Save for the Future or Pay Off Debt Now?
It depends on the type of debt you have and how generous your employer is with its retirement plan.
You know you should be saving for retirement. But what's better: Stashing cash for the future or paying off the debt you have now?
Paying off debt should be a top priority, but you shouldn't let your single-mindedness get in the way of your long-term goals, according to 12 New Rules for Your Money in the September issue of Kiplinger's Personal Finance.
The old rule of thumb was to pay off high-interest credit card debt first because the returns would be greater than what you'd get with most investments. However, that rule can be tweaked if your employer offers a 401(k) plan and will match your contributions up to a certain level. In that case, make your top priority saving enough in your 401(k) to capture the match -- even if you have credit card debt -- because you're getting a 100% return on your investment. Contribute more than the match level once you've paid off your consumer debt.
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You also shouldn't sacrifice saving for retirement to accelerate mortgage payments. For the most part, it's usually not a good idea to pay off your home mortgage unless you have a lot of extra cash (see To Pay or Not Pay Off the Mortgage). After all, Uncle Sam refunds part of your interest payment if you itemize your deductions on your tax return. Use your money instead to invest in liquid assets. However, aim to pay off your mortgage (and any other debt you might have) by the time you retire so you can get by on less money.
Don't be in a rush to pay off student loans, either, because you can deduct up to $2,500 of student loan interest paid during the year, assuming you are not being claimed as a dependent on your parents' tax return. You don't have to itemize to claim this deduction.
If you're struggling to pay down your student-loan debt, you may find relief through loan-deferment or forgiveness programs. See Ease the Burden of Student Loans.
If you're drowning in debt, paying it off trumps saving for retirement (see Cut Debt Now, Save Later). You many need to liquidate assets such as stocks and use your savings -- but not a 401(k) or IRA -- to pay off your credit cards. If you're in dire straits, you can borrow up to 50% (no more than $50,000) from a 401(k). Although you pay yourself back with interest, you give up tax-free compounding, and you will have to pay back the loan immediately if you leave your employer.
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