When Does It Make Sense to Delay Retirement Savings to Repay Debt?

Being in debt isn't fun, and you may want to repay what you owe as soon as possible. In fact, you may even be tempted to put off saving for retirement because of it.

Before you throw every spare dollar at your debt, though, it's important to understand the opportunity cost of putting off retirement investing. You'll want to think very carefully about when waiting to invest for your future is really the right choice and, in many cases, you'll discover you're better off not waiting to start saving for your later years.

There are a few limited exceptions, though. In fact, here are three scenarios when it may make sense to delay retirement savings to repay debt first.

1. When you have very high interest debt

If you have debt at an extremely high interest rate, taking care of that should be your first priority. For example, if you have payday loans, you could face upwards of a 400% ARP on your loans. In this situation, the debt is so expensive that it's worth giving up any retirement savings benefits (like tax breaks or compound growth) to take care of it.

If you have low-interest debt, on the other hand, it makes no sense to put off investing for your future to deal with it. A mortgage loan at a rate of 4.00%, for example, should be paid off slowly over time, and it doesn't always make sense to make extra payments.

Since you can expect to earn around a 10% average annual return by investing in an S&P 500 index fund (based on historical averages), the return on investment (ROI) that you'd get from early mortgage payoff is below the return you'd get from investing for retirement -- even before factoring in any special tax breaks.

If your debt is kind of in the middle, like a credit card at a 20.00% rate, then you'll have to think more carefully about what to do by considering other factors mentioned below. Consider the time it will take you to pay off your debt and the types of retirement investment accounts you have access to.

2. When you don't have access to a 401(k) match

If you have access to a 401(k) match at work, you should almost never delay investing in it to repay debt -- except if you have extremely high-interest loans like payday loans.

See, a 401(k) match is free money your employer provides. Your employer will typically match a percentage of contributions (such as 50% or 100%) of what you invest. This means as soon as you put money in, you get either a 50% return or a 100% return on your investment immediately without any risk.

Since even high interest debt, like credit card debt, is well below a 50% or 100% rate, you should pay the minimums on your debt first, then switch to investing in your 401(k) to max out your match, then consider paying extra on what you owe.

3. When you'll be able to pay off your debt quickly

If you can pay off your debt pretty fast, you may not do a whole lot of damage to your retirement savings efforts. In fact, if you can retire the debt and free up the money you were paying toward it to make larger retirement account contributions, you will often end up better off.

If it will take you a very long time to repay your debt, though, then the delay may not be worth it because you'll miss out on compound growth. Let's say, for example, that you want to end up with a $500,000 nest egg by age 65 and you're 30 now. If you get started investing right away and earn 10% average annual returns, you would have to invest about $154 a month to hit your target.

But if you waited a decade because you were making extra debt payments instead of sending extra money to a retirement account at your brokerage firm or with your employer, you would have to invest $423.66 every month instead. Putting off retirement savings to focus on debt payoff would mean that for the next 25 years, you would have to put an extra $269.66 into your investment account each month to end up with your desired amount.

To avoid that, it may be better to make sure you're hitting your retirement savings targets first before throwing extra money at your debt. Or, even better, set a retirement goal, hit that first, and then find some extra money for debt repayment. That could include doing things like taking on a side gig or cutting expenses by tracking spending, couponing, and giving up a meal or two out each month.

Ultimately, you'll need to think about the big picture when deciding whether to delay retirement savings to pay down debt. But don't let a desire to be debt-free lead you astray. Do the math, consider your interest rate and your repayment timeline, and make the choice that's right for you.