Debt Elimination versus Retirement Savings
How to strike the right financial balance to accomplish ALL of your goals.
Debt is often the enemy of a solid saving strategy – particularly when it comes to revolving debt like your credit cards. As unsecured revolving debt, the amount you owe on your monthly credit card bills varies based on how much you owe. So when you owe a lot, you have to pay a lot each month. As a result, you have less money for things like saving and investing for your retirement.
The information below can help you understand how to balance debt reduction with retirement savings so you can maintain stability in the here and now while still making strides to prepare for your financial future. If you’re struggling to achieve the right balance and need help, call Consolidated Credit today a for a free debt and budget evaluation with a certified credit counselor. You can also complete an online application to request help now.
Don’t wait for 100% debt-free to save for retirement
Retirement savings is often at the bottom of people’s financial priority list because we all have more pressing financial concerns, like paying bills and saving up for our next car or the down payment on a home. And those concerns definitely can’t be ignored in most cases. So you wait until ________ is paid or until next year when you expect to get a raise to starting saving for retirement. Unfortunately, this often leads to delays in retirement saving year after year.
This is why you can’t wait to be completely debt-free before you start saving for retirement, because you may never get there. A new debt will pop up or an unexpected emergency will lead to another bill. So you need to start saving now.
Balancing your financial life
This is where the idea of striking the right financial balance becomes so essential for your short-term and long-term financial success. Basically, you need to balance all of your financial concerns. So you devote some of your income towards debt elimination but you also put a little towards saving and retirement in order to ensure that ALL of your financial needs are being met.
This is known as financial balance and it’s something you achieve by making a plan that ensures all of your financial needs are being met and addressed. It’s often easiest to think of your financial life like a wheel, where each of the different spokes represents a financial need or concern. If all of time and money is being devoted to debt elimination, your wheel is unbalanced and it’s difficult to move forward.
With this in mind, unless you are facing severe financial distress that requires immediate debt elimination to regain control, then your income and interest needs to be divided – if not evenly, then at least to some degree so you’re not ignoring savings and retirement investment.
A note on savings vs. retirement: Looking at the Financial Wheel of Life, you’ll notice that retirement and savings are listed separately. “Savings” is considered what you need for short-term and mid-term needs, while retirement is saving specifically for your golden years. You need both.
So what’s the right balance?
This really depends on your financial situation. The numbers and percentages below can be used as a guide, but you have to tailor the plan to whatever your financial outlook will allow you to do comfortably.
Here are some guidelines:
- In general, you want your debt-to-income ratio to be around 36% or less. This means you put around 36 percent of each paycheck towards the monthly payments on your loans, as well as your credit cards.
- Credit card debt payments should be around 10% of your income. If the minimumpayments equal less than that amount, you should be making larger payments – in fact, ideally you should pay off the debt you accrue at the end of every month to minimize interest charges. If your payments take more than ten percent of your income, look into options for debt consolidation or use credit counseling.
- In total, all savings (including retirement) should equal no less than 5-10% of your income. Although these two types of savings are different, if you have a tight budget and limited means then you may need to split the money you put away between the two but you need to be saving for both if you have the means. If you have more money available, devote 5-10 percent to saving and another 5 percent to retirement (or more to retirement if you’re starting off behind).
That last note is important – how much you should be saving for retirement really depends on your goals AND when you’re starting. If you’re in your 20s and just starting out, then you can put less towards retirement because you have decades to let your contributions grow before you’ll need them. If you’re starting in your 40s then you have to be more aggressive and save more to catch up on the saving and growth you missed in your earlier years.
Determining how aggressive you need to be usually involves looking at the new golden rule for retirement savings and comparing your own situation.
- By age 35 you should have 1 times your current salary saved for retirement
- By age 45, that should grow to 3 times your current salary
- By age 55, it’s up to 5 times your current salary
- By after 65, you’ve moved up to 8 times your current salary and should be close to being financially prepared for retirement
So if you’re 37 and don’t even have half of one year’s salary saved, then you need to devote more money to retirement. Still, even if you’re behind on retirement savings, you should still strive for balance between retirement savings, debt elimination and whatever short-term savings goals you also may have.