Let’s be honest: most people don’t have enough saved for retirement. And most people have some form of debt, whether it’s consumer credit card debt, a car loan, or a mortgage. We know that we’re supposed to be saving for retirement and paying off our debt, but which ones are we supposed to prioritize?

As retirement gets closer, and the amount of time you have to save and pay off debt gets shorter, proper prioritization becomes more important. Most retirees live off of Social Security income and their retirement savings, and even if you choose a semi-retirement path with part-time work, you’re almost certainly going to earn less in retirement. Having too much of a debt burden only limits your budget further. On the other hand, not having enough in savings directly plays into how big your budget is in the first place.

Everyone’s financial plan is different, and there’s no one-size-fits-all advice that I can give you. But, from years of advising pre-retirees on how to get ready for retirement, I do have a framework with which you can decide how to prioritize your savings and debt repayment.

Get rid of toxic debt

According to data from February 2020, the average credit card balance is over $6,200, and the average American has four credit cards. What’s driving all this credit card usage? For a lot of people, it’s not large purchases or irresponsible purchases, but day-to-day expenses like groceries. After paying the mortgage, student loans, and other big monthly debts, there’s often not enough in the budget to cover your real expenses. We end up using credit cards to help us float from month-to-month.

Unfortunately, credit cards usually have the highest interest rates, which means if we can’t pay off the balance every month, we’re stuck in a tailspin paying even more money that we don’t have in the budget on continually occurring interest. It’s crucial to break this cycle before retirement, as you’re highly likely to be earning less in retirement than you are right now or solely living off savings.

Assess your budget and cut back on any non-essential expenses that you can so you’re not turning to credit cards and digging yourself into a deeper financial hole. Keep track of your finances with pen and paper, an Excel spreadsheet, or a full-blown budgeting app like You Need A Budget or Mint. Make sure you’re still able to pay the minimum amount on your credit cards, and use any money leftover in your budget to make extra payments and pay them down faster.

Save for an emergency

It’s impossible to predict the future, but I can almost guarantee you that you’ll face an unexpected expense at some point in the next year. Whether you’re facing something catastrophic or just an expensive nuisance, without emergency savings, you won’t have the tools to respond.

You’ll see a lot of different advice out there about how large your emergency savings fund needs to be, but generally, you should try to save enough that you can cover up to three to six months of household expenses. One way to gauge how much you’ll need is to think about how long it might take you to find a new job if you were to get fired tomorrow. For some people in high-demand specialties, that may only be a month or two. But for many people, the process of finding a new job can last a lot longer than that.

It might take a few years to build up your emergency fund, and you may have to dip into it while you’re still in the process of savings, but that’s all okay. Keep your emergency fund in a high-interest savings account – that way, it’s still easily accessible should you need it, but you’re not tempted to dip into it for everyday expenses. Plus, you’ll earn more and more money from it just sitting there as you continue to save.

What’s next – big debts, or retirement savings?

Once you’ve gotten control over your budget, eliminated toxic debt, and built up your emergency fund, where should you turn next? No matter what situation you’re in, you’ll want to be doing both saving and paying down debt – you shouldn’t totally give up on one in favor of the other. However, you will want to figure out which one you are prioritizing, and how much money goes towards on goal versus the other.

This step is a bit tricky and is nuanced to your particular financial circumstances – you’ll want to compare the interest rate on your debt versus the potential benefit from saving. This isn’t always an apples to apples comparison. For example, you need to consider things like an employer match on a 401(k) or similar retirement account, and how many years you have before you retire.

Get rid of your car loans, mortgage, and student loans

Paying down debt should be a priority before you retire. When you retire, you’ll likely have less income, and having multiple debt payments due every month is only going to reduce your income further. Focus on debts with the highest interest rates first, as these are the ones that will cost you more in the long run.

If you’re only a few years away from retirement, this should be higher priority than saving. Your time horizon just isn’t long enough to see a big impact from saving – you’ll see a much bigger impact on your retirement lifestyle by paying down debt and freeing up your other sources of income, like Social Security.

In some cases, however, paying down good debt isn’t as good an idea as saving. Let’s take a low interest rate mortgage as an example – the interest on that mortgage is tax deductible, and the interest you’re paying is likely less than what you could earn in a qualified retirement account. In this situation, it would make more sense to focus on your savings.

Save for retirement

While Social Security is the bedrock of your retirement income, it’s likely not enough to cover all of your expenses. Putting money away now, while you have a full-time job, is crucial for making sure you have the most comfortable retirement possible. The farther out you are from retirement, the higher priority this should be – you have a longer time horizon and you have the opportunity for more compound growth on your savings and investments before you need to take any distributions.

If your employer offers a retirement plan and they match your contributions, make sure you are, at the very least, contributing enough to get that full match. If you’re not getting the full employer match, you’re leaving money on the table for your future self. Not only can this easily double your monthly retirement contributions, but putting aside pre-tax money into a traditional retirement account reduces your taxable income and saves you even more money in the long run.

Bottom line

Everyone’s financial plan is different, and there’s no one-size-fits-all advice I can give you about whether to save or to pay off debt. Both are important, and should be prioritized above other types of spending as you get closer to retirement. In general, if you’re paying more in interest than earning interest, you’re losing money, and you’ll want to turn that situation around. Attack toxic debt and break the cycle of credit card float. Build up an emergency fund so you have flexibility to tackle unexpected expenses as they come your way. Then, work to eliminate your other debts while taking advantage of retirement accounts to save as much as possible.

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