One of the biggest challenges to making smart money decisions is that many important goals compete for our limited dollars. That’s exactly the case for folks who want to save for retirement but also get out of debt.
There’s nothing like time — and lots of it — to turn your retirement savings into a much bigger pot of gold, thanks to investment returns compounding upon themselves. That means delaying retirement savings is a bad idea.
But letting debt rack up pricey interest charges while you send precious dollars to your retirement account? That doesn’t make much sense, either.
Everyone’s situation is unique, but many experts suggest getting a start on retirement and then focusing the bulk of your money on high-interest debt. Here’s the step-by-step process:
Start saving for retirement
Pay off high-rate “toxic” debt
Start an emergency fund
Turn to lower-rate debt
Stay on track with a written plan
1. Retirement saving comes first
If your employer offers a matching contribution to a 401(k) or other retirement savings plan, contribute as much as it takes to get that free money.
Say your employer offers “100% up to 2% of salary.” That means your employer will add one dollar for every dollar you contribute, up to 2% of your salary. So if you make $60,000 and contribute 2% of it, your employer will add $1,200 a year on top of your $1,200 contribution.
“You’re doubling your money even before investment return or tax savings,” says Joe Heider, founder of Cirrus Wealth Management in Cleveland. Even a 50% match is still a hefty chunk of free money that you don’t want to pass up — you’re not going to get a 50% rate of return anywhere else.
If you don’t have a retirement plan at work, open a traditional IRA or Roth IRA (if you’re not sure which is best for you, read our guide). There's no match to take advantage of, but you can set up recurring transfers from your bank account to mimic the ease of an automated workplace contribution. Here’s our roundup of the best IRA account providers.
per year (approximately)
Up to 1 year
of free management with a qualifying deposit
career counseling plus loan discounts with qualifying deposit
no promotion available at this time
2. Pay off high-rate debt
If you’ve got credit card debt, payday loans, or debt that has variable or high interest rates — anything north of about 9% — tackle that next. (If this toxic debt adds up to more than half your income, consider seeking debt relief.)
For a psychological boost along the way, it can help to use the debt snowball method, where you focus payoff efforts on your smallest debt first — always making the minimum payments on the others, of course. Once that’s paid off, focus on the next-biggest debt, and so on. Read how to use a debt snowball.
“It’s helpful to have a win early on,” says Jessie Doll, a wealth management advisor at TIAA in Fairfax, Virginia. “Now I’ve got some confidence to do some of the other long-term things that need to get done.”
3. Start an emergency savings account
It’s absolutely OK to start small. Get $500 put aside in a savings account. That’ll keep you from running up credit card debt over every unexpected expense.
You can build from there. Even having “at least a couple of months’ worth of expenses saved up is good planning,” Heider says. “You lose your job, you get laid off, you get sick — it gives you a bit of a cushion when you need it most.”
4. Tackle lower-rate debt
Once you have high-rate debt wiped out and a solid emergency fund underway, think about throwing more money at other debt, like student loans.
If you have multiple student loans, consider focusing on one at a time. Say you’ve got four loans, each with a $150 minimum monthly payment, and you can afford to pay $1,000 a month. “I wouldn’t pay $250 on all four of them,” Heider says. “I’d pay $150 on three and $550 on the fourth one. Once that fourth one is done, your minimum now, instead of being $600, is $450.” That can help if a budget emergency occurs.
» Save on interest: Refinance your student loans
5. Put it in writing
There’s nothing like a plan to stay on track toward money goals.
Write it down: Heider suggests a spreadsheet with specific objectives, such as: “This loan will be paid off in 18 months. The next loan will be paid off in four years. In five years I hope to have $40,000 in my 401(k).”
This keeps you focused on the next goal when you pay off a debt. “It can help avoid the temptation of buying a new car when you really don’t need one,” Heider says.
Be explicit: “Naming the goals can be really helpful,” Doll says. “If I know that me not going out to dinner this week means I can take my children on vacation next year, [that] makes it much easier for me to make that decision.”
Build in rewards: Think about earmarking money for a trip or a special purchase when you pay off each debt.
Look for “leaks”: Track where your money goes each month to find dollars that could be better used for retirement and debt goals.
Even financial experts can be surprised. Michael McGrath, vice president of EP Wealth Advisors in Valencia, California, remembers a former colleague who scrutinized his own monthly budget saying: “It shocked me how much my wife and I spend at Starbucks. We’re spending almost a car payment!”