Your Debt Is Mainly Low
When your creditors charge relatively low interest rates, focusing on investing towards retirement might be the better option. Of course, you should continue to pay the minimums. But if your loans have reasonable rates, the return on your retirement investments are likely to exceed the additional interest charges incurred on the debt.
“If a debt’s interest rate is lower than about 5%, you’re probably better off in the long run focusing on savings,” Goren says.
While nobody can perfectly predict the rate of growth of their investments, you can make reasonable estimates to determine whether investing is better than paying off debt. The lower the debt interest rate, the more likely your 401 returns will beat it.
Carefully Consider Home Equity Loans Or Debt Consolidation Loans
Pooling some of your debts to get a lower interest rate can work in some special circumstances. This is especially true if you have untapped equity in your home and can use it for a low-interest home equity loan.
The trouble is this strategy includes all the risks of borrowing money to fix a spending problem. Depending on your particular situation, you may end up violating tip #2: Dont try to fix mistakes with bigger mistakes.
Home equity loans or debt consolidation loans can make a lot of sense for a one-time surprise medical bills, for example. But if the underlying spending/income mismatch isnt fixed, youre just causing more debt headaches down the line.
Should You Use Retirement Savings To Pay Debt
âCameron: What are some things that people can do if they are near retirement or in retirement with a limited income to pay off debt? And are there debts that you should be focusing on first?
âGerri: First I would encourage you to think very carefully and get some advice before you tap retirement funds to pay debtsâeven if those debts feel particularly pressing.
For example, let’s say you have an account that’s gone to collections. You’re getting lots of collection calls and you think, âIâll just take money out of my retirement account to pay this debt so this debt collector will leave me alone.â Really think carefully about that because, in most cases, that money is protected from creditors, and you’re going to need it. If you’re like the average American or even an American who is doing pretty well, you’re going to need that money in retirement. So that’s a don’t.
A âdoâ would be to get some help. So that would be a . There are nonprofit credit counseling agencies around the country that can walk you through your situation and help you understand whether there’s a feasible plan to pay off your debt in a reasonable period of time.
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Pay Off Your Mortgage Before Retirement
Paying off your mortgage before you retire could be more of an emotional move than a strategic decision. Mortgage rates tend to be low, and most people heading into retirement can expect to get more value by investing than speeding up their mortgage payoff.
An early mortgage payoff can also have tax implications. Mortgage loans offer homeowners the potential to deduct the interest they pay on their loan and their property taxes as well, says Harrison. If youre not debt-averse and want to spend your extra dollars where they have the most impact, it can be more beneficial to pursue investments that offer larger dividends than paying off low-interest, tax-advantaged debt.
Renfro agrees but emphasizes the importance of feeling good about your decision: If paying off a mortgage relaxes you to the point of improving your quality of life then that should be given proper weight in your decision, he says.
If retiring mortgage-free is important to you, consider these options: Perhaps the most obvious is sending extra payments to your lender. You could also downsize by selling your house and using the proceeds to purchase a less expensive home in full. If you want to stay in your current home, you may be able to save by refinancing your mortgage to have a shorter loan term.
And if you choose to wait until retirement to pay off your mortgage, make sure youve budgeted for mortgage payments in your retirement savings until youve paid your house off in full.
Strategies For Paying Off Student Loans
Once you know your student loan balance and terms, start planning the debt payoff. Calculating how much you can afford to send to your lender above the minimum payment can help you speed up the process.
The goal is to retire without student debt. But what if you cant comfortably pay off student loan debt and save for retirement?
If you have federal student loans, youve got a few options: You may be able to alter your repayment plan or put your loans on deferment or forbearance. These repayment options may give you some breathing room for reaching your debt payoff goal as well as allow you to prioritize saving for retirement for a period of time.
In addition, if youre disabled, you may be able to discharge your loan entirely if your disability is not expected to improve. Finally, some lenders allow for a co-signer to be released after the primary borrower makes a certain number of on-time payments.
Private student loan relief may prove trickier as there are no standard relief options. Check with your lender to see if you can negotiate repayment options.
Regardless of your student loan provider, though, remember one thing: For optimal returns, youll probably want to prioritize saving for retirement alongside paying off student loans, provided you can make at least minimum payments. For most people, then, it may make the most financial sense to prioritize saving for retirement over all but higher-interest private student loans.
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What If I Cant Afford My Monthly Bills
If you dont have enough money to cover minimum monthly payments, you may consider dipping into your retirement fund early. While using up savings is never an ideal situation, there is a responsible way to do it.
If you choose to borrow from your 401 to pay off debt, youll have two options: You can either take a distribution or you can take a loan. In other words, you can permanently withdraw money from your 401, or you can borrow from it with the intent of replenishing it when you have the funds to do so.
If you take a distribution before youre 59.5 years old, there are tax implications. You might have to pay 10 percent tax on any money you remove, and withdrawn funds cant collect interest down the road.
Borrowing from a 401 wont have these downsides. If youre still working and youll be able to replenish the savings within a few years, borrowing is almost always the better option.
4 Minute Read
How To Pay Off Debts Faster
Often, people in a debt payoff phase either organize their debts by interest rate or by size of loan .
With the debt snowball method, you pay off all debts in order from smallest to largest dollar amounts. Ignoring interest rates on your debts, put extra cash toward the smallest debt balances first . After one debt is wiped out, focus on the next-smallest amount, and so on until it’s gone.
Using the debt debt avalanche approach, you focus on paying off the highest interest rate debts first. Mathematically, it makes sense because you’ll incur less in interest charges.
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Retirement Is Too Important To Ignore
All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and is meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective Life or its subsidiaries.
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Find A Financial Advisor
Financial advisors arent only for the wealthy. You can search for one or find one from a friend. If you bank through a credit union, you may even have a financial advisor that you can work with as a member. But before you hire any advisor, ask about their services, typical clients, communication style, how they get compensated, and how much they charge. The advice they give can more than pay for any fees.
Getting a financial advisor is a good idea regardless of whether you have a retirement plan through your employer. Your employers plan will have a plan advisor that you can meet with each year, but the conversation may be limited to your 401 plan. A private financial advisor will be able to guide you as a whole, helping you understand how to get the most out of your 401 and supplement those savings with other accounts and savings as needed.
Once you find a financial advisor, they can help guide you on setting up Individual Retirement Accounts , including advising on whether you should go for Traditional or Roth. Work with your advisor to set up any accounts you need and, if need be, go back to HR at your employer and adjust your 401 plan savings accordingly.
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Maximize Your 401 Match
If your company encourages retirement savings through some kind ofmatching arrangement, like a 401 match, dont miss out on capturing that free money.
If your employer pays you 50 cents for every $1 you put away up to 6% of your salary, thats a 50% return right away. With that level of high return, it only makes sense to prioritize it over almost all non-mandatory debt repayment.
Investments Need Strategies In Retirement
As with all investment strategies, whether self-directed, with the advice of a financial advisor, or through brokerage, there is always a risk.
You may also find that the custodial and administrative fees for starting with small amounts of retirement funds can seem prohibitive compared to what you have. Tax benefits offset fees. Invested money gets tax benefits.
You should also be aware that prohibited transactions can cause tax problems for your retirement plan. Self-dealing is when you, the account owner, benefit directly from the asset, rather than the retirement plan which made it.
It also means that you should avoid transacting business with disqualified people. Internal Revenue Code Sections 4975 and 408 define a disqualified individual as the IRA holder, the IRA owners ascendants or descendants, and any entity controlled and managed by those individuals.
Certain types of transactions involving the IRA are not allowed to be conducted by disqualified persons. This is outlined in detail on the IRS Website.
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Consolidate Debt With A Personal Loan
If you have several different debts to pay off, you might save on interest by consolidating them into one personal loan. Personal loans generally charge lower interest rates than credit cards, making them a good way to pay off high-interest credit card debt.
With a personal loan, you borrow a lump sum and make fixed monthly payments over time until the debt is paid off. Unlike secured loans such as mortgages and car loans, personal loans generally require no collateral, so your assets aren’t at risk. Because these loans are unsecured, however, it’s easier to qualify if you have good credit.
You can get personal loans from banks, credit unions and online lenders. Before applying for a loan, check your credit report and . This will help you identify personal loans for which you’re likely to be approved.
Shop around for a personal loan to find the most favorable terms. Because each personal loan application generates a hard inquiry into your credit report, aim to keep your loan applications within the span of a couple weeks. Hard inquiries can temporarily cause your credit score to dip slightly, but applications for the same type of credit in a short time period are generally treated as one hard inquiry, minimizing their impact on your credit score.
How To Find Affordable Housing
Housing is one of the biggest expenses youll have in retirement. According to an Employee Benefit Research Institute report, people 75 and older use 45 percent of their budgets on housing, making it their largest expense. Making housing more affordable can save you hundreds of dollars each month, and thousands of dollars overall.
- Downsize your home. Downsizing may sense if youre not flush with retirement savings and you havent paid off your mortgage yet. By moving into a smaller house or condo, you could cut down your monthly and annual expenses and stretch the savings you do have.
- Find a roommate. Cutting some housing expenses can help you but cutting them in half could help you more. Getting a roommate is a great way to cover expenses without taking a huge financial hit.
- Relocate. If youre living in an expensive city, relocating can save you money. If you dont want to move out of your state or city, even finding a more affordable neighborhood can help your savings.
Should You Pay Off Your Mortgage
âCameron: If you don’t have a lot of consumer debt or don’t have any consumer debt, but you still have a mortgage, is it worth it in retirement to try to quickly pay down that mortgage? Or should you be putting that extra cash that you have elsewhere?
âGerri: Mortgages these days typically carry pretty low interest rates. The risk potentially with a mortgage is, of course, if you can’t keep up with the payments for whatever reason, then you could lose your home.
I think the biggest problems we see with mortgages are when people tap their home equity for other expenses and the payments may become unmanageable, or perhaps they get into a predatory lending situation where someone’s convinced them to keep taking cash out of their house. It becomes expensive and unmanageable, and they just aren’t able to sustain it.
You Have The Money In A Retirement Account
Should you pay your mortgage off? No. You shouldnt pay it off in this case.
Why? I get this question all the time, but no one has ever asked me after actually cashing out a retirement account to pay off their mortgage. My guess is that the accompanying tax bill affirmed that it was a bad decision. In Scenario 2, its mostly an investment decision with a tax consideration. This answer is mostly tax-based. When you pull funds from a pre-tax retirement account, those amounts are included in your taxable income and taxed at ordinary income rates. Therefore, if you take a large withdrawal, your bracket will jump, and you will see a significantly smaller amount come into your bank account before you pay off your loan.
Whats the downside? Cost. There is comfort in living debt-free in retirement. Having a lower housing expense provides you more flexibility in your discretionary spending. But, in this case, is it worth the cost?
Neither Dave Ramsey nor Ric Edelman is wrong. They just give different reasons for their advice. Ramsey uses mostly behavioral reasoning. Essentially, he believes that people are not going to use discretionary income beyond their 30-year mortgage payment to invest, but rather to buy things they dont need. Edelmans reasoning is purely mathematical. He does not hypothesize about what people will do with excess income but points out that if you can earn more in an investment account than what you pay in mortgage interest, you come out on top.
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Dont Let Debt Payments Derail Your Savings
Paying down debt and saving for retirement doesnt have to be an either/or proposition. The two can work together. Once again, you have to prioritize. Heres what I recommend:
After that, prioritize other savings and debt reduction goals according to your own situation.
Weigh Investing Vs Paying Down Debt
The good news is, you now have many of your most pressing financial needs covered, so you can start moving down your priority list. That bad news is, this is where your decisions may start to get more complex.
If you still have debtwhether student loans, an auto loan, or a home equity or mortgage loantry comparing the interest rate on your debt to our rule of 6%. That can help you decide whether your next priority should be paying more than the minimum on remaining debts, or investing additional dollars toward retirement.
Ultimately, you should aim to save 15% of your pretax income toward retirement each year . Try to hit that mark before you continue down your priority list.
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How Do You Pay Off Credit Card Debt
Cameron: What about credit card debt? Should you be focusing on that before you focus on paying off a mortgage or other types of debt that you might have?
âGerri: Credit card debt may actually be one of the easier types of debt to deal with. It’s unsecured debt, which means there’s no collateral behind it. There’s not a house. You don’t have to worry that if you don’t pay your credit card, that you can’t go shopping at your local grocery store again. No one’s going to know that you didn’t pay back that credit card debt.
While it’s stressful if you can’t pay it because you will get collection calls, it is one of the easier types of debt to deal with. Two options there: One is that the credit counseling agency that I recommended earlier can help you figure out whether there’s a reasonable payment plan. And that would typically involve paying it all off over three to six years.
Another option, particularly for re retirees, maybe settling the debt. That’s where you get the credit card companies to agree to accept less than the full balance. The advantage that retirees may have in this situation is because they don’t have a lot of income coming in from multiple sources and that income is typically protected from creditors, they may be able to negotiate with the collection agency.