Should I Pay Down My Debt or Save Money for Retirement?
One of the most common questions clients ask is whether to prioritize paying down debt or saving for retirement. Dentists often face significant debt loads throughout their careers, which can make balancing planning for retirement with paying down debt a challenge.
With factors like interest rates, debt amounts, and individual financial goals, there isn’t an easy or one-size-fits-all answer for all dentists. Here are five principles to consider when deciding whether to pay off your debt or save for retirement:
1 - Assess Your Debt
First, evaluate the nature of your debt. High-interest debt, such as credit card balances and possibly home equity and auto loans, are typically the best to prioritize. At the time of this writing, the average credit card rate is over 20%, which can cause the balance of your card to rise quickly if it is not paid off.
Avoid the minimum payment trap:
Assuming a balance of $10,000 with a 20% interest rate and a 2% minimum payment of the balance (a common requirement for credit cards), most of what you pay will go toward interest and not reduce the balance. It would take over 73 years to pay off the balance, and the total interest paid would exceed $47,000!
Use this calculator to estimate interest on credit card debt)
Paying off high-interest debt is a great strategy to save you the most money spent on interest payments. (See more about compound interest work can work against you in our “Is Interest Working for You or Against You?” article).
For other loans, the decision can be more nuanced. Student loans, mortgages, and other loans can have lower interest rates and more flexible repayment options. When you have loans with low interest rates, it could make sense to make minimum payments and use excess cash flow to focus on other financial goals.
2 - Consider Your Retirement Goals
Dentists, like all professionals, need to plan for a retirement that maintains their desired lifestyle. Starting early with retirement savings can leverage the power of compound interest. By far, the most important factor of compound interest is giving your money time to grow. Even if retirement savings start small, building the habit of setting money aside for retirement is powerful in yielding the gains possible through compound interest. Consider the two scenarios below to illustrate the difference between saving early in a career versus catching up later (both examples assume a hypothetical 7% annual rate of return):
Scenario 1 “Catching Up Later:” Dr. Bob does not prioritize retirement savings in his beginning years of practice and feels like he needs to catch up. So, he begins saving $3,000 per month at the age of 45. By the time he retires (age 65), he has saved $720,000 that grew, thanks to compound interest, to just under $1.6 million.
Scenario 2 “Starting Earlier:” Dr. Diane understands the power of compound interest and starts saving for retirement early in her career. She begins saving $1,000 per month at the age of 30. By the time she retires (age 65), she has saved $420,000 that grew, thanks to compound interest, to just over $1.75 million.
Clearly, you can see that in both scenarios, Dr. Diane and Dr. Bob benefited from compound interest. However, the total Dr. Diane put away for retirement was $300,000 LESS than Dr. Bob, but because of the longer time horizon to take advantage of compounding interest, her total retirement savings by age 65 is $150,000 MORE!
3 - Balance Both Strategies
In many cases, a balanced approach is advisable. Finding the right balance will depend on your unique financial situation, goals, and the type of debt you’re managing. Allocating a portion of your budget to debt repayment and another portion to retirement savings is a strategy to help ensure you are reducing your debt burden while also taking advantage of compound growth potential in your retirement accounts.
The benefits of a balanced approach will give you the financial flexibility to protect your practice cash flow, avoid a debt spiral of growing interest charges eating away at your ability to save for the future, and allow you to build retirement savings early to increase your nest egg. Ultimately, assessing your financial situation regularly and adjusting your strategies as your goals, income, and expenses change will allow you to address both short-term financial obligations like debt and long-term goals without sacrificing one for the other.
4 - Maintain an Emergency Fund
Before aggressively paying down debt or ramping up retirement savings, it is important to ensure you have an emergency fund so you are ready for life’s surprises without jeopardizing your financial health. Unexpected expenses such as medical bills, home repairs or temporary loss of income can happen at any time.
Without a financial cushion to mitigate the stress and give you the buffer you need when life events like this naturally occur, dentists may have to take out a high-interest loan or postpone retirement contributions, slowing down long-term savings goals.
We recommend having 3-6 months’ worth of living expenses in a bank account (like a high-yield savings account).
5 - Consider Tax Savings
Retirement contributions can offer tax advantages. For example, contributions to a traditional 401(k) or IRA can be tax-deductible, reducing your taxable income. This can be particularly beneficial for dentists in higher tax brackets during their years of practice. Additionally, some student loan interest, home mortgage interest, and business debt are tax-deductible, which can slightly offset the cost of carrying this debt.
An Example of Tax Savings:
If you’re a dentist in the 32% tax bracket and you contribute the maximum ($23,000 for 2024) to your 401(k), you would reduce your taxable income by that amount and lower your tax bill potentially by $7,360 for the year. This will not only reduce your tax bill but will help you grow your retirement savings.
Conclusion
Ultimately, the decision to pay down debt or save for retirement depends on your unique financial situation. High-interest debt should generally be prioritized, but don’t neglect retirement savings! A balanced approach, combined with a solid emergency fund and consideration of tax benefits, can help you achieve multiple financial goals.
For personalized advice specific to your situation, consider scheduling a Complimentary Consultation with one of our financial advisors. By carefully evaluating your debt, retirement goals, and overall financial picture, you can create a plan that sets you on the path to Financial Freedom!
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