Posted on: 17 June 2018Share
Many individuals aren't planning for their retirement the way that they should because they are busy paying off their debt. Unfortunately, this can leave them in a messy situation once they reach retirement age. Retirement accounts compound over time; your interest makes money on your interest. Foregoing investments to pay off your debt can be a mistake.
Reduce Your Interest Rates
Your first step when dealing with debt and retirement should be to reduce your interest rates as much as possible. Often, you can negotiate with credit card companies to lower your interest rates in exchange for a set payment plan. You can also consolidate expensive loans into less expensive loans, such as your student loans or any personal loans you have. Lending vehicles such as home equity loans are less expensive than unsecured personal loans.
Once you've reduced your interest rates, it's time to do some math.
Calculate Your Gains vs. Your Losses
If you have a credit card of 9%, you're spending 9% a year to carry that debt. It may seem like you should be focused on paying off that debt on its own. However, that might not be true when you consider a retirement account.
A retirement account such as an IRA may have employer matching up to 3%. You're gaining 3% on what you put in. In addition to that, you aren't taxed on what you put into your IRA. This can functionally save you another 20% on the money you put into there. In addition to that, your IRA likely gains anywhere from 6% to 8% a year.
Thus, putting money into an IRA could be building your wealth by 30%, compared to putting money towards a credit card at 9%. That doesn't mean you shouldn't be paying off your credit card, merely that putting money into your IRA first is likely the most sensible financial option.
Your IRA does max out after a certain amount has been added to it, after which you can start paying off more of your debts. Further, it is possible for you to borrow against or cash out most retirement accounts, in the event that you find that you do need the money later on.
Naturally, a lot of the above involves running fairly complex numbers and calculations. These aren't calculations you can expect the average person to do. A professional financial services or retirement services company can help.