You’re determined to be debt-free and throw every single dollar you can to paying off your debt. Does that mean you need to stop investing for retirement until you’re debt-free?
Laura is on a mission to become debt-free and she completed Best Money Class Ever money class ready to do whatever it takes to get out of debt. She recently landed a new job and wrote in to Ask Carly for more advice.
Ask Carly is a way for us to stay connected and support one another on our journey to gaining financial independence. You don’t need to figure this money stuff out on your own. You can submit your questions about life and money here.
Laura asked:
Hi Carly,
My new company automatically enrolls us in their 401(k) plan. Right now, I am solely focused on getting debt-free. They invest 5% automatically from my paycheck, unless I opt out. It ends up being a big chunk each month. Is it okay for me to go one more year without investing? I need to laser focus all of my income on my debt this year and I usually have very little left to actually live on.
Thoughts? I can always enroll in the 401k plan next year…
Best, Laura
Should You Stop Investing for Retirement Until You’re Debt-Free?
Great question! If you enjoy geeking out on finance, check out this similar debate between paying off your mortgage early versus investing.
Some financial experts argue that you should focus completely on one goal at a time and stop investing for retirement while intensely paying off all debt excluding a mortgage.
You didn’t get in debt overnight, and you won’t get out of debt without a good fight. It does take discipline, structure, and endurance to pay off debt, especially since we live in an instant gratification culture.
Having a plan with your money and life is super important, and that is why I created The Ultimate Guide to Managing Money. It’s your step 1, 2, 3, and 4 with money. You can get your free guide here.
Here’s a quick summary:
Step 1: Start saving 10% of your pay. When in debt (excluding a mortgage) of that 10%, save 5% towards retirement, and 5% towards a starter emergency fund.
Step 2: Get out of debt by paying all your minimum payments, and an extra $300 or more towards your highest interest debt. Once you’re debt-free invest all 10% towards retirement.
Step 3: Save 3-12 months of expenses for an emergency.
Step 4: Save for life purchases. Now you have no debt payments, your retirement savings is off to a great start, you have savings for a rainy day, and now the sky is the limit to save for the fun things in life like a home, or car.
I’m not an advocate to stop investing for retirement until you’re debt-free.
Why? Common sense is that you should always live below your means and spend less than you earn. Having debt is a result of spending more than you earn, and to get out of debt you’ve gotta break that habit.
When getting out of debt you’ve gotta stop borrowing money and stop adding to your debt load. That’s why you’ll save 5% towards a starter emergency fund. If you’re paying off debt and your transmission on your car goes out, you don’t have to take out a loan for $2,000.
Show Me the Money!
Let’s break this dilemma down with a specific example. We’ll assume you have a 30-year old who owes $39,725 in total with debt payments of $890 monthly and who will pay an extra $300 towards debt with a gross monthly income of $4100 and 401(k) plan with a company match of 3%.
We’ll see what happens if you invest 5%, or $205 monthly, versus paying an additional $205 towards debt.
Option #1 Invest 5% While Paying off Debt
Assuming no new debt is added, you’ll be debt-free in 36 months. During that time investing 5% of your pay would be investing $205, but you’d only see a difference in your pay of around $150, because your investment is tax deductible and lowers your tax bill now. Pretty sweet!
With $49,200 annual pay, the first 3%, or $1,476 you invest, your company will match (talk about free money!). In the year, you’d contribute $205 monthly or $2,460 annually, plus the match of $1,476, which is $3,936 total.
Assuming you continue to invest the same amount until age 65, earning 8%, you’ll have a nest egg of $736,430. If you’re following The Finance Plan, this is conservative, because you’d increase your contribution to 10% of your pay, or $410 after you’re debt-free.
Option # 2 Don’t Invest Until You’re Debt-Free, Pay Extra $205 Towards Debt
If you choose to not invest and instead pay an extra $205 towards paying off debt, you’ll be debt-free in 31 months, or five months earlier. You’d start investing $205 plus the match, now at age 32.5, come age 65 assuming your investment earns 8%, you’re nest egg will be valued at $574,460, or $161,970 less.
Wowzer. Is becoming debt-free a few months earlier, worth hundreds of thousands of dollars when you retire?
Probably not. That my friend is why I recommend investing during your journey to becoming debt-free.
To answer Laura, pay off your debt as fast as humanly possible, but because of the power of compound interest (some would say it’s like magic), it makes sense to always invest for your future. Congrats to Laura on deciding to be financially smart and taking the time to get your financial house in order.
What’s your take? Are you investing while paying off debt?
