Savings vs. debt payment: “Due to some financial setbacks for my fiance and I over the past couple of years, combined with a lack of spending discipline, my credit card debt has gotten out of control. I am working to pay it down and have resolved to manage my spending better this year. I’ve been bringing breakfast and lunch from home, eating dinner at home more, and I turned down a weekend trip with friends that was very tempting. Most of my credit card debt is currently on a card with zero percent interest, but that time will soon be up. Therefore, I’m wondering if I should pull back on retirement savings to pay down the debt faster. I currently have the equivalent of about a quarter of my salary saved in my 401(k). My company adds 7.5 percent in profit-sharing each year, so contributing enough for matching is not a concern. At the moment, I contribute 8 percent of my paycheck. Should I stop (or just reduce) my retirement contributions and focus instead on eliminating the credit card debt and building up an emergency and ‘life happens’ fund? I didn’t want to miss out on the advantages of saving early for retirement, but I realize now that the debt is the more urgent issue.”
Investing vs. paying off debt: “My wife and I have some significant debt, and we are wondering if we should suspend contributing to our 401(k) plans for the short term, until the debts are paid off? At the same time, we are concerned about losing our retirement match."
Ideally, with enough money coming in, you should try to continue paying down the debts and contributing to your retirement account.
But life is often not ideal. Although I hate all debt — yes, even a mortgage — the answer to both of these questions depends on a lot of things: your age, the amount of debt, how expensive it is to carry the debt and if your employer is offering a match for your retirement contributions.
Yes, it’s vital that you start to save for retirement as soon as possible. However, if you’re relatively young and have more than a few decades to go before you retire, you can pause saving for retirement to build some cash reserves and get rid of debt.
Because the chat forum is anonymous, I don’t always know a lot about the people who post. However, the first question came from an individual who said that she’s 29. The mean age that retirees report having retired is 61, according to a report last year by Gallup. Based on this average retirement age, the reader has time to catch up on retirement savings if she pulls back for a few years. Plus, her employer is offering a very generous match without her having to contribute to her plan.
And the type of debt matters because it’s not all equal.
In the case of the younger worker, I would suggest she take a break from contributing to her 401(k) and aggressively attack the credit card debt. Unless she gets another zero-percent balance transfer, she’ll be paying a lot to carry the debt once the deal ends.
The average rate on new-card offers is 17.3 percent, according to a recent report by creditcards.com. The average maximum credit card rate is 24.54 percent, as of the first week of February. The average median card rate is 20.92 percent.
Speaking of the balance transfer, be careful relying on this debt-reduction strategy. As I have warned, there are many reasons it isn’t always a smart move.
If you’re carrying a significant amount of high-interest debt, it makes more sense to pay it off rather than to stockpile money in a savings account or, in some cases, even invest for retirement. (You should keep a small cash cushion while paying down debt. Otherwise, if you have a financial emergency, you may end up increasing your debt load.)
Keep in mind that stock market returns are not guaranteed. Just look at how the market seesawed recently in part because of the coronavirus spreading through China. The market has been trending back up, but that can change at any time. However, you’ll definitely save money by getting rid of high-interest debt when compared with what you hope to gain by investing.
Let’s look at the couple struggling with significant debt that I suspect is also on credit cards.
Because their employers are matching their retirement contributions, I would not recommend that they pull back completely from putting money to their 401(k) plans.
“It is important to prioritize your spending and savings values,” said Carolyn McClanahan, a certified financial planner based in Florida. “People should strive to minimize debt and pay down any debt that they incur, but it wouldn’t be smart to not put in enough to get a 401(k) match because you are leaving significant free dollars on the table. Eventually, the goal should be to maximize your retirement plans."
I think the couple should divert whatever they were contributing to retirement above the match to the debt that’s concerning them. But to make it worth pulling back, they have got to stay disciplined and committed to getting rid of the debt.
In either case, it’s important to have a plan of attack, which includes a timeline. If you don’t, and you pull back or pause from saving for retirement, you may not get back on track.
Reader Question of the Week
If you have a retirement question, send it to firstname.lastname@example.org. In the subject line, put “Question of the Week.”
This week’s question comes from Marcy O'Ward of Great Falls, Mont.
Q: How much can I contribute to a traditional IRA for 2020?
A: For 2020, your total contributions to all of your traditional and Roth IRAs cannot be more than $6,000 ($7,000 if you’re age 50 or older) or your taxable compensation for the year, if your compensation was less than this dollar limit, according to the Internal Revenue Service.
Please join me on Thursday, Feb. 13, at noon (Eastern time) for a live discussion about your money.
My guest will be William Emmons, assistant vice president and economist at the Federal Reserve Bank of St. Louis. He is the co-author of “Is College Still Worth It? The New Calculus of Falling Returns,” a journal article published in the Federal Reserve Bank of St. Louis Review.
I wrote about the research last month.
Retirement Rants and Raves
Your thoughts: Was there a time when you pulled back on retirement savings to get out of debt? How did it work out?
I’m also interested in your experiences or concerns about retirement or aging. You can rant or rave. Send your comments to email@example.com. Please include your name, city and state. In the subject line, put “Retirement Rants and Raves.”
Many people are still steamed about changes to retirement saving rules as a result of the Secure Act. They dislike a provision that affects inherited IRAs. There’s now a 10-year window for beneficiaries to draw down the inherited account.
As I explained in an previous newsletter, under the old rule, if you inherited an IRA or 401(k) from a non-spouse, you had to take required minimum distributions, or RMDs, but you could extend the withdrawals over your lifetime to minimize the tax hit. But, starting in 2020, except in some limited circumstances, people inheriting a retirement account cannot stretch the RMDs.
James Royal of Northampton, Mass., wrote: “I turned 70 1/2 in November. My children will both be of age by 2025, so potentially, if I’m no longer living, the government will be forcing them to spend my hard-earned retirement funds during their college years. The children also won’t be eligible for loans/scholarships because they will both be paying taxes on the IRA earnings. There should have been a special provision to make these distributions tax-free if used for college for children of the deceased IRA owner. Some grandfathering should have been mandated, especially because many of us older retired parents arranged our whole estate plan including 529 contributions and many other things on this IRA being based on the child’s life span.”
“I don’t understand why you have to take withdrawals,” wrote Jubill Austin from Maryland. “It seems like another way for the government to interfere in your portfolio and get more money to waste and give to corporations.”
In response to such sentiments, the IRS writes: “You cannot keep retirement funds in your account indefinitely. You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 72 (or 70 ½ if you turned age 70 ½ before January 1, 2020).”
You can be upset, but just let me warn you: If you don’t take the required distributions, or if the distributions aren’t large enough, you may have to pay a 50 percent tax on the amount not distributed as required.
Many people find that even if they have saved well for retirement, a major health crisis can upend their plans.
“My husband and I felt we would be comfortable in retirement until he was diagnosed with Alzheimer’s four years ago,” one reader wrote. “The costs of care in the D.C. area are astronomical. I now live with the fear of depleting our savings and having to live on the street in our 80s.”
The cost of care in retirement is a critical issue for a lot of people. And, as a recent Gallup report found, many Americans are putting off getting medical treatment as a result.