Should I Pay Down My Debt or Invest In My Roth IRA?

Published June 1, 2023 at 2:45 PM

I am 62 years old and make about $63,000 a year. Currently, I’m putting $300 a month into my Roth IRA and $700 a month into my pension. I have $56,000 in a 401(k) and regular IRA, and an additional $6,000 in my Roth IRA. I will have a small steelworkers’ pension when I retire that will pay $200/month.

We currently owe $119,000 on our mortgage, $26,500 on a second mortgage and $9,000 on a 0% interest on a credit card (0% expires in November). We also have two car loans totaling $23,000 and we’re paying out about $550 a month on those (they have very low interest rates: 1.5% and 2.5%).

Should I switch from putting money in my Roth to paying down debt?

Ray O’Brien

Hi Ray,

When you have battling financial priorities — in your case, paying down debt while also saving for retirement — it can be tricky to figure out how to best prioritize. To help you out, I spoke with Taylor Sutherland, CFP, director of portfolio strategy and senior wealth advisor at Halbert Hargrove. He said that figuring out where to prioritize often will depend on how you think about it — will you approach it from a left-brain, analytical perspective, or a right-brain, emotional perspective?

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“From the left-brain perspective, you should consider retaining any debt where the interest costs are lower than your potential rate of return on the dollars you’d use to pay down those debts,” he said. “Beating the 0% rate on your credit card, and the two car loans at 1.5 to 2.5% respectively, is a no-brainer. You could put every dollar you would otherwise use to pay off those debts ($32,000) into a high-yielding FDIC-insured online cash program that is currently paying >5%. This would mean you effectively earn the difference between the 4% and the 0%, 1.5% and 2.5% rates. (I understand that you don’t have this $32,000 in hand, but every dollar you put into the Roth has the potential to out-earn the cost of those debts.)”

He notes that you may have to re-prioritize and/or make some changes once the 0% introductory rate on your credit card expires.

“You should consider either transferring to a new credit card — assuming you’ve not recently applied and your credit is sound — where they may offer another 0% preferential rate period. If that is not an option, then you should prioritize this balance over saving the additional monies into the Roth,” Sutherland said. “It is highly unlikely that you would out-earn the cost of the new higher-interest rate on your credit card debt as those interest rates are usually in the high teens, even low 20% range given currently higher interest rates. As soon as that credit card is paid off, please go back to putting money away in your [Roth].”

As for your mortgages, keep in mind that even though this is debt, it can have tax advantages.

“You did not mention the current rate of your primary mortgage or your second mortgage, but the good news is the interest payments on those items are likely tax-deductible, so the net out-of-pocket costs of those payments are likely lower than the stated interest rate,” Sutherland said. “However, if either your primary or your second mortgage rates are in the high single-digits range, basically in line with a reasonable return expectation of a diversified portfolio, then paying down these items is a wash: neither good nor bad, financially. Holistically though, we’re OK with retaining debt on a home as long as there is sufficient equity (20-30%) to offset a possible decline in home value.”

While Sutherland’s advice is sound from a logical perspective, he notes that there is also an emotional way to approach this situation that may change how you prioritize your financial moves.

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“From the right-brain perspective, paying off debt can be a big win now,” he said. “Investing is very much appropriate for your future, but no one is ever upset to see themselves keeping more money in their pocket each month for today’s needs. Paying off line items like car payments can make a big difference in cash flow and help you retain more income to pay off other items, or have money for emergencies if need be. But I’ll remind you, if you pay the cars off early, financially, it’s really only the interest payments that you’re saving — which again, are likely less than what you could earn on those dollars if they were invested in the Roth.”

Regardless of your left or right brain perspective, Sutherland said that you should have a clear prioritization of how you should pay off your debts: Start with the debt with the highest interest rates, which is likely your credit cards. Then, focus on paying off debts associated with assets that decline in value — i.e. your cars — and finally, pay down debts that are associated with assets that appreciate in value — i.e. your homes.

To summarize, you should keep putting money into your Roth since all of your debt is low interest. However, if your credit card interest rate jumps after the introductory period, consider focusing on paying down that debt over saving for retirement.

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Where would you put an extra $300,000 in today’s market?

– Mark Potter

Hi Mark,

There’s no shortage of things you can do with $300,000, and even in today’s volatile market, there are a number of wise ways to invest these funds. To find out some of the best options available, I spoke with financial professionals to get their takes.

Jennifer Adams, a financial advisor with Edward Jones in Temple, Texas, said to really consider all of your options and your personal goals before making any decisions.

“There’s no need to rush into any decisions on how to use the money,” she said. “If your funds weren’t intended for a specific purpose, think about your financial strategy; it will probably give you some ideas for how to put that money to work. Regardless of how much money you received or where it came from, this influx of funds can help you achieve your goals and give you more flexibility in making financial choices in the years ahead.”

Adams said to consider both your long- and short-term financial goals.

“Then you can develop a strategy that addresses these most immediate money needs, which you can tackle first, and your longer-term goals,” she said. “While you may have pressing short-term financial needs such as paying off high-interest loans or credit card debt, you should always be thinking about your future.”

If you’re unsure about where to start, Adam recommends building an emergency fund with three to six months’ worth of living expenses. Next, consider whether or not you are on track with your retirement savings, and put money towards retirement funds if you are currently behind. If you have children or grandchildren, consider putting funds aside to help pay for the cost of their education.

Once you take stock of your financial goals, you can start to figure out where to put your funds. Andrew Crowell, financial advisor and vice chairman of wealth management at D.A. Davidson, said that this will likely depend on your phase of life, specifically your age, financial situation, and job and family situation.

“For young working professionals with little to no debt, dollar cost averaging the funds in equal dollar amounts over perhaps three to six months (or longer) into a diversified growth fund or index fund makes sense,” he said. “If the investor is concerned about continued uncertainty in the economic or inflation outlook, extending the investing timeframe to even 12 to 18 months makes sense. Of course, the young professional should also be taking advantage of their company’s retirement plan and any matching funds that are available.”

If you have debts, such as student loans, car loans and credit card debt, use this money to help pay them down, Crowell said.

“It makes sense to consider paying off some or all of these obligations to avoid having to make continued interest payments, particularly during a time of rising interest rates,” he said.

If you are in a phase of life where you are looking to buy a home, the funds can be used for a down payment.

“Using some of the funds to make a larger down payment — and therefore taking on a smaller mortgage — could be a wise choice,” Crowell said.

If you are currently retired, Crowell offers the following advice: “Retirees now find themselves in the fortunate position of being able to purchase attractive yield for the first time in many years. High-quality tax-free municipal bonds and high-quality corporate bonds show the potential for strong single-digit or even low double-digit returns over time from current levels. Averaging into a bond ladder or an actively managed bond fund can provide both attractive current income and total return over time. Dividend-paying stocks are also attractive for total returns, as many stocks remain well off their all-time highs. Investing in companies that have paid and raised their dividends over 10 years or longer tend to be relative safe havens during tumultuous stock markets, and can provide steady income while waiting for the broader markets to recover.”

You have a lot of options available, and since there is no “one-size-fits-all” answer to this question, you’ll have to take some time to figure out the best course of action for you personally. If you need some extra help, consider working with a professional.

“Working with a financial advisor can help ensure you are taking advantage of the tools available to you to help you achieve your financial goals,” Adams said

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