Ask the grumpies: Retirement vs. debt

Rented life asks:

If you have credit card debt should you pay that off completely before setting up and contributing to retirement? (And does your advice change is the employer doesn’t offer a plan and your retirement is just whatever you set up?) My friend thinks you should pay off credit card first, no matter what and then when that is gone you can start saving for retirement. I feel that can do more harm than good, waiting to set up retirement until your debts are gone might have you setting up really late or possibly always having to push it off. Who is “right?”

If you get an employer match that is anywhere decent you should absolutely save for retirement up to the match before paying off the credit card.  In fact, depending on the match rate, your credit card interest rate, and penalties, there can be situations in which you would put money in, get the match, then take your original money out minus the penalty and you would still be ahead.

If you’re young (with a lot of earning years left), have high interest debt, and have lousy options for saving for retirement at work (no match, high cost plans at work, etc.) and can (and will) knock out that debt really quickly, and will definitely start putting money away for retirement as soon as you’re done with the debt, then go ahead and pay off the debt first!  This is, in fact, what DH and I did when we got married.  We paid off his (relatively high interest rate) student loans first and were still able to max out our IRAs the next fiscal year.  We benefited more from those 6K getting rid of the debt than we would have putting them in an IRA (especially since it would have been a market peak!  But we didn’t know the tech bubble was going to burst, so that was just luck.)

After those two easy scenarios, there’s a lot more grey area.  And it’s going to depend on your personality and your options what you do.  You will have to sit down and run the numbers, think about the risk, the benefits, and your own personality.  The goal is not necessarily to make the most money on paper, but to get rid of your debt and have enough saved for retirement.  It is far better to make a little less money on paper if it means you’re going to make more money in reality because you actually stick to your goals instead of giving up.

If you’re really bad at doing multiple goals at the same time and you would have to save for your retirement manually (and you don’t get a nice match), then go ahead and focus on the debt.  However, even if you’re bad at doing multiple goals at the same time, if you have retirement through work, you can usually have it auto-deducted so you don’t even think about it.

Similarly, if you know deep down that as soon as your credit card debt is gone or down, you’re just going to spend again until you’re back in the same situation you were in before, put money away for retirement so you can’t touch it.  We don’t understand people who can’t keep from maxing out their credit cards no matter how much they make (and we try really hard not to read their blogs because they’re so depressing), but if that’s you, then you need to contribute the max to your retirement accounts in a way that it’s auto-deducted without you even realizing it’s happening.  That way you can continue to pay off your debt in your 60s, 70s, and 80s, or at least still have something to live on when you’re old after declaring bankruptcy multiple times (as retirement money is protected).

Speaking of which, if you have plans to file hard-core bankruptcy, max out that retirement.  I’m not sure what you should do if you’re planning on doing the lighter kind of bankruptcy… you should probably talk to a lawyer about that.

If your work offers good plans, that’s more attractive than if it offers bad plans.  But, as you note, even if your work only has bad plans, you can still invest up to the IRA or Roth IRA limit with Vanguard.  However it’s more difficult to set up auto-deduction before you see the money than it would be with work, which may interact with your personality type and how many goals you can focus on at the same time.

If you aren’t going to remember to set up auto-deduction for retirement just as soon as you get out of debt, then do it right away when you’re thinking of it instead of paying off debt.

If you are going to be in debt for a long time, then it might also be worth investing in the stock market just to add a little bit of risk to your portfolio, or, as mentioned before, to protect your future self in case of bankruptcy.

There’s probably even more scenarios that I’m not thinking about.  But no, I don’t agree that you should always pay off high interest debt first while ignoring retirement (*especially* if you’ve got a 100% match at work!), nor is it always the best idea to contribute the max to retirement while you’re still paying off high interest debt.  (Heck, if you work for the government, the max you can contribute to tax-advantaged retirement savings might be a lot more than 20% of your income!)

What say you, grumpy nation?  High interest debt?  Retirement savings?  Both?  Neither?  Is it always clear-cut what you should do?


31 Responses to “Ask the grumpies: Retirement vs. debt”

  1. plantingourpennies Says:

    I think you’re right that there’s no one “always right” answer. I’ve always liked making 401K contributions automatically so it’s easy mindless savings even when we have debt – though I guess it was a little easier since my highest interest debt was 6.8%. No doubt it was less than ideal to be putting $ into my 401K in 2007 at that market peak rather than paying off that student loan quicker, but I still think there’s something to be said about keeping some long term savings requiring no conscious thought every month. It just feels way easier that way.

  2. Contingent Cassandra Says:

    Auto-deductions/contributions to a retirement account may not be that hard to set up even if your plan isn’t at (or you have a plan in addition to) work. I’ve got USAA checking and savings, and a USAA IRA, and could program a monthly movement of funds if I chose (and will do so, at some point, once I get my finances better organized after a long-delayed promotion and raise). USAA is available to members of the military, veterans, and their families (my category; I’m the daughter of a peacetime vet from the days of the pretty-much-universal male draft), but I’m pretty sure other banks do the same (I think my CapitalOne 360 — formerly ING) accounts work in a similar way. Of course, there is the question of fees; USAA is member-owned, which keeps it fairly affordable, but other banks with similar arrangements may be skimming off more in various kinds of fees than the arrangement is worth. The other issue is that this kind of retirement account isn’t exactly out-of-site; out of mind; the total is likely to show up on the summary screen that shows up when you log into the website. If that’s a psychological disadvantage (temptation to withdraw, and/or simply feeling more flush than the situation warrants), it wouldn’t be a good setup (on the other hand, if you also have a credit card and an auto loan with the same company, as I do with USAA, your debts will greet you as well. I think some companies even allow you to add in accounts from other holders to the summary, a la some money management software, but that gets into the question of how much information you want to share with one company. Of course, they’ve got access to it anyway, via your credit report; in fact, Discover is now providing free access to one of the credit reports & scores — I can’t remember which — with its cards).

    • Leigh Says:

      You can set up automatic investments with most investment firms. With Vanguard, you can set it up to automatically contribute the maximum to your Roth IRA, which is pretty neat. I can also split my direct deposit with my employer to multiple places, one of which can be at Vanguard.

    • nicoleandmaggie Says:

      Discover gives the score on the statement now. I haven’t bothered to read where they get it from, but it’s kinda nice.

      • Linda Says:

        And this just reminded me to add “call Discover” to my To Do list. I’ve had a Discover account since 1989, yet they’re only doing this on the “newer” version of their accounts. Apparently I have to call and open an entirely new account to get this feature. *grumble, grumble*

      • nicoleandmaggie Says:

        That’s odd that your account is too old. My account is from 1998 and they give my score.

  3. bogart Says:

    My personal rule of thumb is that any debt at or under 5% (after tax, if applicable) should be completely ignored (beyond of course paying the required minimum) in order to max retirement savings. After that it gets a bit hazier and I’m quite sure that at 10% (or maybe 8% or maybe …) the rule is reversed.

    As I am (still!) playing the balance transfer game, I keep enough in cash equivalents in a Roth that if ever I needed to pay off all the not-forever-fixed debt RIGHT NOW, I could, without undue trauma (Financial trauma. I’d be emotionally stunned for a bit, though I’d probably get over it.). Also, touch wood, I have a good credit rating. So cheap short-term borrowing is readily available to me, in the current interest rate environment. And assorted other components of my life look fairly stable (again, touch wood): I own a home, not planning (or wanting) to move, not anticipating having more kids, etc.

    But I do think you make good points about personality, etc. The above works reasonably well for me, or so I tell myself. But that doesn’t make those rules of thumb the right ones for everyone.

    (I think the extent to which retirement savings is sheltered in bankruptcy may depend too on which state one lives in, but I could be wrong about that)

  4. Flavia Says:

    Both, for me. With my work retirement contribution it’s an easy decision — I put in 3% and my employer matches with 7% (!!!) — but even when I was young and poor I made a small contribution to a Roth IRA every month. I had very, very little spare money and a lot of debt when I was in grad school, but being able to carve out $50 and then $75 a month and put it toward retirement was like a gesture of faith in a more adult and more responsible future. And since it was an automatic deduction, it was easier than paying more on my credit cards. (I finagled low interest rates on my CCs, however.)

    I could to Vanguard’s website and “skip” a monthly payment if I was really broke (and if I remembered in time!), and there were a couple years I skipped almost half my payments. One of the nice things about growing more financially responsible was getting to the point where it didn’t even occur to me to do that, because I wasn’t living quite so close to the wire.

  5. Linda Says:

    Whenever one is trying to start a new habit, I think it’s always good to try routinizing it from the very beginning. We do that with diets and exercise, so why not with savings? So I’d suggest setting up an automatic savings plan for retirement right away, even while paying down high interest debt.

  6. chacha1 Says:

    Personal note: if I hadn’t been contributing religiously to company 401(ks) for the last 24 years, I would have essentially no retirement savings because the truth is I suck at saving. AS DO MOST PEOPLE.

    General commentary: anyone who advises a friend not to contribute to retirement “until you do other stuff,” whatever that other stuff may be (e.g. buy a new car, pay off credit cards, get married, buy a house) probably has no retirement savings now, never will, and is likely to wash up on your doorstep broke at the age of 67 asking if you have a spare room.

    So my advice is, if your employer offers a retirement plan of any kind, get into it. If your employer does not offer a retirement plan, set up your own. Contribute to it as if it were a utility bill or your rent, because paying for your future housing is just as important as paying for your housing in the here and now, and that is ultimately what retirement saving is all about.

    Secondary advice: if you have credit card debt that is in any way troublesome (for me personally this means a balance higher than I could pay off with a single month’s discretionary income), stop using the cards RIGHT NOW and live like a broke person, because guess what: you’re broke.

    • nicoleandmaggie Says:

      “anyone who advises a friend not to contribute to retirement “until you do other stuff,” whatever that other stuff may be (e.g. buy a new car, pay off credit cards, get married, buy a house) probably has no retirement savings now, never will, and is likely to wash up on your doorstep broke at the age of 67 asking if you have a spare room.”

      I don’t know that this is true. If you know the person well and you know the person isn’t going to just spend money, then you might give advice to pay off the credit cards first because it might be economically optimal. This is especially true if we’re talking about someone who has debt from unsubsidized student loans that a parent took out, a divorce that left someone in bad financial shape, medical debt, and other kinds of one-time deals. Heck, we’ve just given that advice here and we’ve got plenty in our retirement accounts. There’s also cases in which paying for a car first might be optimal if you need that car to get to work. I can’t think of any good reason, absent a crystal ball that allows you to forecast housing prices, that saving for a house first would make sense.

      • Rented life Says:

        I agree, I don’t think it’s true. It wasn’t advice as in me asking friend what to do, as we were talking about other people’s money, not our own. Last I knew, friend didn’t. have any debt. I do. But if Zie showed up at my door at 67, I’d be fine with that as this is my oldest friendship and I know I could do the same!

    • Leigh Says:

      I actually recommend to most people that if they can pay off their student loans quickly (< a year), they should do that and then save for retirement. Why? Momentum and focus on one goal at once. Getting the match is still sometimes not a bad option. I'm also okay with postponing maxing out retirement accounts until you buy a first car, but not subsequent ones. And I don't think you should be buying a house if you can't max out your retirement accounts while saving for the house and owning it.

      – says the 25 year old with $130,000 in retirement accounts

      • nicoleandmaggie Says:

        Absolutely. The other thing that’s different about saving for a house vs. paying off high interest debt is that once the high interest debt is gone, it becomes *easier* to save for retirement. The interest is a drain on your assets and your cash flow. Buying a house makes it harder to do so since it locks you in. Again, a car can go either way depending on whether or not you will lose your job without one.

      • Rosa Says:

        There’s a big difference between not contributing at all and maxing out, though. I keep finding out people I know aren’t saving anything at all for long term. Or anything at all. Getting them to make the first teeny tiny step, whether it’s “$10 per paycheck into a jar in the cupboard so you don’t charge groceries if you run out of cash next month” or “start the 401k with some amount of money”. Just having the very first step done helps them make the next one when they can.

        Though they may still fit in your rubric because I can’t imagine any of them could pay off their student loans in one year or less either.

      • chacha1 Says:

        Rosa, that was my point. People who say “do it later” are overwhelmingly doing it never themselves.

        Without being intimate with the situation, I read it like the father – or stepfather or whoever it was – a few weeks back, who was recommending taking a 401(k) loan to do something like pay off student loans. I responded to a generalized scenario, not a specific one, because hey, I don’t know anything about the specifics.

        “Pay yourself first” is the first piece of advice my Dad gave me that has proven to be, without reservations, true and good. The second is “Know thyself.”

  7. Rented life Says:

    I have a lot of debt (well it feels a lot to me but to others it seems small.) student loan and credit card. I plan the balance transfer game. I think 0% out weighs transfer fees but said friend thinks no fees is better. (I can do math–fees cost a lot less than interest in my case.) I have no employer retirement options. Being young depends on who you ask. I feel young and then I feel like OMG we need to save now! I don’t like debt so building it up again isn’t an option, but paying in down in a year isn’t either. Especially the student loans. (Which stay even in bankruptcy!)

    I will say the worst financial advice I ever got was from a different friend who suggested being a slum lord was the way out of debt. Because that’s what he was doing–buying fixer uppers in crappy neighborhoods (at 17% interest!!!). He’s also working on a phD while he fixes the houses, allows leniency on rent payments, etc. He couldn’t understand why I wasn’t just snatching up tons of houses and doing this.

    • nicoleandmaggie Says:

      Yeah, that does seem like pretty lousy advice. And it’s the kind where for some small % of people, they hit it big, and for a larger % it ends in disaster.

      It’s hard to say what to do in your situation.

  8. Sandyl FirstgenAmerican Says:

    I started saving right away for 5 reasons:

    1. I was used to being poor when I was in college, so my out of college salary – 15% retirement savings was still a whole lot more money than what I was making as a waitress. Starting off making more money still seemed like a better deal than making a lot more money and then having to scale back later.

    2. I had an employer match and it was automatically withdrawn from my pay, so it was easy.

    3. My debt was going to take years to pay off, so I didn’t want to wait that long to start saving for retirement, plus once you opt out of the employer match for a particular year, it’s not like you can change your mind and go back and get it.

    4. Lots of older, financially savvy people told me to start saving right away. Also people at my company would often gossip about the technicians at work who were retiring as millionaires because they were the smart ones who saved since day 1. Of course the ones who Didn’t save were the ones telling the stories and kicking themselves. (The company I worked at had had a stock that did very well for many years so even modest savings plans led to big bucks for most people who participated in the retirement plan.)

    5. There is always something else to spend money on.

    It is truly much easier to save smaller amounts for many years than it is to save a bunch when you’re older. Plus, as time goes on, you have other expenses that crop up…buying a house, replacing a car, kids, kid’s education expenses, daycare, etc. Even if you are a good saver and pay off your debts quickly, it’s SO easy to now put off retirement again until you have money for a house downpayment…and on and on it goes. I am totally doing that now with my kids’ college expenses. I haven’t really made it a priority and now my older son is 9 and I am not even close to being 1/2 way to my goal.

    • nicoleandmaggie Says:

      I dunno, as we say above, debt really is different than saving for an asset. Even just being rational and running the numbers, it sometimes makes sense to put off retirement for debt repayment but it never makes sense to buy a house (unless you’re psychic, in which case you’re not taking any risks and the house is an investment).

      Of course, for many Americans, housing *is* their retirement plan. Which is kind of depressing (though not completely depressing since many people actually do ok with SS + selling the house, even/especially those without pensions, because they never made that much when they were working either).

      • Sandyl FirstgenAmerican Says:

        Maybe the compromise is to start saving a nominal amount, just to get into the habit of saving for retirement (like 1 or 2% of your income) and then up it by 1% a year until you’re out of debt. At that point you can decide what the right number is. It doesn’t have to be all or nothing.

        Most of my mom’s net worth was indeed her house but that’s how you did it back in the day before retirement plans and nursing homes. You left your house to the person who took care of you when you were old. It usually was a child or another relative. My mom was the old maid who didn’t get married so she could take care of her parents. Of course, she had an ulterior motive (going to America), so she was okay with it.

  9. Comradde PhysioProffe Says:

    “We don’t understand people who can’t keep from maxing out their credit cards no matter how much they make (and we try really hard not to read their blogs because they’re so depressing)”

    People write blogges about their financial incontinence?

  10. Liz Says:

    Instead of doing what Leigh suggested, I found a way to balance my financial approach that makes me happy. I don’t have CC debt, but I do have student loans (varying %) and a car loan (0% APR). I just recently saw my debt figure and retirement savings figures wave to each other in passing on their respective trajectories, at around $19K. This was/is a slow-and-steady race, 5 years and counting. I set aside a comfortable figure in my budget to pay off debts (about double the minimum) and contributed an automatic 10% to my company’s 401(K) plan. As I got raises, I could increase the part of my other, non-automated budget that went to savings. And then I got a good enough raise where I could get a separate IRA and start automating that, reducing my 401(K) contribution to the newly-introduced company match level (2%). (Technically I already had an IRA, one of my first post-college moves since CDs were no longer the awesome thing they had been in my high-school saving years. But I never had enough to be able to contribute beyond a stray $100, like once a year.) The debts are being attacked through snowballing, starting with the smallest debt: anything beyond the minimum gets thrown at one of the loans at a time, until it dies. Rinse and repeat.

    In the meantime, I live frugally so that I can travel some and eat healthily, and enjoy my body/mind/spirit before it’s too late. My parents’ experience showed me that it is important to save asap for retirement. Other parents’ experiences showed me that I should live as much in the moment as in the future, before I physically can’t, say, hike a mountain or walk 10+ miles in a day while visiting a foreign country.

    It’s not $130K at 25yo, but it is greater than zero and (hopefully) only going up from there.

    • nicoleandmaggie Says:

      Some economists also recommend a “save more later” approach, where you automatically start saving a larger percentage of your income (up to 15%) with each raise.

      • Liz Says:

        Thanks! That was the plan, and now I have a justification. w00t! :)

      • nicoleandmaggie Says:

        Apparently it’s a Richard Thaler invention, but it’s heavily endorsed by lots of other famous behavioral economists and I think some of them have actually gotten some companies to implement it as a choice when you sign up for retirement plans.

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