Maximizing Mid-Career Wealth: Balancing Debt Payoff, Retirement Savings, and Market Valuations
By: Scott Van Den Berg, CFP®, ChFC®, CEPA®, AIF®, CRPS®, CMFC®, AWMA®
While it is a good conversation to have at any point in your career, from a mid-career perspective, typically defined as being in your 30s to 50s, the decision between paying down credit card debt and outstanding loans versus funding your 401(k) or other retirement plans becomes even more critical as you're likely to have more financial responsibilities and goals. Here are considerations specific to this stage of life:
Retirement Goals: Assess your retirement goals and timeline. Mid-career individuals often have a clearer picture of their retirement needs and may need to ramp up savings to meet those goals. Balancing debt repayment with increased 401(k) or other retirement plan contributions becomes crucial to ensure you're on track for retirement. Remember, goals are generally easier to accomplish when you have a roadmap, which means having a thoughtful financial plan is a must!
Income Growth: Consider your income growth potential. Mid-career professionals may expect salary increases or career advancements that can positively impact their ability to pay down debt and contribute more to retirement savings. Allocate these additional funds wisely to strike a balance between debt reduction and retirement preparedness. You mustn’t get caught up in the trap of using an increase in your income (salary or bonus) or even an inheritance to further your non-essential spending without first prioritizing living debt-free, fully funding your retirement accounts, and creating a rainy-day reserve.
Tax Efficiency: Evaluate the tax efficiency of your debt and retirement contributions. Contributions to traditional 401(k) accounts are tax-deductible, reducing your taxable income. This can result in immediate tax savings, especially if you're in a higher tax bracket. With that said, even though non-deductible debt like credit cards offers no tax benefits, the interest costs on these cards are generally high enough that it is prudent for you to apply most of your discretionary savings to debt reduction.
Risk Management: Assess your risk tolerance and the risks associated with your debt and investment choices. High-interest debt, such as credit cards, carries significant financial risk due to compounding interest on the unpaid balance. By paying down high-interest debt, you're effectively earning a guaranteed return equal to the interest rate saved. On the investment side, consider your risk tolerance and asset allocation within your 401(k) to ensure it aligns with your financial goals and risk profile.
Employer Contributions and Vesting: Consider any employer contributions to your 401(k) or company retirement plan and the vesting schedule. If your employer offers a matching contribution, it's generally advisable to contribute at least enough to receive the full match, as it's essentially free money. However, if you're not fully vested in your employer's contributions, weigh the potential benefits against the vesting schedule. Also, consider weighing the benefits of participating in your employer’s stock purchase plan or funding your health savings account if these are available to you.
Opportunity Cost: Consider the opportunity cost of not contributing to your 401(k) or company retirement plan. Delaying retirement contributions means missing out on potential market gains and the benefits of compounding over time. However, if the stock, bond, and real estate markets are at unsustainable high levels, it may be an opportunity to temporarily delay making contributions to your retirement account in the short run and instead pay down your high-interest debt. As famed investor Warren Buffet said, “Earnings can fluctuate, but debt is guaranteed.” This highlights the importance of managing debt levels carefully to ensure financial stability and sustainability. Be sure to run scenarios or consult with a financial advisor, like Century Management, to compare the long-term impact of different strategies on your retirement savings and debt reduction.
Emergency Funds: Prioritize building an emergency fund alongside debt repayment and retirement contributions. Having a financial cushion for unexpected expenses can prevent you from going further into debt or tapping into retirement savings prematurely.
Debt Management Strategies: Explore different debt management strategies, such as balance transfers for high-interest credit card debt, loan consolidation, or negotiating lower interest rates. These strategies can help alleviate the debt burden while still allowing you to focus on retirement savings.
Psychological Factors: Consider the psychological impact of debt and retirement savings on your overall well-being. Some individuals may prioritize debt repayment for peace of mind, while others may feel more secure knowing they're actively saving for retirement.
Conclusion: Ultimately, the optimal strategy depends on your unique financial situation, goals, risk tolerance, and the specific terms of your debt and retirement accounts. Balancing debt repayment with retirement savings is often a prudent approach to achieving long-term financial stability and security. At Century Management Financial Advisors, we work with individuals, families, and business owners to provide personalized guidance based on a comprehensive analysis of your financial landscape.
Disclosures: Century Management ("CM") is an independently registered investment adviser with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Century Management is also registered as a Portfolio Manager in the Province of Ontario. This information is educational in nature and does not constitute investment advice. CM does not provide legal or tax advice and the information herein should not be considered legal or tax advice. A full description of our Firm’s business practices, including our Firm’s investment management services, wealth plans and advisory fees, are supplied in our Form ADV Part 2A and/or Form CRS. CM-2024-03-26