If you are like many Americans trying to sort out priorities between balancing the urgency of getting out of debt and the need to save for retirement, you are not alone. And a common question arises when people try to sort out contradictory expert advice on the subject.
“Do I eradicate all of my debt before contributing to a 401(k) and IRA, or do I find some way of tackling both goals simultaneously?” you likely have asked yourself.
During my years of reporting on personal finance, I’ve concluded that the two perspectives are very much worth examining — and may well help you decide which approach applies to your own personal psychological makeup.
Bestselling personal finance author and radio show host Dave Ramsey warns Americans that a strict approach of eliminating all consumer debt is necessary before investing in 401(k)s and IRAs. After reading further below, you will see how Ramsey believes motivation and behavioral tendencies play a big role in achieving success using this method.
Major financial services firm Fidelity Investments seems to downplay personal psychology and takes a mathematical approach by prioritizing paying off high-interest credit card debt, then tackling lower-interest debt while simultaneously contributing to retirement savings accounts such as 401(k)s and IRAs.
I’ve put together the following breakdown of these two approaches in the hope that, if you are one of the many facing this debt vs. retirement savings dilemma, reading further may help you decide which approach is best suited to you.
Dave Ramsey urges paying off all debt before using 401(k)s, IRAs
“A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts,” the Internal Revenue Service (IRS) clarifies.
A 401(k) can sometimes be enough for retirement when a person has strong investment options and consistently invests 15% of their income, according to Ramsey. This level of disciplined saving can allow the account to potentially grow into a fully sufficient retirement fund.
But is a 401(k) enough?
“It might be if you have access to a Roth 401(k), solid investment options and are able to invest 15% of your income,” Ramsey wrote. “It might not be if one or more of those above points aren’t true in your case. You may need to look at options outside your workplace retirement plan, like a Roth IRA.”
For clarity, let’s use a government-sourced definition of a Roth IRA.
“A Roth IRA is a tax-advantaged personal savings plan where contributions are not deductible but qualified distributions may be tax free,” according to the IRS.
But Ramsey wants to be sure a person meets two conditions before contributing to a 401(k) or a Roth IRA.
“You should only start saving for retirement once you’re completely out of debt and have a fully funded emergency fund in place,” Ramsey wrote.
“If you still have consumer debt lying around, pause all your investing until you pay it off.”
Ramsey’s snowball approach to paying off debt
Ramsey argues that the best and fastest way to pay off debt is to pay the smallest amounts first, then the largest amounts, ignoring interest rates.
Make the minimum payments on all your debts except the smallest one — that’s the balance you’ll focus on first, according to Ramsey. Put every extra dollar you can toward eliminating that smallest debt.
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Once that debt is gone, roll the payment you were making into the next-smallest balance, then keep repeating this pattern until every debt is paid off.
“By knocking out your smaller debts first, you free up more money faster,” Ramsey wrote. “Like a snowball rolling down a hill, you gain more momentum to tackle the rest of your debt. And each quick win gives you the motivation to keep going.”
Fidelity proposes tackling some debt while using 401(k)s and IRAs
Now, let’s take a look at the more mathematical approach.
“Choosing between paying down debt and investing can be like trying to solve a riddle,” Fidelity explained. “So we crunched the numbers to come up with a clearer formula.”
“Our conclusion? For many people, it generally makes sense to first pay down any debt with an interest rate of 6% or greater,” Fidelity continued. “This assumes you have at least 10 years before retirement, that you’re investing in a balanced portfolio with about a 50% allocation to stocks, and that you’re investing in a tax-advantaged account, such as a 401(k) or IRA.”
“If the interest rate on a person’s debt is below 6% (based on the same assumptions), putting extra money toward investing often provides a better long‑term payoff, according to Fidelity.
At those lower rates, the potential returns from steady, long‑term investing are more likely to outperform the benefit gained from speeding up debt repayment.
Fidelity is sure to remind Americans to be sure these other financial obligations are taken care of before contributing to 401(k)s and IRAs.
- Pay the minimum on all debts.
- Put away some emergency savings.
- Capture any employer match on retirement savings.
- Continue to pay off credit card debt.
“Why do these other tasks take priority?” Fidelity asks. “Paying your minimums, socking away a cash buffer for emergencies, and digging out of any credit card debt are crucial to establishing basic financial security (plus protecting your credit score), so that your finances could survive any unexpected curveballs life might throw your way.”
“And an employer match is essentially ‘free money,’ which you should generally try to capture in full.”
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Ramsey takes issue with ‘debt avalanche’ approach
Ramsey disagrees with Fidelity’s approach, which involves only eliminating high-interest debt before contributing to 401(k)s and IRAs.
“The debt avalanche (aka debt stacking) is when you pay off your debts in order from the highest interest rate to the lowest interest rate, no matter the balance,” Ramsey wrote. “The math makes sense on paper — but paying off debt isn’t just about math. It’s about behavior.”
“Here’s the deal,” Ramsey continued. “With the debt avalanche, you’ll be working on that first debt payoff for-freaking-ever. That’ll cause your motivation to die out quicker than a campfire in the rain.”
“Motivation inspires behavior change. Behavior change keeps you going, debt after debt after debt.”
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