Retirement vs. Debt: From IOU to IRA in Two (Sort of) Simple Steps

Are you ready for retirement?

If you’re like most Americans over the age of 25, chances are, probably not.  According to a recent study conducted by the Employee Benefit Research Institute (EBRI), Americans are dreadfully unprepared for their golden years.  In fact, according to the EBRI data, about 30 percent of us only have about $1,000 in our retirement funds.  Some people have even less than that.

If you want to retire someday (and, really – who doesn’t dream of escaping the daily grind someday?), you’re going to need more than a couple thousand dollars to get by.  You’ll have to start saving money.   And, before you start saving money in retirement size quantities, you need to get out of debt.  Now.

Here’s how to get on the track to retirement in two steps.

Step One:  Stop the Cycle of Debt

If you’re trying to save for retirement and pay off high-interest credit card debt at the same time, you know it’s not easy.  Your credit card payments take such a big bite out of your paycheck that there’s not much left over for the essentials like food and shelter.  You’re lucky if you can put aside $100 for retirement every month – and you’re even luckier if you don’t have to pull it out to cover unforeseen expenses.

When you’re in debt, saving for retirement is difficult.  That’s why you’ll need to focus on paying down your credit card debt.  That’s step one of the plan.

How do you pay down your debt?  I suggest my tried-and-true “10 percent” method.  Here’s how it works:

Let’s say you have one credit card.  You’ve got a balance of $8,000.  With an interest rate of 18%, you’re looking at a minimum payment of about $200 a month.  First, you pledge to stop using it.  Cut it up.  Hide it.  Whatever it takes.  You’ll never pay it down if you don’t stop adding to your balance.

Next, instead of paying the minimum each month, add 10 percent to every payment you send in (so, in this example, $220).  That doesn’t sound like much, but that extra $20 a month will go a long way.  Think about it this way:  If you continue to pay only the minimum monthly payment, you’ll be paying on the card for approximately 30 years.  However, if you pay $220 every month, even when your required minimum monthly payment goes down (and, if you’ve stopped using your card, your balance will go down), you’ll knock your debt out in about four and a half years.  Big difference.

And, even though it won’t be easy, you need to put something – even if it’s only $50 a month or so – into your retirement fund.  It’s not much, but every little bit helps.  When the time comes, you’ll be glad you started saving as soon as you could.

Before you know it, you’ll be debt-free, which means you’re ready for . . .

Step Two:  Start Paying Yourself

If you’ve stuck with my 10 percent plan, you’re out of debt.  You’ve stopped using the credit card that got you into debt in the first place.  (Note:  Don’t cancel your card.  It seems counterintuitive, but closing your account can actually hurt your credit score.  Keep it open, unless you’re paying an astronomical annual fee.) And, you’ve gotten used to parting with $220 a month.  That’s good, because if you want to guarantee that you get a jump on your retirement savings, you’re going to have to stay used to it.

Now that your debt is paid off, take that $220 and, instead of sending it off to your credit card company, put that money into an IRA (or a 401k, if your employer offers one).  Do that every month, without fail.  Save more if you can.  If your account generates an 8% return, you’ll have approximately $130,000 in 20 years.  Not too shabby.

So, there you have it.  Get out of debt.  Pay yourself.

Even if you don’t have a penny in retirement today, you can start saving your way to a secure retirement.  It’s never too late.