Pay off debt or save for retirement? 5 steps to balance both

Photo of a couple in their kitchen deciding what to do with their excess money, save for retirement or pay off debt.

You’ve settled into your career and have a little extra money in your pocket. What do you do with it?

Knock out debt? Save for retirement?

The good news: It doesn’t have to be an either-or question. It’s all about finding a balance. Here’s how:

1. Focus on your cash flow.

“It all comes down to cash flow,” says Don Hammond, a Principal® financial advisor in Sheboygan, Wisconsin. “Figure out how much you have coming in versus what's going out and adjust so you have money for retirement and paying off debt.”

Use a household budget worksheet (PDF) to help free up money each month to put toward debt reduction and/or savings. Look at recent bills, plus bank and credit card statements, to give you the real facts.

Of course, more income helps. Lots of people have a side hustle for extra money. Maybe you can be a math tutor, make earrings for the local art fair, or join the ranks of Uber drivers. Search for "side hustle ideas" to get started.

2. Beef up your savings.

Keep long-term savings top-of-mind. “Building liquidity while paying down debt is helpful,” Hammond says.

Contributing to your retirement accounts while paying off debt can help. If your employer offers a matching contribution on a 401(k) or 403(b) retirement plan, put away at least the minimum so you get the match. It’s sort of like free money.

Even a 1% bump in your retirement plan deferral can make a big difference over time.

3. Make debt reduction a priority.

Start early and chip away. “Don't wait until a serious crisis to prioritize and pay down debt,” says Hammond. Instead:

  • Make a list of debts from the highest interest rate to lowest.
  • Pay off the highest-interest credit cards and loans first. Pay more than the monthly minimum on these.
  • Continue to make at least minimum payments on the rest.

Once you’ve paid a debt, consider putting that same monthly amount toward retirement savings. (And pat yourself on the back.)

4. Be cautious about credit.

How you manage credit depends on your financial situation, Hammond says.

If you carry a credit card balance: “Just because you have a box of chocolates doesn't mean you have to eat them all at once,” Hammond says. “If you're in the hole, don't keep digging. Work toward paying off your credit cards.”

If you're essentially debt-free: Continue to use credit within reason, of course. Why? Because not using it may damage your long-established credit score and make it harder to get financing when you really need it. Hammond suggests charging a little bit each month and paying the balance in full each month. That’s the key part … in full.

5. Talk to a financial advisor.

To plan for your future, you first need to know where you stand financially. Then, if you want assistance, contact a financial advisor for help with your personal finance strategy.

Next steps:

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

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