Save or Pay Off Debt?

Editor's note: This article originally appeared in the July 2014 issue of Kiplinger's Personal Finance.

Saving for long-term goals tends to take a back seat to expenses such as child care, groceries and health insurance. And if you’re also paying off debt, saving for retirement and college may get pushed to the curb.

But putting off saving for retirement until you’re debt-free could cost you the most valuable asset you have: time. Thanks to the magic of compounding, even small contributions to a 401(k) or similar retirement plan will grow significantly, especially if your company matches contributions. If you can’t come up with enough money to hit the annual limits, or even close to them, “at least contribute enough to get the match,” says Sheryl Garrett, founder of the Garrett Planning Network.

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Saving for college isn’t as pressing as saving for retirement or paying off credit card debt, says Cheryl Sherrard, a certified financial planner in Charlotte, N.C. “It’s nice if you’re able to save something for your children’s education, but the biggest priority should be taking care of your needs. You can’t borrow for retirement. You can for college.” As for getting rid of the credit card debt, “I think that trumps saving for education.”

To free up more money for savings, pore over your expenses for ways to cut; look at how much you pay for your cell-phone plan, cable package and restaurant meals. Use the extra money to “really attack your debt. Go at it with guns blazing,” says Garrett.

Prioritize your debts. Start with credit card debt, which you should pay off as quickly as possible. Paying off a card with an 18% interest rate is the equivalent of earning an 18% return. Be wary of transferring your balance to a card carrying 0% interest, says Garrett. Ask yourself whether you’ll have the discipline or ability to pay off the balance before the rate goes up; if not, you’re back where you started. “The only way I’d advise people to switch to a 0% or teaser rate is if they have a plan to truly attack the debt and get it paid off by the end of that term.”

Student loans can generally come second. These loans, especially federal loans, have lower rates than most other types of consumer debt, and you may be able to deduct up to $2,500 of the interest. To free up more for retirement, pay the minimum required each month under the terms of your loan. (For repayment plans that best suit your circumstances, see Kiplinger’s Starting Out Guide to Your Money.)

Bottom line? While your creditors will go after you if you fail to pay your debts, Garrett says, “nobody is going to force you to save for retirement. We’re the only ones that are going to force ourselves to save.”