Like most people, you have a limited amount of money and must decide what to do with it. This can be a complicated choice if you have debt you're trying to pay back, but you're also eager to begin saving for retirement so you can have financial security in your later years.
So, how should you decide whether to focus on debt payoff or investing for your future? Here's what you need to know to help you make this tough choice.
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How to decide if debt payoff or retirement savings is the smartest choice
To decide if debt payoff or focusing on retirement savings makes sense, there are a few things to consider. But one of the most important factors of all is which approach will provide you with a better return on investment (ROI).
You'll always want to pay the minimum balance due on any debts you've taken on. But if you pay extra beyond the required payment instead of directing that money to retirement savings, your return on investment will equal the amount of interest saved. If you have credit card debt at 17%, you get a pretty high ROI. But if you have low-interest mortgage debt at 3.50% and you are able to itemize your deductions and deduct the interest paid on your home loan when you file your taxes, then your ROI is very low.
If you invest instead of prioritizing debt payback, on the other hand, your ROI is the money that your investments make. But you could also get a 401(k) match from your employer, which could provide as much as a 100% return on investment if your company matches your contributions on a dollar-for-dollar basis. And you could qualify for tax breaks for retirement investing. These tax breaks could include deductions for contributions to a 401(k) or IRA and even the saver's credit which could cut as much as $2,000 off your tax bill if you're eligible and contribute the maximum.
If you can get a better ROI from paying extra toward debt -- even after taking tax savings and 401(k) matching contributions into account -- then you'd be better off devoting your extra money toward paying back your loans as soon as possible. But if your ROI is better by investing, you should make minimum payments and put the rest of your money toward retirement savings.
Often, for most people, this leads to a hybrid approach. For example, you could put extra money into your 401(k) until you've earned the maximum employer match and could then redirect extra funds to paying credit cards off ASAP. Or you could work on paying off your payday loans and credit card debt before investing in an IRA, but then focus on retirement savings rather than sending extra to a mortgage or to a low-interest car loan.
By making a strategic assessment as to what use of your money is going to best pay off for you, you can decide where exactly your extra money belongs. Remember, you do need some retirement savings since you can't live on Social Security alone. So be sure you don't put off investing for your later years for too long. If you're focusing on getting rid of your debt first, be aggressive in your extra payments and get that task checked off your list ASAP so you can start building a secure future.
