Last Updated: January 21, 2011
You would not be alone if you were thinking these questions: Should you stop saving for retirement and use that money to pay down your debt? Should you withdraw money from your retirement accounts to pay down your debt? Or should you do something entirely different?
FPA member, Eric Reid, CFP®, a regional development consultant with Level Four, suggests that you think about those questions against this backdrop. "You need to look at two areas as you plan for retirement, assets and liabilities," he said. "The financial industry has programmed society to look at assets that you will need for retirement and now the industry is doing a good job of helping society turn assets into retirement income. However, reducing liabilities is rarely covered by the financial industry. My opinion is that reducing, or eliminating liabilities gives you a much better chance at meeting the ability to be financially independent." Consider these points in support of his thinking:
- "I can tell clients with complete certainty the type of return they will get by using their money to pay off debt," he said. "If the credit card or bank is charging 10 percent, you can earn 10 percent on the amount you owe by paying off the debt. Even following the best asset allocation strategies and picking the best investments, I can estimate ranges of returns but I cannot give the client an exact return number."
- "I know from my experience that clients are happier when they don't owe anyone money," he said. "My clients who do not have any liabilities are less concerned with their investments, the economy, and job security and actually spend less while saving more."
But what are some of the best ways to eliminate your debt? According to Ken Clark, CFP®, author of The Complete Idiot's Guide to Getting Out of Debt, getting out of debt requires a plan — a spending plan. "A spending plan helps you spend less and pay more toward your debts," he wrote in his book.
To make a spending plan work, he recommends using what he calls the "two-account system" whereby you open two bank accounts. You use one account to pay for all your fixed expenses and the other account to pay for all your variable expenses. At the end of the month, you simply take whatever is remaining in the second account — assuming that there's something left in the account — to make an extra mortgage payment or pay more than the minimum on your credit card.
When it comes to paying down debt, Clark recommends that you establish a payment strategy, paying as much as you can as soon as you can and using what he refers to as the "roll-down" method. "The "roll-down" method requires that when one debt is paid off, the amount that had been going toward that debt is now added on top of the debt on your list.
Clark also recommends eliminating the following debt first: payday loans, credit cards, the Internal Revenue Service (IRS), and anything in collections. He suggests getting rid of this debt next: installment debt, car loans, 401(k) loans, and home equity line of credit. And the debt to get rid of last includes: student loans and mortgages.
Learn more about getting out of debt.