The challenge of paying down debt, whether college loans, house payments, or credit card debt, while saving for the future can be daunting—especially in a weak economic environment. For many, paying off debt is easier and more emotionally satisfying than building up savings. That's because debt obligations can be whittled down in to concrete chunks, while savings goals are more ambiguous and can change as easily as changing one's mind about how much to save. And, of course, contributions put into regular savings can be taken out and spent on a whim.
The top three financial priorities for African Americans, each chosen by more than half of respondents in a recent study, are reducing debt, saving for retirement, and building an emergency savings account.
But is paying off debt ahead of saving for the future always a good idea?
In many cases, routinely saving and funding your retirement even while paying off debt is the smartest choice.
Consider these options:
- Even if you have high interest loans or credit card debt, you may want to make it a priority to contribute to your 401(k). Put in at least the highest amount your employer will match. You'll receive a 100% return on your investment, and the sooner you contribute, the longer your money will have to compound.
- Do the math. Compare the interest you'd receive in savings (e.g., bank accounts, stocks, bonds, mutual funds), to the interest you'd pay in debt (e.g., credit cards, high interest loans). If the interest you'd make on your savings is higher, then consider putting as much as you can into savings and doing it as soon as possible.
- Think twice (and then think again) before tapping into your retirement savings to meet immediate cash-flow needs, pay off debt, or cover emergencies. The penalty for early distribution from a 401(k) is sizable. The withdrawal amount is generally included as part of your taxable income plus a 10% additional tax penalty fee applies if you are under age 59 1/2 unless an exception applies. If the tax hit exceeds the interest penalty on your debt, it's a bad deal for you.
So don't let the seeming urgency of current debt cause you to shortchange your future. Give your long-term financial goals their due. Find a balance and take an approach that considers both your immediate needs and your long-term goals. You can decrease debt while saving for the future.
Don't fall behind.If you’re at risk of falling behind on debt payments due to unemployment, get in touch with your creditors before the default notices start piling up. Many companies are willing to work with you, even deferring or temporarily lowering payments while you look for employment.
Source: Prudential.com
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