Saving for Retirement vs. Paying Off Debt: Which Should You Do First?

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Making smart financial decisions can often seem like a catch-22. You know you should be saving for retirement, but it's difficult to save when you're loaded with debt. But put your limited cash toward debt, and you're missing out on valuable time to save for retirement.

Saving for retirement and paying off debt are both important financial priorities, but there's no straightforward answer as to which one is more important. As with most financial decisions, it depends on the situation.

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Sometimes, it's best to pay off the more expensive types of debt first, because you may be paying more in interest than you're earning on your investments. Other times, it's smarter to put more toward retirement and continue making minimum payments on debt, even if it takes longer to pay it off. The solution that's right for you will depend on several factors, so it's important to look at the big picture to determine which option will have the best long-term results.

When to prioritize debt over saving

Not all debt is created equal, and some types are more harmful than others. High-interest debt, such as credit card debt, can be incredibly toxic. Even if you're consistently making minimum payments, because the interest rates are so high, your balance may simply grow the longer it takes to pay the debt down. Even relatively small balances can take years to pay off (not to mention rack up hundreds or thousands of dollars in interest payments), and taking your time paying off this type of debt can sometimes do more harm than good.

For example, if you have thousands of dollars in credit card debt and you're paying an interest rate of 18%, putting money into a retirement account earning a 7% rate of return may not be as beneficial as it seems. If you're paying more in interest than you're earning on your savings, you're not actually coming out ahead financially.

That said, if you have a 401(k) that offers employer matching contributions, it's a good idea to contribute enough to your retirement fund to earn the full match, regardless of how much debt you have. Those matching contributions are essentially free money and can potentially double your savings, so take advantage of them.

Focusing on your higher-interest debt first is also smart if your retirement fund is relatively healthy. While it's never a bad idea to save consistently, if you have a strong nest egg, you may be able to afford to press pause on saving just long enough to pay off your high-interest debt.

When to prioritize saving over debt

Lower-interest types of debt such as a mortgage or student loans aren't as harmful or expensive, so it's not as critical to pay those off as soon as possible. Although you'll still need to make the minimum payments on all your debts, aim to save the rest of your money for retirement.

Saving for retirement sooner rather than later has one key benefit: Your savings grow much faster when you start early, thanks to compound interest. For example, say you have a goal of saving $500,000 by age 65. If you start saving at age 25, you'd need to save just over $200 per month to reach that goal, assuming you're seeing a 7% annual rate of return on your investments. But if you were to wait until age 35 to start saving, you'd need to save around $450 per month to reach that same goal.

By taking a time-out to focus on debt, you're missing out on your most valuable asset: time. If you focus on paying off less-expensive debts before saving for retirement, it's only going to be more difficult to catch up on your savings down the road.

Saving for retirement should typically be your primary financial goal, unless you're saddled with thousands of dollars in high-interest debt that's racking up interest by the day. If that's the case, pay off your most expensive debt as quickly as you can, then devote the rest of your savings toward retirement.

Balancing retirement and debt

Ideally, you should aim to save for retirement and tackle your debt at the same time. It may take a little longer to pay down your debts if you're devoting some of your savings to retirement, but it will also be easier to establish a strong retirement fund if you're saving consistently.

If you're struggling with high-interest credit card debt, one way to ease the burden is to take advantage of balance transfer cards. The best balance transfer cards allow you to shift your credit card balance to a new card with a 0% APR introductory period of up to 21 months. In other words, you can convert your existing debt into interest-free debt for a set period of time. This allows you to chip away at your debt quickly and potentially save thousands of dollars in interest.

At the same time, try to sock away at least a little for retirement. Saving even a small amount each month is better than nothing, and if you can take advantage of employer matching 401(k) contributions, you'll be in even better shape.

Money management can be challenging sometimes, especially when you have competing financial priorities with only so much cash to go around. By being strategic about which priority you tackle first, though, you can potentially save money and set yourself up for long-term financial success.

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