There is nothing new about recommendations to pay down debt or consistently contribute to retirement accounts. The reality is, Americans carry too much debt and don’t put enough money away for future needs. The actual facts are pretty bleak. The Employee Benefits Research Institute reports consumers over 75 carry an average debt of $27,409. Those between 55 and 64 have the highest debt averaging $107,060. Retirement savings are no better with 20% of the population having no savings and 62% with less than $1,000. 29% of the population over 55 does not have any retirement savings or a pension to rely on.
With high debt loads and low savings rates, it can be hard to create an effective plan that addresses these two essential pieces to the financial puzzle.
Interest rates on credit cards average 15%, leading you to believe putting 100% of additional funds towards debt reduction might be the best plan of attack. However, with the majority of those nearing retirement and still carrying heavy debt balances, this might result in having no retirement savings and still carrying debt balances.
Benefits of Debt Reduction
Extra payments to reduce high interest debt can save you thousands of dollars over the years by reducing and eliminating high interest rate debt early. This strategy only works if you maintain a debt free life after pay off and put the payments that went towards debt, funneling them towards retirement. Not preventing additional debt build up can back fire and leave you with no retirement savings and debt payments well into retirement.
What you lose in this strategy is time. One of the big benefits to retirement savings is that you are able to let investments grow for several decades, reducing the amount that must be invested to reach your goals. For every year (or decade) you wait, the monthly investment needed to fund retirement grows. The other reality is that with such a high percentage of seniors still carrying debt, reality declares that debt elimination at the expense of retirement savings is not an effective strategy.
Benefits of Retirement Contributions
Pensions are only offered by 20% of private companies and social security payments will barely keep you out of poverty. This alone should make setting aside money for retirement a high priority. Living longer can mean living 20 or more years in retirement leaving you with more years to pay for with the same working timeframe.
To increase the incentive of retirement investing, the government offers tax incentives to those who are vigilant. Traditional IRA’s offer an immediate tax benefit by reducing taxable income. Roth Ira accounts do not reduce taxable income, but offer tax free growth when funds are used in retirement. 401Ks and other work plans reduced taxable income like a Traditional Ira and include a simple sign up and investing process through payroll deductions.
Reducing taxable income through your employer’s retirement plan is an easy place to start. Begin by maximizing your employer’s match and then increase contributions each year. This strategy will operate on auto pilot and can increase balances quickly. From there take end of year bonuses or tax refunds to build a Traditional Ira account or other long term financial goals.
For debt reduction, working off a budget that sets measurable goals is the best formula for success. Set aside funds dedicated to debt reduction and change spending habits so you are able to live within your means. Tax refunds and bonuses are also a good way to jump start a debt reduction program and help you see quick success.