get professional guidance on your best course of debt repayment if your debt is overwhelming. Nonprofit organizations like the National Foundation for Credit Counseling (NFCC) can provide help and answer your questions.

Other resources for free or low-cost financial advice to consider include:¹²

• Banks, credit unions and online brokerage firms
• Online education
• Government agencies and services
• Industry pro bono groups
• Project-based financial advisors
• Employee benefits

Consider Your Bigger Financial Picture

Paying off debt versus saving for retirement can coexist in your financial landscape without being an all-or-nothing choice of one or the other. Becoming debt-free while simultaneously saving for retirement both serve the same goal of ultimately achieving long-term financial security.⁹

Creating a financial plan that balances both priorities means adjusting your strategy over time as your debt decreases and you're able to contribute more to your retirement savings.

Take Charge of Your Health and Wellness

If you are looking for an option to help manage your health and wellness finances, consider the CareCredit credit card. The CareCredit card can help you pay for the care you want and need and make payments easy to manage.* Apply today and use our Acceptance Locator to find a provider or retailer near you that accepts CareCredit. Continue your wellness journey by downloading the CareCredit Mobile App to manage your account, find a provider on the go, and easily access the Well U hub for more great articles, podcasts, and videos.

Author Bio

Anne-Marie Kennedy is a freelance writer with more than 20 years of experience covering health and wellness, personal finance, and real estate/investing.