There are a lot of things you can do with your discretionary income and it can be hard to know how to balance saving with paying off debt. For instance, should you pay off your car loan or fund your IRA for the year? Should you work on funding a 529 for your child’s college tuition or bury extra cash in the backyard? (Call before you dig!) We’ve created a guide to help you prioritize your dollars and answer these questions. The idea is to ensure you’ve satisfied each step that applies to you before working on later steps. Keep in mind that this is a general guide and it may need to be tweaked a bit for your situation. Reach out to our advisor team if you would like a more personalized recommendation.
- Take Full Advantage of Your Employer Match
If your employer offers a 401(k) or similar plan, chances are that you may have an employer match. Figure out what that matching structure is and take full advantage of it. Typically, your employer will match you dollar for dollar up to a certain percent of your salary and we encourage you to get your full match. Don’t leave free money on the table!
- Build an Emergency Fund
We recommend keeping an emergency fund in a high yield savings account as a buffer for when life happens—unexpected car repairs, medical bills, etc. How many months of savings you choose to keep on hand will likely be influenced by your comfort level, how stable your job is, how many dependents you have, and other factors of your personal situation. A good rule of thumb is to aim for 3-6 months of living expenses.
- Pay Off High Interest Debt
This refers to debt that carries the highest interest rates—things like credit card debt, payday loans, and certain private student loans. You’ll continue servicing your other debts in the meantime, you’ll just be throwing your extra cash towards paying off the principal of your high interest debt until it’s gone.
- Pay Off Other Non-mortgage Debt
This typically includes debt like federal student loans and car loans. While you may be tempted to invest more at this point since this type of debt typically carries a much lower interest rate than your credit cards and could be less than what the market returns on average, we recommend eliminating it before investing more. We can’t guarantee what the market will return in any given year but you are guaranteed to save on whatever remaining interest payments you have by eliminating your debt. Plus, there’s usually a lightness that comes with freeing yourself of all non-mortgage debt.
- Max Out Your HSA
HSAs don’t get the attention we think they deserve. These accounts are more tax advantaged than IRAs and 401ks, so we recommend finding out if you’re eligible to contribute to one and maxing it out if possible. You won’t pay income tax or capital gains taxes on HSA dollars at any point if you use your HSA funds for qualified medical expenses. You can read more about HSAs here.
- Max Out Your IRA
Typically it’ll be cheaper to invest in your IRA before contributing more to your 401k because you’ll likely have access to lower cost funds in an IRA. How much benefit you get from prioritizing this account over your 401k largely depends on your employer’s plan and how much you intend to contribute. For a more personalized recommendation on whether you should focus on your IRA or 401k account, reach out to the blooom advisor team. Don’t forget—blooom manages IRAs at select institutions! Learn more about IRAs here.
- Max Out Your 401k
This may feel like a lofty goal for many but once you’ve eliminated those non-mortgage debt, we recommend turning your attention to your 401k. If you can max out your 401k, that’s fantastic. If not, just work on increasing those contributions as you’re able to. Read about the basics of your 401k here.
- Pay Off Your Mortgage
Having a paid off house can greatly help your cash flow in retirement. If you have a low interest rate locked in for your mortgage, you may opt to visit step 9 or 10 before paying off your mortgage and that’s okay. Personal finance isn’t one size fits all.
- Fund a 529
Helping your children pay for college is one of the very lowest priority items because while your children can get scholarships or borrow for college, you can’t borrow for retirement. It’s best to secure your own financial future before helping others.
- Fund a Brokerage Account
Once all of your other financial boxes are checked, you might consider opening a brokerage account. This account type doesn’t come with any special tax advantages, so generally you’ll want to ensure you’ve contributed to your eligible retirement accounts first.
Every client has a unique financial picture, which is where our advisor team comes in, but hopefully this guide provides a solid roadmap for balancing saving goals with paying down debt.
Published on August 27, 2021