993. Laura answers a listener's question about stopping retirement contributions to get out of debt faster.
993. Laura answers a listener's question about stopping retirement contributions to get out of debt faster.
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Hey, friends, and welcome back to the Money Girl podcast! This is Finance Friday, a special edition of Money Girl, where I answer your burning money questions.
Today’s topic is an email from Heather, who says, “I work for a nonprofit and contribute 4% to my 403(b) retirement plan. But I’m also trying to get out of debt. Should I stop making retirement contributions so I can send more to my debt, or continue investing the same amount knowing it will take me longer to get out of debt?”
Thanks for this great question, Heather! Knowing how to prioritize saving and eliminating debt is a classic financial dilemma. This post will give you a four-step priority plan to follow anytime you’re unsure how to manage or allocate money. Following this guide will give you confidence that you’re using your precious financial resources wisely to balance debt payoff with long-term wealth building.
This is episode 993, and I appreciate you downloading the show! If you’re a new listener, I'm Laura Adams, an award-winning author, female money speaker, and founder of The Money Stack, my Substack newsletter and community. To learn more and sign up, visit LauraDAdams.com.
If you have a money question, I’d love to feature it on a Finance Friday show. Leave me a voicemail at 302-364-0308 or send an email using my contact page at LauraDAdams.com.
Your 4-step priority financial plan
Knowing the best way to manage money can be tricky because there isn’t always a right or wrong answer. Yes, eliminating high-interest debt is always wise, but you also need to invest for the future, maintain a healthy emergency fund, and achieve many other short-term goals.
When you’re unsure what to prioritize in your financial life, use the following four-step plan.
1. Check your employer matching.
The very first step for Heather or anyone participating in a workplace retirement plan, like a 401(k) or 403(b), is to know if you’re eligible for employer matching. A retirement plan match is when an employer contributes to your retirement plan based on how much you put in.
While employers that offer a retirement plan aren't required to contribute matching funds, most do because it's a valuable benefit that helps attract and retain good employees. It’s a great way to encourage eligible workers to participate.
Companies choose to pay either a partial or a full retirement match. With a partial, your employer matches a portion of the amount you put into your account up to a limit.
For example, a partial matching example is receiving 50% of your contributions up to 6% of your salary. If you earn $100,000 annually, 6% of your salary is $6,000. If you contribute at least $6,000 over the year, your employer will match 50% or contribute $3,000 on your behalf. To get the maximum match in this example, you must contribute at least 6% of your salary.
With full matching, your employer matches 100% of your retirement contributions up to a limit. For instance, you might receive 100% of up to 4% of your salary. If you earn $100,000, your maximum match would be 4% or $4,000.
Heather didn’t mention the details of her income or match. But let’s assume she’s eligible for a full match and she stops contributing. In that case, she’d miss out on receiving 4% of her income from her employer.
Since matching contributions are free, they give you an immediate return on your investment. So I don’t recommend turning down a match because it’s almost like agreeing to a pay cut!
If Heather pauses retirement contributions to pay off a credit card with a 20% interest rate, she saves 20% interest on an after-tax basis. But by skipping the employer matching, she loses out on a minimum guaranteed gain of 100%.
Plus, the potential investment growth of matching funds could put tens or even hundreds of thousands of additional dollars in your retirement account over the long run.
So, even if you have high-interest debt, always contribute enough to a workplace retirement plan to max out any free matching funds.
If your employer doesn’t offer a retirement plan or one with matching, I recommend following the next steps.
RELATED: How to get retirement matching without an employer
2. Review your emergency savings.
Before aggressively paying down debt, Heather needs an ample emergency fund, also known as a cash reserve or a cash cushion. So, the next step in prioritizing your finances is to review and evaluate the health of your savings. Ask yourself:
Many people have some savings, but actually need more. To me, an emergency fund is like buying insurance that will keep you financially safe and reduce stress in the future.
The right amount of emergency money protects you from a potential hardship, like a job loss or sudden downturn in your business income. Having savings can be the difference between surviving a hardship and getting buried under it and going further into debt. Therefore, building your cash reserve may be more important than aggressively paying down debt or investing.
The amount of emergency savings you need depends on your lifestyle and work situation. For instance, if you work in an unstable industry, are self-employed, or are the sole breadwinner for a large family, you need a larger financial cushion than a single person with no dependents and plenty of job opportunities.
A “large” cash reserve could be at least three to six months’ worth of living expenses, and a “small” one could be a month or two. You’re the only person who can really gauge the amount that’s right for your situation.
Another good rule of thumb is setting aside a percentage of your annual gross income, such as 10%. For example, if you earn $60,000, maintaining a $6,000 emergency fund is a terrific goal.
However, if you’re starting with zero savings, you could begin with a small goal, like saving 1% or 2% of your monthly income. Then increase it annually until you have enough to help you manage the stress of a potential hardship.
In addition to the amount you keep in cash, where you keep it is important, too. A common mistake is treating your retirement investments as an emergency fund.
Instead, keep your cash reserve in a separate high-yield savings account that’s FDIC-insured. Don’t worry that it isn’t earning a high interest rate because that’s not the purpose of this bucket of money.
The purpose of emergency savings is to be accessible and never lose value. Investments rise and fall in the short-term but can experience significant growth over the long term. Therefore, if you invest emergency money, its value could decline the moment you desperately need to cash it out.
If you or Heather don’t have enough savings in the bank for an unexpected financial crisis, that should be a top priority. One way to make saving easier is to automate it. For instance, you could ask an employer to direct deposit a portion of your paycheck into a dedicated savings account. Or you could set up a recurring transfer from checking to savings, weekly or monthly.
If you try to accomplish other financial goals, like eliminating debt, before accumulating a cash reserve, you could end up back in debt. So, evaluate how much emergency savings you have, how much you need, and automate a plan to slowly bridge the gap.
RELATED: 5 options to manage your 401(k) after leaving a job
3. Attack dangerous debts.
After maxing out any employer matching at work and building some emergency savings, your next financial priority is attacking dangerous debts. These might be tax liens, overdue child support, or accounts in collection. If you have any of these types of debt, you need to get caught up as quickly as possible.
Dangerous debts also include high-interest credit accounts—such as payday loans, credit cards, and car loans—with rates in the double digits. These accounts can destroy your financial health by draining your resources and keeping you from using your money to save or invest.
In general, it’s best to tackle your highest-rate debt first because it costs you the most in interest. Don’t worry yet about paying off low-interest debts, like mortgages or student loans, ahead of schedule, because they’re relatively inexpensive. Additionally, they come with built-in tax deductions, which further reduce their cost.
Heather didn’t mention the amounts or interest rates of her debt. So, I’d encourage her to create a debt payoff spreadsheet and list each account’s balance, interest rate, and payoff date (for loans). Then sort them from highest to lowest interest rate and attack them in that order, a strategy known as the debt avalanche.
However, if you have a small debt balance that isn’t your highest interest rate, there’s nothing wrong with wiping it out first. That can feel great, especially if it has a high monthly payment.
Another popular payoff strategy is called the debt snowball, where you aggressively pay debts from smallest to largest balance, no matter their interest rate. While it doesn’t save the most money, getting rid of a small balance can boost your motivation to keep paying down your debt. In my opinion, any debt payoff method you can stick with is a win!
RELATED: How to maximize 401(k) matching funds
4. Analyze low-interest debt.
Once Heather eliminates dangerous or high-interest debt, she’ll likely have some low-interest balances remaining, like a mortgage or student loans. This is where you must do your best to compare the after-tax interest rates to your potential investment returns. That’s because you may be eligible to deduct some or all of the interest paid on those types of debt.
For example, if you have a federal or private student loan that charges 6%, you can generally deduct up to $2,500 in interest paid, with certain income limits, even if you don’t itemize deductions. That could effectively cut your after-tax interest from 6% to 5% or 5.5%, depending on your balance.
The question you must ask yourself is whether you’d prefer to save approximately 5% by paying off your student loan early or investing it for retirement. The S&P 500 has historically returned 7% over the long term, even when adjusted for inflation. Your choice is whether to have a guaranteed return and eliminate the debt or have a higher expected return from investing.
My recommendation is to invest in a diversified portfolio, such as an S&P 500 index fund instead of paying off low-rate, tax-deductible debt ahead of schedule.
However, money isn’t just about math–it’s also about psychology. While the math tells me to invest, you may strongly prefer to eliminate debt, and that’s OK. The best choice for you depends on your risk tolerance and personal feelings about debt.
Remember that student loans and home-related debt, such as mortgages, home equity loans, and home equity lines of credit (HELOCs) are tax-deductible, making them cost less than the interest rate on their face.
Your goal should be to figure out what’s more profitable: saving the interest you’re currently paying or investing with the expectation of a reasonable return. Paying off a high-rate credit card is always a smarter move than investing. But I don’t recommend rushing to pay off low-rate, tax-deductible debt early.
Unless your finances are in great shape with plenty of emergency money and regular retirement contributions of at least 10% to 15% of your income, make low-rate debt one of your last financial priorities. You shouldn’t put your creditors’ best interests ahead of your own. Not saving for retirement is just too risky.
If you’re like Heather and have a retirement plan at work, you can contribute up to $24,500. If you’re over 50, you qualify for catchup contributions that total $33,500, or up to $35,750 in super catch-ups if you’re from age 60 to 63.
If you don’t have a workplace plan, anyone with earned income can have an IRA. For 2026, you can contribute up to $7,500 or $8,600 if you’re over 50. And if you’re self-employed, you have more retirement account options, including a SEP-IRA or a solo 401(k). In general, you can even max out multiple retirement accounts in the same year.
RELATED: 7 things every successful investor should know
Thanks again to Heather for such a great question! That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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