Should You Pay Off Debt or Save For Retirement?

6 July 2022

This is a question that many people are facing. If they have extra money left at the end of the month, should they use it to pay off debt or to start/increase their pension contributions? The answer to this question is not straight forward and if you ask different financial advisors, it is unlikely that you will get a uniform response. The answer to this will depend on your individual financial situation. There are different types of debt such as credit cards, personal loans, and mortgages, each of which should be approached differently when considering paying them off. A credit card may have an interest rate of close to 20%, a personal loan may have an interest rate of 10%, dependent on the purpose, whereas your mortgage’s interest rate may only be 3%, or lower.

The main advantages of paying into a pension are the tax relief benefits and tax-free growth during the savings term. The average annualised return of the S&P 500, since adopting 500 stocks into the index in 1957 through December 31 2021, is 10.67%. This much higher than the interest rate that you are paying on your mortgage but lower than the interest rate that you are paying on a credit card and very similar to personal loan interest rates.

The best thing to do is to evaluate your debts and make a list of them, including the current balance, minimum payment, and interest rate. Any debts with high interest rates such as credit cards should stand out and it might be worth considering paying these off before you pay any extra money into your pension.

The second important consideration is that you have an emergency fund in place. This can help meet any unexpected costs such as car or home maintenance issues. The nature of emergencies is that they are unpredictable and having an emergency at the most inappropriate time is all but guaranteed! It is recommended that you have three to six months of living expenses saved in your emergency fund. This is not money that is invested in the stock market but rather money that is sitting in a low interest, capital guaranteed account such as with the bank or the credit union.

When you have saved for an emergency fund and paid off your high interest debts you can then plan to use any excess money that you have each month towards pension contributions. Right now, the chances are that you will average a higher return on a long-term pension investment than you are charged on your mortgage. To be honest, if you wait to start your pension until your mortgage has been paid off, you might never do it! So, in this scenario a two-fold approach is often best, where affordability allowing, you pay some money into your pension alongside repaying your mortgage.

Paying into a pension provides the following benefits which will help your fund to grow over time:

  1. You will get tax relief at your marginal rate on any contributions that you make. At the very minimum, if you pay tax at the lower rate, a monthly pension contribution of €200 would only reduce your income by €160.
  2. The money in your pension will grow tax free. This means that it will be easier to accumulate growth than if you invest the money personally, where the growth is being taxed at 41% on an ongoing basis.
  3. You will not be able to access a pension fund until retirement so you will not end up dipping into your retirement savings to pay for things such as a last minute holiday.

If you have any questions about starting a pension or increasing your contributions towards a pension as opposed to paying off debt, I highly recommend that you talk to a Trusted Financial Advisor. It is often easier for someone who is not involved in your budget, to look at it from an outside perspective and guide you as to what might be the best decision from a financial standpoint!

Robert Downes QFA RPA is a Qualified Financial Advisor and Retirement Planning Advisor.You can contact him through John F. Loughrey Financial Services by telephone on 074-9124002 or by email on robert@jfl.ie

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