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Pay Off Debt or Invest?

People often ask the question, "Should I pay off all of my debt before I start saving for retirement?" At first glance, this may seem like a very difficult question. However, by considering a few simple concepts, you can make the right decision for your situation.

As a general rule, whether debt is a mortgage, car loan, student loan, credit card or medical bills, all debt should be retired as soon as possible! The feeling of living debt free for life is certainly worth the sacrifice required to reach that goal. Everyone should be debt free before retirement. However, the question remains, should a person commit all available funds towards paying off debt at the expense of saving for retirement? Understanding the two types of debt will make your decision easier.

On one end of the debt spectrum is high-interest, nonproductive debt such as credit card debt that originates from credit cards and department store charge accounts. Nonproductive debt is financially destructive and should be avoided. If this type of debt is necessary for short periods of time, the debt should be paid off as quickly as possible. The other type of debt is productive debt such as a mortgage and reasonable debt for education, transportation or the cost of doing business. Productive debt is an investment and the interest paid is often tax-deductible. Productive debt can be paid off over time as long as the interest rate is reasonable and the debt is paid off before retirement.

Before choosing to delay saving for retirement, two important concepts must be considered. First, the University's Retirement Savings Program ‘matches' personal contributions up to 4%; That is, if you invest 5% of your paycheck, the university will invest 4% into your account. That amounts to an 80% return on your initial investment without considering what your money may earn in the investment. Generally, it is not a good idea to refuse ‘free' money!

The second concept to consider is the ‘miracle' of compound interest. A dollar invested today earns interest. As future interest is calculated, it is not only calculated based upon the initial dollar invested, but on every dollar of interest earned as well, thus compound interest. In almost all cases, a few dollars invested consistently over a long period of time will produce more of an accumulation at retirement than larger amounts invested over shorter periods of time.

Key points to consider:

  • Credit card or nonproductive debt should be avoided, but if incurred it should be paid off as soon as possible.
  • Productive debt can be paid off over time as long the interest rate is reasonable.
  • All debt should be paid off before retirement.
  • Take advantage of the university match and the miracle of compound interest as soon as possible

For more information, contact the Benefits Office, D-240 ASB, (801) 422-4716

Updated by the HRS Web Team, Brigham Young University, Provo, UT 84602 - Copyright 2008. All Rights Reserved.