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If you’ve ever asked yourself, ‘Is it better to save or pay off debt?’ you’re not alone. The big question of whether you should use what’s left over each month to pay off your debt or put it away for retirement is a common one.
Unfortunately, the answer isn’t straightforward. Each option has its pros and cons – some money based and some psychological. Ultimately it comes down to the ins and outs of your financial situation, interest rates, and your relationship with money.
Overview of saving versus debt
Firstly, let’s look at savings and debt.
Putting money away into savings is a must. It gives you financial security and the ability to cover any emergencies or big purchases. It can also set you up for the future so you can enjoy a comfortable retirement.
However, saving, including saving for retirement, isn’t easy, especially if you’re on a low income, have high expenses, or it’s not your natural default. The average savings per individual in Australia today (minus super) is $28,426.
You might be asking, ‘How much do I need to retire?’ Well, according to Moneysmart.gov.au, the average savings needed for a comfortable retirement is $545,000 for singles and $640,000 for couples.
On the flip side, the average debt per person in Australia is $25,149, which 37 per cent struggle to pay. In addition, nationally, we have a debt to income ratio of 200 per cent – one of the highest in the world.
Being in debt isn’t always a good place to be. It puts you in a negative financial position, impacts your credit score and places you at the mercy of lenders and interest rates. It can also make saving impossible.
Paying debt off can free you from money stress and secure your future.
How to make the save or pay off debt decision
Both saving for retirement and paying off debt are important. In an ideal world, you want to be doing both. However, how can you do this if you’re struggling?
Here are three crucial steps to managing it:
1. Evaluate your debts and perform a budget review
Make a list of the balance, interest rates and monthly repayments of each of your debts. Next, divide the total monthly debt repayments of all debts you owe, by the total monthly amount you make after tax. Multiply this figure by 100 to work out your monthly debt to income ratio, as a percentage. The guide below will help you to understand how you are performing.
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Once you’ve evaluated your debts, the next step is to perform a budget review. This involves looking at what’s coming in and what’s going out on a monthly basis. Ideally, your budget percentages should be weighted as follows:
- 60 per cent on daily expenses
- 10-20 per cent for short or long term goals/savings/enjoyment
- 10-25 per cent for additional debt payments
- Emergency fund
Use an online budget calculator to help you. Alternatively, engage an expert to carry out a debt review and provide professional budgeting advice.
If your debts are high compared to your income and owned assets (such as your home or savings), or your interest rates are steep, prioritise paying them.
2. Create a debt reduction plan
Assuming you’ve budgeted to meet minimum debt obligations and the other areas covered above, focus on improving your repayments with leftover funds.
The best approach is to create a debt management plan that targets your more expensive debt first. This includes ‘bad debt’, such as credit card and personal loans, with a five per cent or higher interest rate. If left to simmer, this type of debt can build to the point of being unpayable.
Not all debt is bad. Home loans and HECS/HELP, for example, typically have low interest rates and are viewed as ‘good debt’ as they can increase your wealth over time. Once you only have these debts left, you can start to get serious about saving.
3. Consider your savings options
There are several options when it comes to saving for retirement:
- Savings account – A savings account is low risk, keeps your money secure, puts you in full control of your savings, and can be a great motivator when the balance rises. You can also dip into it in emergencies.
- Investments – Investing money as a way to save can help you achieve a higher return faster. However, there is a higher element of risk and loss involved, so make sure you seek expert advice before putting money down.
- Super savings – For most people, super is the most effective way to save for retirement. Not only are your investments carefully managed but super funds in the long term average over five per cent returns.
Because of their ability to generate higher returns, investments and/super savings are generally your best bet.
Super savings super benefits
Super has some additional benefits, including tax benefits. Not only does it operate in a lower tax environment of 15 per cent but, to help you fund retirement faster, the government also offers super co-contributions.
If you’re a middle or low-income earner and make personal after-tax contributions to a super fund, the government will also contribute up to $500.
Another benefit is that super has strict access regulations. This means you can’t dip into your retirement savings to pay your bills, protecting your savings for longer.
So is it better to save or pay off debt? The best approach is to do both. But if you’re struggling with bad debt, tackle this first. Once you’ve done that, you can start to save for retirement without debt making it hard and weighing you down.
