Should you postpone contributing to your 401(k) to pay off debt? Here's when it makes sense to delay investing until your debt is paid off.

Conventional wisdom says you should always make saving for retirement a priority (even when you’re young), either through a 401(k), IRA, or other plan.

Just look at this powerful example of how compound interest can make anyone a millionaire.

But is there ever a time when you should delay retirement contributions to pay off debt?

This is an important question, since many young adults are burdened by outsized student loan debts as well as a host of other debts. It can be almost impossible to make progress on other fronts, financial or otherwise, when you have large monthly payments to make.

So when is the right time to make paying off debt a priority – even to the point that you will delay retirement contributions?

Everyone who can do both should do both

Let’s make the point up front that anyone who is in a position to both pay off debt and fund their retirement plan should do so. Even though retirement is decades away, it will be important to get a leg up on investing early in the game.

In fact, if you earn a comfortable income and only have student loans, some go as far as suggesting you shouldn’t make extra efforts to pay off your debt early; instead you should invest as much as you can.

So what we’re really discussing here are those who are attempting to do both, but don’t necessarily have the income to manage it comfortably.

We can also argue, even for those who are struggling financially, that the question of paying off debt or contributing to a retirement plan isn’t an either/or debate. You can actually do both, but do so while prioritizing one over the other.

As an example, let’s say that you’re carrying a large amount of student debt, a car loan, and several fairly large credit card balances. If you’re struggling to make the payments, then you will need to prioritize paying these off. But that doesn’t mean that you have to abandon making retirement contributions altogether. You can continue to make them, but do so at some minimal level.

Here’s some financial advice on which almost everyone agrees: Regardless of your debt, you should contribute a percentage of your income that will generate the maximum employer match on your 401(k) or similar plan.

If your employer will match 50 percent of your contributions up to six percent of your pay (meaning a maximum matching employer contribution of three percent of your salary)—which is a typical arrangement—then you should contribute six percent to max out the employer match.

But even if this type of contribution is putting the squeeze on your budget, you can always opt to contribute four percent of your pay, to get a two percent employer match, or even contribute two percent of your pay to get a one percent employer match.

Sometimes you don’t have to turn the faucet off—you just have to lower it to a trickle. If you can do this while prioritizing paying off debt, you’ll come out ahead in the end.

Use our Loan Payoff Calculator to see how different payments and interest rates affect your loan.

When should paying off debt should be a priority?

We just discussed a recommended strategy in the event that you’re “merely” struggling with debt. But what if you’re facing something approaching a bankruptcy situation?

It’s not ridiculous question. The advent of large student loan debt has put a lot of young adults in exactly this situation.

For example, if you are earning $30,000 per year, and you have $60,000 in student loan debt, plus other debts, this could begin to describe your situation.

If that is the case, then you will have to pull out all the stops in order to reverse your fortunes.

Think of it as a divide-and-conquer strategy, where you are marshaling all of your resources to deal with the most threatening obstacle first, and holding the other for later. In this case, you should prioritize paying off your debt, and then focus your efforts even more fully on retirement savings later on, when you are in a better position financially.

The benefits of paying debt first

If you’re in a substantial amount of debt right now, then you know the emotional toll it takes. You spend time worrying how you’re going to pay your bills and meet your budget every month, let alone trying to get ahead. You may even lose sleep over the state of your finances. By getting out of debt, you will free up your mind and your emotions to freely concentrate on moving forward in life.

On a more tangible level, once you’re out of debt, you will not only have more control of your finances, but you’ll have more free cash to direct to retirement savings and other investments.

In a backdoor sort of way, paying off your debt may be the best way to maximize your retirement contributions, at least at a later date. When you are paying off your debts, you can even tell yourself that you’re doing this to help prepare yourself for retirement.

There’s another benefit that most people don’t think about. Understand that, while the terms of any loan arrangement are fixed, the results of investment activity are not. Stocks can fluctuate in value, but debt doesn’t. That is to say that there is a fundamental imbalance between debt and investments.

Worst-case scenario: while you are prioritizing retirement contributions over paying off debt, the stock market crashes and 40 percent of your retirement assets are wiped out. But what happens to your debt in that scenario? Nothing—you still owe as much on your debt after the crash as you did before.

In that way, paying off debt is a guaranteed investment. It not only eliminates the interest expense that the debt carries, but it also guarantees improvement in your future cash flow.

The opportunity cost of paying debt first

Here’s the problem with paying off debt and not saving for retirement:

The IRS puts limits on how much you can contribute to tax-advantaged retirement accounts every year. If you don’t take advantage of contributing up to that limit this year, you can never get that opportunity back.

This, combined with the fact that delaying investing means you lose time to grow your investments, is a compelling reason to save for retirement even if you have debt.

Related: 23 Things Beginners Must Know About Saving For Retirement

As an example, let’s say it will take you five years to pay off your debt completely.

During that time you could have been contributing $5,000 per year to your employer-sponsored retirement plan, which would also come with a $2,500 employer matching contribution. If all of your money would have been invested in stocks providing an average annual return of 10 percent per year, you would have $48,232 after five years.

We can think of this as the opportunity cost of paying off debt instead of funding your retirement. As you can see, it’s a steep price to pay, and that’s why you need to seriously weigh the benefits versus the cost of an either/or decision.

To pay off debt, consider debt consolidation

If you do decide paying off debt is something you want to do right now, debt consolidation may be your best bet. It’s a simple process—you take multiple debts and combine (or consolidate) them and pay down that one, lower interest debt.

You can do this a couple different ways: A balance transfer, a debt consolidation loan, or a home equity loan or line of credit are just three of the options we recommend.

A balance transfer involves transferring your debt (let’s say, credit card debt, for this example) to a o percent APR balance transfer credit card. This is the way to go if you can pay off all your debt during the 0 percent APR promotional period (usually between 15 and 18 months).

A debt consolidation loan is exactly what it sounds like: A loan with the express purpose of paying down debt. Personal loans are a good option because you don’t have to put down any collateral and you can choose from a range of repayment periods and rates.

Finally, a home equity loan or line of credit can help you pay off debt, but only if you own a home. You can use the equity you’ve built up on your home to secure a loan or line of credit to use for debt consolidation. However, this is our least recommended way to pay off debt, since it involves putting up your home as collateral.

The true lesson? Avoid debt as a lifestyle

We can see there is an obvious cost to prioritizing paying off debt. But there is one fundamental reason why you might choose to payoff your debts anyway: to avoid the possibility of debt as a lifestyle.

Typically, people who are in debt in middle age were also in debt when they were young adults. It often happens because debt becomes a bad habit that’s hard to break. And it’s harder still when you consider that debt is often used to pay for a lifestyle that you couldn’t otherwise afford. It’s easier to fall into that trap than you may think.

When debt becomes a lifestyle, it’s almost impossible to get out of it—other than through bankruptcy, or even a series of bankruptcies. You know that this is a possibility if the use of credit becomes an important part of your overall financial life. And once it does, nothing short of drastic action can reverse it.

Summary

If you’re under 35, the time to deal with a debt problem is now. Having a well-funded retirement plan will be of no benefit if it is offset by an equally high level of debt.

If you are deep in debt, seriously consider your situation and your options, as well as the implications for your future.

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About the author

Total Articles: 165
Kevin Mercadante is a freelance personal finance blogger and the owner of his own personal finance blog, OutOfYourRut.com. A recent transplant to New England, he has backgrounds in both accounting and the mortgage industry.

Article comments

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9 comments
Hank Clausen says:

If I took out a loan for my daughters college, is it possible to redirect my contributions to my 401k to go towards paying off a loan? Of coarse keeping my companies contributions?

Josh says:

I’m not sure I buy the arguments here. Any money you put towards retirement instead of paying off debt is like taking out debt to retire. Think of it this way – If you were completely debt free would you take on debt to put into your 401k? No, right? That’s silly. That’s essentially what you do though when you invest now and don’t pay down debt.

Morgan D Guest says:

No, you took on debt when you purchased something on credit that you couldn’t afford with the money you actually had. With your logic i could say: “Well, if you are debt free and contributing to your 401k, you wouldn’t take on any debt right? Because then you’d have to stop contributing to your 401k.”

Nice article. I came upon it while wondering how to tackle this very thing. I got myself into $25,000 of credit card debt from business expenses but now that all the interest is kicking in, its literally killing me to pay it off. I been thinking about foregoing all retirement savings from my job to pay this down. But after reading a few articles, I am going to continue to match my employers 401k at 4%, which I was going to give up completely, and also change my HSA from the max contribution to a trickle, since my employer contributes 500/yr to that without me having to match anything.

Nick says:

A well written and informative article! I have asked this very question myself for my own situation. At the age of 30 making $55,000 a year (before taxes) but being $26,900 in debt which includes a $12,000 personal loan, $8,500 car loan, $4,050 in credit card balances and $2,350 in student loans…has caused me to have to adjust my 401k contributions accordingly.
With interest rates on my debts ranging from 13.49% to 2.33%, I’m mostly just attacking the highest interest ones first unless there’s a small enough debt I could pay off in a few months. In that case I’ll just take care of it to reduce my total number of debts…which gives me motivation.
I am now paying for my reckless 20’s, but I plan to be debt free in 3 years or less. Even sooner if I can get some side hustle going like selling stuff on eBay or craigslist. The two biggest difference makers in my behavior that have helped me the most? Making and following a budget and NOT using credit cards…AT ALL! Even just using one card “for the points” saying, “Oh, I’ll pay it off in full to never pay interest” is a noble goal, but it’s easier said than done. Swiping a credit card is just too easy. Doesn’t feel like you’re spending money…until you look at your balance in a week or two haha.
I may increase my 401k contributions up as my debt goes down, especially when I only have debts with interest below 5% but we’ll see. To be totally debt free other than rent and utilities is a feeling I cannot imagine. I certainly do not remember the feeling before I got my first credit card at 18! So, again, great article and site! I wish I had discovered this site earlier in life!

Hi Nick – I think you’re heading in the right direction. 30 is an excellent age to get a debt problem behind you, because you risk if becoming a lifestyle if you keep it around much longer. Maybe what you can do is increase your 401k contribution with each loan that you pay off. Oh, and I fully agree with your take on using credit cards.

Josh says:

Thanks for the article, Kevin!

This topic really pertains to me right now – I’m a 23 year-old engineer with a near-6-figure salary, but ~$73,000 of student debt (no credit card debt, mortgage, car payment etc). My employer matches 100% of my 401(k) contributions up to 5% of my salary – so I’ve been investing my 5% to get the 5% employee match, but no more than that. My extra income has been going neither to my 401(k) nor towards my student debt. Instead, I’ve been focusing on building a solid 6 month emergency fund that includes the cost of an emergency move in case I lose my job (I’m in the oil industry, so a definite possibility – and one that accounts for ~90% of my stress at the moment). I feel confident in my decision to put extra money in an emergency fund until I have enough for 6 months – as the added security this fund provides/ will provide me is worth a lot to me right now. However, once I’ve built up this fund, I have to ask the question – more student debt payments, or 401(k) contributions?

I’m not a huge fan of the “both” answer – and here’s why: I have a minimum payment on my student debt, which I of course make every month. After that, I make my 5% 401(k) contributions, but that’s only because of math: I get an instant 100% return on that investment, plus the interest it garners. The extra money I have (currently going towards emergency fund), I will want to put in what will make me the most money in the long-term. Paying off my student debt gives me a guaranteed ROI of 5.5% (interest rate on my loans), while extra 401(k) payments are at the mercy of the stock market.

So you see, this is my dilemma. You touched on many of these points in your article – I just thought I’d add my story to the mix.

Thanks!

Josh

Hi Josh – First of all, congratulate yourself for being just 23 years old and having a solid grasp on the reality of your employment situation (I’ve been hearing and reading about the oil patch problems). Your emergency fund-first strategy is the best response to this.

Maybe what you can do is keep the emergency fund as the priority, but once it exceeds 6 months by a wide margin, you can make a lump sum paydown on the student loan debt? That would give you control over the funds for an extended time, just in case you do lose your job. Even with an engineering background, $73,000 is a lot of money to owe, even and especially in the event that you lose your job. Getting it cut down is a worthy goal.

Good idea on taking full advantage of the 5% employer match on the 401k. You’re in a tight spot – at the moment anyway – but you’re doing all the right things. When oil prices head back up, which they will, you’ll be in excellent shape.

Michael says:

From a fellow oil-industry colleague, I would like to give you a little bit of peace of mind. As said above, oil prices will be back up, and, if you’re in Houston like the rest of us, you will be fine. 6 months is a bit much to save up in my book, and 70k of student debt would take a high priority over anything else for me.

I was in your exact position 3 years ago (with less student debt), and here’s exactly what I did:

4% match for 401K (employer match w/out profit sharing)
Set amount to live on based on living expenses (the rest gets dumped to savings). Direct deposit is your friend
Get guaranteed 6% return in an unstable market by paying student loans, but do not get below said emergency fund
Increase 401k/Roth annually, and live on the same amount as your first year

Live life, and don’t get bogged down with money problems. Some of these people basically say to live as if you were broke while still making a lot of money. Why? So you can enjoy it in your LATE 60s?! I don’t know about you, but I don’t see myself enjoying things in my 60s as much as I do now. Be smart and prepared for retirement (increase contributions), but don’t make yourself poor when you went to college to do the opposite. Doing what I mentioned previously, I will have enough for retirement, even by financial samurai’s standards. Yet I still have been able to enjoy what I work for.

Oil industry people like us will be fine in a good or bad market. Resume building will take care of the industry transition. You will constantly get calls from other sectors, because an oil resume holds value in your particular discipline.