Saving for Retirement
Cut Debt Now, Save Later
Sometimes whittling down credit-card balances trumps saving for retirement.
By Laura Cohn, Associate Editor
From Kiplinger's Personal Finance magazine, September 2010
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OUR READER
Who: Ron Jones, 42
Where: Annapolis, Md.
Question: Should I focus on paying off debt or saving more money for retirement?
Ron wants to do all he can to make sure he's financially secure after he leaves the military in about eight years. Currently a critical-care nurse at Malcolm Grow Medical Center at Andrews Air Force Base (the home field of Air Force One), he hopes to quit his job entirely or work only part-time once he's a civilian. Understandably, Ron is worried that he isn't socking away enough. He also frets over $40,000 of credit-card debt, which he says mushroomed because of legal expenses involved in a divorce. "I'm torn between saving for retirement and paying off my debt," says Ron.
That's a decision that many people wrestle with in their peak earning years. Some are fortunate enough to be able to save for a lengthy retirement while avoiding debt. But for most people, day-to-day life gets in the way. Ron has remarried and has four boys -- one from his first marriage and two plus a stepson from his second -- so his expenses won't shrink for a long time. He won't be able to ramp up retirement savings anytime soon.
His savings decisions so far have been sensible. He puts 10% of his income into the federal Thrift Savings Plan, which operates like a 401(k) for federal workers. Contributions are pretax. Earnings grow tax-deferred; taxes are due when money is withdrawn from the plan. Ron has roughly $40,000 in his TSP, with about half invested in stocks of large U.S. companies, one-fourth in international stocks, and the rest mainly in shares of small and midsize companies. He also has two Roth IRAs, which hold $20,000 in funds at Vanguard and Dodge & Cox. He contributes $1,000 a year to each Roth.
Trouble is, no matter how well his funds do, Ron won't have enough money in eight years to be set for life. The good news, says Ron, is that he has stopped using his cards and has found favorable, low-rate credit lines via cards from the Pentagon Federal Credit Union and elsewhere. The mission now is to chop off principal. "Debt is like a monkey on your back," says Karen Lee, a financial planner in Atlanta. "The best thing for him to do is pay off his debt." After that, he can focus on saving for retirement.
Where to start. Ron should total his essential monthly expenses, tighten his belt and see how much he can set aside to pay down the debt. He could put pencil to paper or use free online tools at sites such as Mint.com. Or he could use Kiplinger's free budgeting tool.
As for whether Ron should raise his contributions to the retirement plan, the answer is a resounding no. In fact, he should defer less of his pay, not more. "He's not in a situation where he should focus his attention on retirement planning," says Christopher Reilly, a financial planner in Philadelphia. "Siphoning off money that could go toward the interest payments on his debt isn't worth it."
If anyone can afford to put other needs before retirement, it's a career soldier. Ron will get a veteran's pension worth at least 50% of his salary. It's the most ironclad retirement plan remaining in the U.S.
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Reader Comments (5)
Posted by: mike at 08/17/2010 08:20:26 PM
REference the 40k in credit card debt. He should go to the local credit union and get a loan to pay off the credit card and cut it up. Thus putting the amount on payments and stop the higher interest rates. By do this the cost of paying of debit will be reduced. This is what the Federal Government is doing. They are holding interest rates down so they can issue longer term debt at lower rates.So do the same restructure you debt. But the individual needs to balance savings too.
Posted by: Nomen at 08/23/2010 11:27:19 AM
How much does the ex-wife get of his pension? How much child support for the stepson? Why only work part time when he retires? Why not work full time until age 55 or 60 and reevaluate his financial position then? I worked with a guy who was married four times. On his pension plan, each ex-wife gets $550 per month of his pension. He can't afford to retire. While this is an extreme example, I have never read about retirement planning with ex-wives and child support taken into consideration. A 55 year old guy with a younger wife and very young children is pretty common. College bills at 65 are pretty common as well.
Posted by: Denise at 08/23/2010 04:36:17 PM
Thank you for this article. My husband was recently had a $15,000 pay cut, this combined with medical bills has resulted in credit card debt significantly lower than the $40,000 in the article, but sill a concern. After reading the article and evaluating our options, We have decided that I should defer less for retirement. Deferring less will mean that my credit card is paid in 22 months rather than 35. Paying this debt will mean that in eight years, when I retire, my mortgage will be paid and I will have no credit card debt.
Posted by: lane at 09/14/2010 11:49:17 AM
Cut Debt Now, Save Later...Daaaaaaaa are you sure!
Posted by: James at 09/29/2010 12:08:58 PM
I hope no one believes this article. You should never reduce the amount you are saving for retirement. Debt can be paid down over time. Once you retire, you can continue to pay down your debt if you didn't stop saving for retirement. Paying down debt is important, in fact its probably the second most important thing to focus on after retirement savings. Some good tools for paying debt is to first sell your new car. Buy a used car for around $6000. Thats the price level where you find high quality dependable vehicles. One of the cardinal rules of personal finance is if you have debt, you can't afford a new car. See where else you can save money. Americans hate the truth....Something else to consider is that retirement plans and IRAs are safe from bankruptcy. In the case above filing bankruptcy might be the best choice. The money invested is safe and you can eliminate debt. A soldiers job is not in jeopardy due to bad credit. Bottom line: saving for retirement takes priority. You need to save 20%. If you have a pension you can get by with 15%. If you have a pension and social security you might get by with 10%. If you are under 40 you will not have social security. Also these numbers only apply to 25 years olds. Add 1% for each additional year you waited to start saving. I also (am) a financial planner. I am not a corporate broker that calls myself a planner...I expect better from Kiplinger.