For those of us in our twenties and thirties, retirement seems fairly far off and remote. After all, when you’re planning school, buying your first home, or traveling the world, let’s face it: thinking about your “golden years” is pretty far down on your list. However, as the news media likes to remind us, all we have to rely on for retirement is ourselves – not our pensions (if you have one) or Social Security.
Regardless of your thoughts on Social Security’s longevity, the news media does get one thing right: we really do only have ourselves to rely on when by the time we reach retirement. We can no longer expect anyone to provide us with a livable wage in retirement and guaranteed health care (or, at least the quality of health care you’d like to receive).
However, when you have student loans (or other debt) to pay off, are trying to save up for medium-term goals, and have to save for the longtime goal of retirement, it’s confusing to determine where to allocate your income. Whether you’re underemployed, entry-level, or making a good salary, there is a system you can follow to make the most of your money – all while still addressing debt and saving.
The 50/30/20 Rule
The 50/30/20 rule is one way to efficiently tackle all your expenses. Instead of saving intensely, and neglecting your debt, or paying off debt and ignoring your emergency expenses, this rule helps you divide up your income and cover all bases. It works like this:
- 50% of your take-home pay should go to essential expenses, like housing, utilities, transportation, and groceries (note: not entertainment and going out to eat!) The 50% rule is for the bare minimum amount you need to survive.
- 30% of your take-home pay should go to lifestyle choices, which is all of the fun stuff that make life worth living. This includes saving up for travel, gifts, Internet, going to the gym (or making your own home gym).
- 20% of your take-home pay should be put toward financial priorities, including your debt, retirement and emergency savings.
Does your “bare minimum” (50% of your salary) take up more than 50%? You may want to consider moving closer to work to lower transportation costs, or move farther away if it means a cheaper cost of living. And yes, you can allocate more than 20% of your money to your financial priorities, if you can.
About That Debt…
Let’s say you have the 50/30/20 rule down, but you’re still not sure about that debt you have. When you’re young, shouldn’t you focus on paying off debt and save for retirement once you’re settled? Well… yes and no. Helpful, huh? Here’s a rough guide for when it’s better to pay down debt and when it makes more sense to save for retirement.
First, a quick note: save something for retirement, no matter how small. Most financial advisers typically recommend you save 10% of your take-home pay for retirement (part of “paying yourself first”), but sometimes that’s hard on a small salary. The best advice is to save what you can. If that’s only 5% of your salary, save 5%! The power of compound interest is too important when you’re young!
Once you have a small retirement savings, take a look at your debt. What kind of debt do you have?
- School loan debt: depending on how much your interest rate is, you may be better off paying the minimum on your student loan debt for a variety of reasons. First of all, you can deduct $2,500 in student loan interest from your taxes, so if you pay $2,500 or less a year on student loan interest, you can write it all off. Second, if you’re in the student loan Public Service Loan Forgiveness program (you work in public service, including the government and certain nonprofits), you can be eligible to have your loans forgiven in 10 years or less.
If student loan debt is taking a large amount of your take-home pay, look into an Income Based Repayment plan to consolidate and possibly lower the amount you pay monthly on your student loans.
- Home loan: mortgage interest (on first and second mortgages) is also tax deductible, so it may make more sense for you to continue paying the minimum on your home as well. Particularly if you plan on selling your home (for a profit) in a few years, it may make the most sense for you to pay the minimum and pay off the house when you sell.
- Credit card debt or auto loans: in most cases, pay this debt off first! Credit card and auto loan interest rates are usually higher than student and home loan interest, which means paying off this debt will cost you less in the long run.
Remember: these are all general guidelines. If your student loan debt is held by a private company that charges you 7% or more in interest, and your car loan is only 4%, tackle the student loan debt first. This may mean you try to consolidate your debt at a lower interest rate, or try to negotiate with your loan holder, but the bottom line is you’ll end up paying more on your student loan than your car (in that scenario). Pay off your highest interest rate debt first, no matter if it’s credit card, auto, or student loan to save yourself money in the long term.
If you’re a long-time Your Personal Finance Pro reader, you already know how important it is to not rely on anyone but yourself to pay for your retirement. However, without a plan, it’s difficult to know if you should pay off all your debt first, and save money later, or save a small amount while paying off debt.
Track All Your Accounts With Personal CapitalPersonal Capital lets you see all of your accounts in one convenient place. Sign up now for free.
Although it feels more satisfying paying off every single one of your debts, it won’t feel that great if you’re 35 or 40 and only just beginning to save for retirement. Slow and steady wins the race and, as you get raises, consider splitting your raise and putting half in retirement and half to increasing your debt repayment. You will eventually pay off your debt, plus you’ll benefit from years of compound interest.