The message has been hammered home time and time
again: save for retirement — you – must — save – for – retirement. Americans
are saying, “Message received.” And since the financial collapse, there has
been a major shift in priorities among the so-called “mass affluent.”
Retirement saving is now the top priority of 39% of Americans, followed by
paying down debt (26%), according to a Bank of America Merrill Edge report. This is a complete
reversal since the 2008 money meltdown.
Wait, what? We’re placing a priority on
saving for retirement over paying off debt? Won’t the financial experts say
we’ve got it all wrong? Aren’t we supposed to pay off the debt — and then start setting aside retirement savings?
come in here with a skull full of mush
“Depends on the debt,” says Shane Fischer, an
attorney in Winter Park, Fla. “If it’s a low interest rate debt that is tax
deductible, why not save for retirement first? You get the tax benefits of
retirement contributions with the tax write-off of the low interest on the
debt. And since you are limited to the amount of 401(k) or IRA contributions
you can make every year, why not maximize those contributions first?
Additionally, if your debt burden forces you into bankruptcy, your 401(k) contributions
are protected from creditors. So if you’re going to declare bankruptcy wouldn’t
you want to keep as much money as you can?”
Fischer is “thinking like a lawyer,” as John
Houseman portraying crotchety Professor Kingsfield so famously spewed in “The
Paper Chase.” But what do the financial advisors say?
James D. Osborne, president of Bason Asset
Management in Loveland, Colo. says the debt comes first.
“High-interest consumer debt — anything
carrying a higher rate than your mortgage payment — should be treated as an
emergency,” says Osborne. “This means credit cards, auto loans, personal loans
(like the one you borrowed for that European vacation), private student loans
and home equity loans. Once these loans are eliminated, it’s appropriate to
first build an emergency fund of 3-6 months of living expenses and only then
start saving for retirement. The only exception to this rule is that investors
should always contribute enough to earn their company match in a workplace
OK, got it. Pay the debt first. Unless you
get a 401(k) company match.
your investments in prison
But, not so fast, says Nancy D. Butler, an
advisor in Waterford, Conn.
“The fact that you have built up this debt
says that you have had difficulty managing your finances,” Butler says. “If you
apply the funds you have available to reduce the debt, what is to keep you from
building the debt back up again? And, you will still have no retirement
So save for retirement first?
“Although the debt typically has a cost
associated with it, sometimes you can come out ahead financially by applying
any money available above the required minimum debt payment, to save for
retirement,” says Butler.
She goes one step farther. And I have to
admit, I haven’t heard this as being a positive investment strategy before: tie
the retirement savings up with big withdrawal penalties.
“I often suggest applying the retirement
savings to an account that has a high surrender charge if you withdraw it too
soon,” Butler says. “Between the surrender charge, 10% penalty for withdrawing
before age 59½, and federal and state income taxes, a withdrawal could cost you
50% or more of every dollar you withdraw. This cost can be a deterrent and
therefore help to save the money [rather than] spending it and not having a
And so we all agree: save for retirement
your future self
Uh-oh. Rachel McDonough, a financial planner
in Bloomington, Minn. is urgently raising her hand to speak.
“I believe that debt is only truly safe
for those who don’t need it; those who could simply write a check and pay it
off anyways,” says McDonough. “If that’s not you, then your debt load puts
pressure on your future earnings and reduces your financial freedom. Plus,
stock, bond or mutual fund retirement investments have no guaranteed rate of
return. Sometimes they lose money. But paying off expensive debt guarantees you
a savings in the total amount of interest you’ll pay.”
Ell Kaplan, a “female finance CEO” agrees
with paying off high-interest debt, but low-interest bills like student loans
can be slowly satisfied with minimum payments.
“In investing, the most precious resource is
time,” Kaplan says. “By waiting until all of your loans are paid off, you will
have detracted extremely valuable time during which you could be contributing to
your retirement resources. Think of it as paying your future self, and make it
as non-negotiable as any other bill.”
One advisor has considered both sides of the
issue, created a definitive strategy – and then changed his mind.
“I too have read the “book” advice about
paying off debt before saving for retirement,” says Thom W. Newcomb, a
financial advisor in Pensacola, Fla. “However, about 5 years ago I abandoned
this philosophy and made a 180 degree turn and began advising clients to focus
on savings and less on paying off debt.”
Newcomb cites the following reasons:
reality, there is a psychology to debt. Everyone has an “acceptable
debt threshold” so paying off debt is a never ending battle. The moment it’s
paid off, most consumers with no debt will soon take on new debt within their
threshold. So focus on savings and simply keep debt under control.
began asking clients a simple question, “Would you be comfortable if we didn’t
pay off the debt but you had the money where you could pay off the
debt at any point, if you wanted to do so?” Clients would almost always
generally, he says a client can make more than they pay with compound versus simple
interest. Cash is King. Plus he takes into consideration the tax advantages of
investments and interest payments, such as mortgage interest.
And Newcomb is dead set on his debt-last
Oh, wait. With two exceptions: clients with
high interest rate credit cards or loans, and people who are above their “acceptable