Save for Retirement or Pay Off Debt? Prioritizing Your Money Moves

A couple walks with their dog at sunset discussing whether to save for retirement or pay off debt.

Key Takeaways

  • Evaluate your full financial situation including income, expenses, debts, and savings before deciding priorities. Create a list to guide where your money should go first.
  • Build an emergency fund with 3-6 months' worth of living expenses. Automate contributions if possible to help it grow.
  • Focus on paying down high-interest debts first, like credit cards. Look into refinancing or reorganizing your debts to lower interest rates.
  • Save for retirement early and consistently, even if starting small. Use employer-sponsored plans like 401(k)s and HSAs if possible.
  • Revisit your budget and financial goals regularly to stay on track. Small, consistent contributions to savings and debts add up over time.

Setting up a system for managing your money is a significant first step toward achieving financial health. But once you have your basic living expenses and needs covered, what do you do with your excess funds? Do you save for retirement or pay off debt first? And if you choose to save, should you focus on an emergency fund or your retirement?

The questions can get overwhelming, and there's often no easy answer. In an ideal world, the decision to pay off debt or save wouldn't be an either/or choice — you want to be able to do both. However, the right path for you depends on your situation and needs, so it's important to understand how to set your priorities and be aware of the potential pitfalls you may face along the way.

Evaluating Your Situation

Before you decide whether you're going to pay off debt or save first, it's a good idea to look at your current financial standing. That can help you get organized and set your priorities.

To begin, review how much money you have left every month after paying your bills and other living expenses. This can be a baseline to guide you through prioritizing the rest of your needs. If you find yourself only with a bit of extra money leftover — or none — you may want to reevaluate your spending and income. Of course, you can only cut so much. But taking on a part-time job or side gig can help boost your take-home pay. Then, you can use that money to help pay down your debts and build your savings.

Once you've looked at your income and expenses, review what you have in savings, including retirement and emergency funds. Then list all your debts, including monthly loan amounts, minimum payments and interest rates. Comparing the amounts of your debts side-by-side and identifying which have higher interest rates makes it easier to prioritize what to pay down first.

Creating a List of Priorities

Digging into your finances can be stressful, especially if you're worried about having high debt and not a lot of savings. With your full financial picture in front of you, it can be easier to set your list of priorities. One tool that can help clarify where you should put your money is a debt calculator .

If you have high-interest or credit card debt, you may want to focus on paying that down first as well as putting some toward your emergency fund. Once your money is earmarked for those things, you can put the rest toward your retirement savings. However, if you mostly have "good debt" such as a mortgage, you may want to just pay the minimum on that and prioritize putting your extra money into your emergency fund and retirement savings first.

There are many factors to consider that depend on your individual situation. The best plan is the one that works for you and helps you reach your goals.

Building an Emergency Fund

An emergency fund is money you've tucked away to tap into when needed, such as for unexpected car repairs, a medical expense that insurance didn't cover or a job layoff. A common guideline is to save enough to be able to pay three months of your usual living expenses — your housing, utilities, food, transportation, etc. A recent study from the Federal Reserve Bank of Minneapolis found that about 55% of people have a "rainy day fund" with three months of expenses set aside.1 But another 36% said they would have trouble paying a $400 surprise expense.

Set a Starting Goal

Everyone's financial situation is different and can change often, so how much you aim to save in case of an emergency will be personal to you. Set aside some time now to think about how much you may need should an unexpected situation arise.

Don't be intimidated if you're not close to your emergency savings goal. You can start with a smaller goal and build on it over time. Having even a few hundred dollars set aside that you add to regularly can provide a cushion when something comes up. It can help you avoid relying on a credit card or loan when unforeseen events happen.

Gain Momentum by Automating

One low-effort way to grow your emergency fund is to automate it. Many banking institutions offer the ability to schedule transfers between your accounts. Each week or around paycheck time, you could set an amount to be moved from wherever your paycheck is deposited to your emergency savings. With the money automatically separated, it can build on its own.

Similarly, there are apps and online services where you can create a dedicated emergency account that pulls periodic debits from your banking accounts. One perk here is that having a fund that's not directly accessible through your bank may help you avoid dipping into it.

Paying Down Your Debt

Paying off debt is often a long-term goal. Ideally, you'd chip away at it over time. But one thing to consider is that not all debt is bad. A mortgage payment, for example, is not something you generally worry about paying off quickly. It's considered a necessary debt that often ultimately benefits your net worth.

When paying down debt, high-interest and credit card debts are what you want to tackle first. Part of the reason is that having a lot of credit card debt can affect other parts of your financial life. Carrying a high balance on your credit cards can translate to a high utilization rate, which can lower your credit score. And that may mean that when you take on a mortgage or car loan, you'll pay higher interest rates than if you had low or no credit card debt.

Begin by Prioritizing

There are many ways people go about paying down debt, but two are most common: avalanching and snowballing.

With avalanching, you sort your debt by interest rates, from highest to lowest. Pay more per month on the one with the highest rate to decrease the balance more quickly. When it's under control or paid off, then move to the account with the next highest rate. For the snowball approach, you instead start with your smallest debt amount and aim to pay it off, then move to the next smallest, and so on.

Regardless of which approach you take, make sure you're still paying at least the monthly minimum on the rest of your debts. If your budget allows, aim to pay at least a little more than the minimum due when possible. That can also build up and help reduce the balances on your cards and loans.

Look Into Reorganizing

If you've done a good job of paying your bills on time, consider requesting that your debt servicers reduce your interest rates. You may also find that refinancing your debt, especially for student loans, could help lower your interest rates and total monthly payments. Then, you can put your extra money toward your emergency or retirement savings.

Saving for Retirement

As you build your emergency fund and pay down your debts, also aim to save for retirement. With retirement savings, you have to plan for the long haul. Depending on your age, you may have 20 or 30 years before you leave the workforce, so putting even a little bit away while also paying off your debt can help. With the way compound interest works, starting early can potentially help your savings grow into a significant amount down the road.

A good place to start saving for retirement is through your employer. Many employers offer 401(k) plans, and you can choose to automate your contributions by pulling money out of each paycheck. These plans may have tax advantages, too, since contributing to one may lower your taxable income. And if your employer offers matching contributions, it's like putting "free" money into your 401(k), which helps increase your overall contributions. It's something to take advantage of when possible.

Something else to look for from your employer is a health savings plan (HSA). These are also tax-advantaged accounts. Any contributions, growth and withdrawals are tax-free. You can contribute money to your HSA — thereby reducing your taxable income — and then use the funds in your HSA to pay for approved medical-related expenses both now and during retirement.

If you don't have an employer-sponsored retirement plan, you can open an individual retirement account (IRA) on your own. These days, many banks and online brokers let you open one with minimal paperwork so you can start contributing quickly. Virtually any IRA plan will also let you set up automated contributions, pulling from your bank account every week or month.

Tips for Avoiding Potential Financial Pitfalls

Maintaining your financial health takes practice and dedication. Unfortunately, sometimes it's easy to get off track or make mistakes. But you can help avoid making errors with these tips:

  • Track your income and expenses with a budget to know exactly what you're working with each month.
  • Revisit your plans a few times a year so you can tweak things if needed.
  • If you get a cash windfall or a sizable tax return, consider applying some of it to your debt or savings.
  • Speak with a financial professional who can look at your debt and savings needs and help you develop your goals.
  • If you get a new job or bring in more income, adjust your savings and debt contributions accordingly.

Taking care of your finances is a lifelong task. Setting up good habits and goals now can help you stay on track for years to come. Keep in mind that even a small amount of savings adds up if you do it consistently. You don't need a lot of money to start paying off your debts or building your savings. So when it comes to deciding whether to save for retirement or pay off debt, you may not have to choose.

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  1. What a $400 emergency expense tells us about the economy.

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