Don’t be surprised if thinking about your debt causes you stress. Consumer financial debt is correlated to “higher perceived stress and depression as well as higher diastolic blood pressure,” according to a Social Science & Medicine survey. For many people, deciding whether to invest for retirement before paying off debt is one big piece of a stress-causing puzzle.
“We need to realize that not all debt is created equal, said Chris McGovern, a director with Transamerica’s Advanced Markets Group says. “There are two kinds of debt, one is good, and the other quite bad.
“Installment debt, like your mortgage or student loan, usually has a low interest rate and it’s really good debt. Also, you are decreasing the premium with every payment, so you’re always making progress and paying less interest with every payment.”
On the other hand, revolving debt, such as a high-interest credit card debt can be a hindrance for consumers. “When you only make a minimum payment, you can never really make progress,” McGovern said. “This type of debt works against someone trying to get ahead.”
McGovern recommends people pay off high-interest debts quickly. And that they don’t pay off their mortgage or student loan until the term is due. “The low interest rate may give you more income to invest in an account that offers a higher rate of return,” he said.
Though this math makes sense, it’s more complex than these simple guidelines. Everybody’s situation is different. Here are a few examples to illustrate various stages of life, and may help you better identify a path that works for you.
Millennials with significant student loans
Recent college graduates who have student loans report they are struggling financially and often hold down a second job.
“Younger clients may have student loan debt and feel like they shouldn't save for retirement until their student loans are paid off. They may miss out on the trifecta of the employer match, tax deferral, and the time value of money,” said Marguerita M. Cheng of Blue Ocean Global Wealth. But some people’s emotional state may give them enough concern that paying off debt is better for their health in the long run. Only the individual can decide how much debt and anxiety he or she can tolerate.
Michelle Buonincontri, Certified Financial Planner™ , CDFA, and founder of Being Mindful in Divorce, discusses the challenges for recently divorced couples. “Debt paydown and saving for retirement can be difficult for clients to reconcile after a divorce,” she said. “Both parties need to work toward both goals to rebuild their finances. I usually advise them to pay off debt first because credit impacts so many areas of their lives. However, I believe it also depends on the emotional needs of the client. It’s not just about the number.”
When people get close to retirement, their situation can change, and they may need to shift their payoff-versus-investment strategy. Financial professionals can help guide clients to determine what makes the most sense given their priorities. It pays to retire with as little debt as possible since your income likely will decrease and it will become more difficult to pay off those debts in retirement.
Hopefully you can see the importance of weighing all parts of the equation when choosing whether to pay off debt or invest for retirement. Keep in mind your debt tolerance, 401(k) matching proceeds, upcoming expenses, time until retirement, and potential unforeseen expenses.
Share what you think about debt payoff versus saving in the comments below.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ , and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete the CFP Board’s initial and ongoing certification requirements.
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