Should you put extra money towards paying off debt or saving for retirement? The biggest challenge is to do both well enough, reducing debt as much as possible while moving towards pension age. Here is how to find that balance ahead of retirement.
Retiring with debt is certainly not ideal. It spells bad news for your retirement income, but so does prioritizing debt reduction exclusively without a retirement savings plan.
Eliminating all debt before retiring is an excellent financial goal, but being debt-free won’t help if you don’t have liquid funds in the bank once you hit the pension age.
There is a solution. If you’re still in debt and actively planning for retirement, your debt repayment plan should sync with your retirement goals. It means calibrating all debt repayments to ensure you can still afford to retire.
Optimizing your debt repayment plan to fit retirement
Start by looking at the benefits and costs of repaying particular debts faster by adding the extra money to repayments versus saving or investing the same amount towards retirement. A financial adviser or debt counsellor will be able to assist.
The general rule is to reduce and eliminate debt as quickly as possible if the debt interest rates outweigh by far the potential investment returns set for retirement (stock market, equity, provident funds, real estate etc.).
- Pay-off high-interest ‘bad debt’ first
The cost of servicing high-interest repayments is generally higher than any investment returns you may expect in retirement, so you have to get rid of this type of debt before entering pension age. Prioritize this debt above the other low-interest debts.
Resolve to pay off any credit card debt or high-interest loans first. You may need to consolidate multiple credit lines into a single debt and negotiate its loan terms to ensure repayment in the time you have left before you exit the workforce.
- Reduce low-interest debt
Secondly, focus your debt repayment plan on reducing all low-interest debt, usually property or vehicle loans, but keep your retirement investment goals in mind.
Adding retirement savings in the mix while paying off debt makes sense when the debt interest is significantly lower than the estimated investment returns. In this case, you’d rather put the extra cash towards retirement funds and reap the future benefits.
- Balance remaining debts with retirement savings
Thirdly, there is no one-size-fits-all approach to your debt repayment plan and retirement strategy. Balancing these two is important to get the most out of retirement. For example, you may derive more value long-term from actively investing in a retirement fund and diversifying your portfolio further than speeding up mortgage repayments.
Also, you may want to eliminate the home debt entirely or decide it’s better to use part of your retirement income to finish paying it off, channeling your extra funds into future investments. Therefore, it’s essential to budget those debt repayments according to your individual risk profile, indebtedness level, future financial plans and specific retirement needs.
Consulting a debt counsellor to discuss debt priorities can add immense value to improving your retirement chances. It is imperative to get specialized debt help if you worry about not having enough retirement income to cover debt instalments or want to become a debt-free pensioner.
ezDebt counsellors advise on the best debt repayment management plan to fit your retirement needs.
Our professional debt advisers help you stay on track with debt repayments through quick and affordable debt counselling. All our debt counsellors are registered with the National Credit Regulator (NCR). Get in touch at www.ezdebt.co.za.