Eliminating Debt to Increase Retirement Savings

As a financial advisor in Birmingham, here’s another way to look at debt:

If you’re paying 6 percent interest on a particular debt, $1 in payments does not really equal $1, because a portion goes right off the top directly to interest.

On the flip side, say you earn 6 percent on your retirement contributions. If you were able to contribute that same $1 to your retirement account instead, and you get an employer match of 100 percent, that $1 immediately becomes $2, and over time, compound interest can turn it into something significant.

Add a few zeros to these numbers, and that’s quite a lot of money you’re either leaving on the table or putting toward your future.

With this in mind, why are so many Americans spending their hard-earned money on debt and putting their retirement planning on the back burner?

Keep in mind that retirement can last 30 or more years, and any money you have in your Golden Years will need to keep pace with inflation.

If you want to boost your retirement savings, the first place to look is your budget – how much of your money is going toward debt?

Having Less Debt Gives You More to Contribute to Your Future 

If you have any form of debt, you likely pay it down every month, as you pay your mortgage, your credit card bills, your car loan, etc. Whether you pay $50 or $5,000, debt is part of your monthly expenses.

According to a recent report, almost 70 percent of Americans worry they don’t have enough to retire. Further, the average amount of debt across the country stands at $92,729 per family.

The more you reduce or eliminate your debt, the more you have to put toward retirement. As a financial advisor in Birmingham, the solution is pretty clear.

 

Are you saving enough for retirement? Schedule a no-obligation conversation with the Linscomb & Williams team.

 

How to Attack Debt

There is more than a single strategy for paying off debt. Talk to your financial advisor about the type of debt you have (mortgage, credit cards, car loans, school loans, etc.), your income and your goals to see what makes sense for you.

There are two fundamental ways to pay down most consumer debt with the goal of eliminating it: The snowball method and the avalanche approach.

With the snowball method, you work on your debts by the amount you owe. You target paying off the smallest amount first, putting any extra money you have toward that goal. When the smallest amount is paid off, you turn to the next smallest account, and then the next.

With an avalanche approach, you focus first on debts with the highest interest rate. The idea is to put all available funds toward paying off the debt with the highest interest rate first. Once that is accomplished, you move down your list, focusing on the next highest interest rate, and then the next.

Depending on the type of debt, one strategy may make more sense than the other.

If your major debt is a mortgage or a home equity loan, your financial advisor may have a different strategy for you, such as making extra payments to pay off the loan quicker, moving into a 15-year mortgage from a 30-year mortgage (which will increase payments but pay off your home quicker) or refinancing. There can be pros and cons to each process, so discuss your situation with your financial advisor. This is particularly true in the current environment of very low long-term fixed mortgage rates.

Some pre-retirees even decide to sell their home and downsize, which can also have a major effect on your budget. It’s important though to keep in mind where that new, smaller house is located. Because of cost-of-living differences, a smaller home can actually cost more! Read our recent blog post: Flying South for Retirement? 6 Factors to Consider if Relocating.

Student loan debt is another common concern. As the price of tuition increases, many younger people are facing student loan amounts that resemble mortgage payments. If one of your goals is to pay for your children’s college education, read our recent blog post: 5 Steps for Parents Saving for College.

Believe it or not, high net worth individuals can also be hindered by debt. Sure, their incomes may be higher than the average person, but their debt can also be high – and so can the cost of their plans for retirement.

How Not to Pay Off Debt

Unfortunately, a lot people chose debt-payment methods that aren’t ideal, such as cashing out a retirement plan early to pay off debt. Retirement plans like 401(k)s and Individual Retirement Accounts (IRAs) can be tempting, because they can hold large amounts of money. A retirement account balance of $200,000, for example, may sound like for a lot, especially for younger folks. But remember, if you plan to retire before age 70, your retirement could last 20 or 30 years.

Not only do you not want to run out of money later in life, but when you withdraw from a retirement plan early or cash it out completely, you lose in multiple ways.

First, you obviously no longer have that money for your retirement.

Second, you’ve lost the opportunity to make money on your retirement savings, and that loss compounds over time.

Third, you are likely to incur tax penalties. Retirement plans are tax-advantaged. Money placed in 401(k)s and Traditional IRAs grow tax-free until you withdraw from them. If you withdraw money from these plans before you turn 59-½, the money will be taxed at your current rate, plus you’ll face a 10 percent early withdrawal penalty. In other words, that $200,000 becomes considerably less once you withdraw it.

Read our recent blog post: What Cashing Out Your Retirement Plan Really Means: Atlanta Financial Planner Explains.

Another unfortunate way we see people decide to “pay off debt” is taking on new debt, such as a personal loan or a low-interest credit card with a lower interest rate. The interest rates on personal loans are typically lower than those for credit cards and other types of high-interest debt, and introductory offers on credit cards can promise 0 percent for a specific period of time. But if you’re really trying to eliminate debt, taking on different debt doesn’t really make sense.

Discuss your situation with a financial advisor. If you’re looking for a financial advisor in Texas, Georgia or Alabama, contact us. Linscomb & Williams is here to help.

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Sheri Robinson, CPA, CFP®, AEP®

Sheri Robinson, CPA, CFP®, AEP®

Sheri Robinson is a Managing Director and Wealth Advisor for Linscomb & Williams.

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