Retirement Planning For 30-Somethings: Reducing Savings
If you have accumulated savings, but find yourself highly in debt, it is possible that you are saving too much. Having a large nest egg can be attractive, but the associated benefits can be eroded by the interest paid on outstanding debt. If you do have outstanding debt, you will need to determine whether you should reduce the amount you add to your savings so as to allocate more towards paying off your debts, or continue adding your usual amounts to your retirement nest egg. The following are some points for consideration:
Interest Cost vs. Interest Earned
The net amount of the interest that you would earn on your savings versus the interest that you would pay on your debt should be assessed. If your savings are invested in vehicles that provide a fixed rate of return, it is easy to project the amount of interest that you will earn over a given period. However, if you invest in stocks and other assets for which there is no guaranteed rate of return, you may need to work with a financial advisor to determine a reasonable rate of projected return, which is usually based on several factors, including historical performance of the assets in which your savings are invested.
Calculate the amount of interest that you would pay on your outstanding debt over time if you pay the amounts that you can afford, and compare that to the earnings that would accrue on your savings. The calculated earnings on your savings should take any income tax that would be owed on the amount into consideration. For regular savings and brokerage accounts, the income tax owed would generally be paid every year when you file your tax return, whereas the income tax on tax-deferred savings would be owed at the time the amount is withdrawn from your retirement savings account.
If you find that you would be paying more interest than you would earn, it may make more financial sense to reduce your savings and increase the amount allocated towards paying off your debt, so as to reduce the amount of debt-related interest you would eventually pay.
Do You Get a Matching Contribution?
If your savings are being added to an employer-sponsored retirement plan, such as a 401(k), 403(b) or SIMPLE IRA, and you receive a matching contribution, that factor should be taking into consideration. If reducing the amount that you save also means giving up the opportunity to receive matching contributions from your employer, that too should be factored into your calculation. In some cases, the matching contribution may result in a higher return on your savings than the amount of interest you would pay on your debt, but that is not always the case.
Are Your Earnings Tax-Free Eligible?
If your savings are added to a Roth account, income tax due on the amount would be paid when you file your tax return for the year. However, the earnings on those amounts could be tax free, which could make saving your disposable income a better option than allocating more to paying off your debt. However, an analysis should be done so as to make a reasonable determination.
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