In a perfect world, this question would be completely ridiculous—we wouldn’t have to make the choice, we’d do both. We’d have no debt and we’d go forward happily funding our retirement savings until we’re—let’s say it—wealthy!

But this isn’t a perfect world, especially when it comes to debt. People routinely come out of college buried in enormous levels of student loan debt. Cars now come almost automatically with loans attached, and credit cards are commonly used to cover shortfalls between income and expenses, or just as often, to spoil ourselves with what we can’t quite afford just yet. And then there are mortgages…

21st Century reality is that most of us live with some level of debt for most of our lives—how does that impact retirement planning?

The great majority of us make compromises, especially when it comes to finances. Do we save for the future, or do we put out the fires that immediately surround us? There’s a school of thought on both approaches, especially where retirement planning is concerned.

Making retirement savings the priority

There’s a large base of support for making retirement savings THE priority. Since it works with compounding of investment returns, the sooner and more effectively you can build up a large portfolio, the better and more efficiently the savings process works. And if you can accumulate enough funds early in life, you might not need to save so much later in life.

Another big advantage to doing it as early in life as possible is that you have more time to recover from market falls—that means you can be more aggressive in your investment selection. A longer time horizon enables you to invest in high risk/high return investments that pay the best returns over the very long term.

Though it’s never stated explicitly, this approach tends to ignore debt in retirement planning. Perhaps it assumes you have so many years before retirement that you’ll attain a debt free position as some point in the interim. Or maybe it’s the idea that a large enough investment portfolio will ultimately overcome all obstacles. Maybe there’s something to it, maybe not.

The debt payoff advantage

Though building up retirement savings looks compelling for all of the reasons stated, paying off debt has it’s place in the retirement planning picture. Some of the advantages include:

  1. By prioritizing debt payoff, you free up more income for retirement savings contributions
  2. By paying off debt, we lower living expenses, reducing the need for greater savings accumulation
  3. Attaining a debt free position is a form of retirement diversification—it adds expense reduction to the income/asset accumulation process, and provides something of a safety net if those efforts fail to meet expectations
  4. Retirement savings are about the retirement years—reaching a debt free position not only helps your retirement, but all of your life between now and then.

It might be that paying off debt is the process of clearing the decks for retirement, and if that is the case, then it need to be the priority.

When paying off debt needs to be the priority

There’s one group of retirement planners for whom paying off debt should be a priority: those who have inadequate retirement portfolios. Here’s the thing, in order to make a healthy income on retirement savings—that is, an income large enough to afford full retirement—you need to have a very large amount of savings.

If you could expect a six per cent rate of return on your portfolio, you’d have to have $500,000 saved up in order to make $30,000 per year. But let’s say you’re 50 years old and you’ve only managed to accumulate $50,000 in retirement savings, and you don’t think you’ll be able to save more than a few thousand per year going forward; it may be better to concentrate on debt elimination. By paying off debts, you’ll lower your expenses which will also lower your income requirement.

In this example, maybe you won’t get from $50,000 to $500,000 in 15 years, but maybe you’d would be able to payoff your $150,000 mortgage in the same amount of time. By paying off the mortgage, you’d eliminate a $1,000 per month expense. That’s the same as creating a $1,000 per month income stream, except that there won’t be any tax consequences!

Using even lower debt numbers, let’s say you have—and have basically always had—loans on your cars (both yours and your spouses), as well as substantial credit card debt; how much cash flow would you free up by paying those off for good? Let’s say you have two car loans, totaling $20,000, with $800 in monthly payments, plus $25,000 in credit card debt at $500 per month—by paying them off you’d eliminate $1,300 in monthly expenses, or $15,600 per year.

To create an equivalent income stream at six per cent, you’d have to save up well over $250,000, but you’ll accomplish the same thing by just eliminating $45,000 in debt!

Bonus: by paying off the loans now—well ahead of retirement—you free up $15,600 per year that you can invest in retirement savings. That’s $15,600 per year in additional retirement contributions—how quickly would that accumulate? It’s a double win—paying off debt always is, but nowhere more so than with retirement planning.

Which do you think should be the retirement planning priority—saving as much as possible as soon as possible, or attaining and maintaining a debt free position?

Kevin Mercadante

Kevin Mercadante

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.