One of the most common questions I get is should I pay off my debt or should I save more? While this can be very client specific, today I thought we would cover a few general ideas on the subject.
First, you should consider the following factors: your age, debt level, asset level, income, desired retirement age and income goal in retirement.
Generally, I’m a fan of paying off the highest interest and nondeductible debt first. This means credit cards — get rid of those things! I often advise clients to use all available extra cash to help get rid of the highest interest first and then move onto the next highest. I suggest you still continue making contributions to your retirement plan. If you need more cash flow to do this, then look for ways you can cut back. Do you really need a $6 coffee? Look at where your ATM withdrawals are being spent. That’s a big one. Many people can easily cut a lot of expenses out of their budget by simply looking at each one in detail.
Once you cut the expenses, look at ways to earn extra income. Can you rent out a room? Ask for a raise? Turn a hobby into a small side business? Every little bit helps! Use all of this extra money to get rid of “bad debt.” Bad debt is debt on things that lose value over time and don’t give you a tax break. “Good debt,” by comparison, is the use of leverage on things that go up in value, such as a house or rental property.
Do I pay off my mortgage with extra money? That one can be harder than it looks on the surface. Financially, it doesn’t usually make sense to pay off a mortgage in today’s interest environment. If you have a 4% mortgage, which the interest on may be deductible, then it might only cost you as little as 2.75-3% net of the deduction. If you can invest money for retirement in the market for a long period of time and earn a return even close to the equity market’s return, say 8%, then why pay off 2.75% debt at the expense of 8% savings. In that example, you are making 5.25% on the difference between what you are paying out and what you are taking in. If you simply can’t sleep at night knowing you have a mortgage in retirement, remember, just because the answer is right financially, doesn’t mean it’s the right answer for you. Sleeping at night is more important than always maximizing finances.
The key on the saving more side of the equation is knowing how much your current savings are going to be worth in retirement, and more importantly, how much income will that savings provide you with! Once you know that, you can determine whether savings or debt reduction is more important in your situation. Don’t forget to add in Social Security, too. For a married couple, that can add up to $70,000 to your annual income in retirement. Another way to increase retirement income is to wait 1-2 extra years to retire. That equals more savings and less time drawing down your assets.
T. Eric Reich, CIMA, CFP, CLU, ChFC, is president and founder of Reich Asset Management.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.