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Pay Down Debt or Save? The Spock vs. McCoy Debate

As you near retirement, the 'Star Trek' approach can help you decide whether to increase savings or focus on paying off credit cards and loans

By Chris Farrell

An age-old problem in personal finance is whether to focus on paying down debts or increase savings.

The tradeoff between eliminating mortgage, car loan, credit card and other payments versus socking away money for emergencies, college and retirement becomes especially acute for boomers. The reason: Time is short. (By the way, where did the time go?)

So, what do you do? Follow the rule of thumb that says don’t retire until your debts are extinguished? Or worry less about debt and more about adding to savings so your investment gains will, ideally, boost your financial flexibility and living standards when you decide to stop working?

Dangers for Boomers’ Debt and Savings

Here’s the rub: Alarm bells are going off about both the size of midlifers’ debts and their limited savings.

(MORE: The Dirty Little Secret of Baby Boomer Debt)

On the debt side, the nonprofit National Foundation for Credit Counseling says one-third of its 3 million clients last year were 55 or older. More than 41 percent of families with heads of household between age 55 and 64 had credit card debt in 2010 (up from 33 percent in 1989), according to the AARP Public Policy Institute and the Demos research group. The median total debt for 55- to 64-year-old households is $76,600, says the Employee Benefits Research Institute.

The savings picture isn’t any better.

According to the Federal Reserve's 2010 Survey of Consumer Finances, the median total balance in 401(k)s and IRAs for households nearing retirement is $120,000. A recent survey by Financial Finesse, an El Segundo, Calif.-based provider of workplace financial wellness programs, found that three-quarters of Americans age 45 to 54 don’t contribute to an IRA.

Fortunately, many boomers should have an opportunity to reduce debt, increase savings or do both over the next several years, assuming the economy continues to mend.

The Tricky Tradeoffs

Of course, even though it’s commonplace to talk at home about the trade-off between paying down debt vs. increasing savings, we know the issue is a lot more complicated.

You’ll want to consider which kind of debts you owe. Credit cards? A mortgage? A home equity loan?

It’s also critical to take into account the type of retirement savings accounts you contribute to, especially if it’s a 401(k), 403(b) or similar employer-sponsored plan.

And, as always with personal finance strategies and tactics, the nuances of thinking through tradeoffs matter.

“A healthy frame of mind is to assess: ‘What if I am wrong? What has to happen for me to be right?’” says Jonathan Guyton, a certified financial planner and principal at Cornerstone Wealth Advisors in Edina, Minn.
Zvi Bodie, finance professor at Boston University and co-author of Risk Less and Prosper: Your Guide to Safer Investing, adds, “Especially in the good times, always consider worst-case scenarios.”

Two Financial Matters to Consider

Here’s a twofold approach to help you start thinking through the process:

The first step is easy. If you have credit card debt, focus on eliminating it (with one caveat I’ll note shortly).

Credit card debt carries, on average, an annual percentage rate of 13.02 percent for fixed rate cards and 15.19 percent for variable rate plastic.

By paying off credit accounts, you effectively earn a rate of return equal to the rate charged on your cards. For instance, if you owe $10,000 on 15-percent credit cards, paying that off is like making 15 percent on your money. Not bad, huh?

On the savings side, if you have access to an employer-sponsored retirement plan, you’ll want to contribute enough to at least get the employer match, assuming there is one. Most employers with matches kick in 50 cents for every dollar contributed, up to 6 percent of pay.

Free Money You Shouldn’t Pass Up

This brings me to the caveat about paying down credit card debt before increasing savings.

“Even if you have a lot of debt, you’ll want to participate up to the match,” says Andi Y.H. Kang, certified financial planner and president of Crown Wealth Management in Costa Mesa, Calif. “It’s essentially free money.”

The second framing issue is more intriguing and vexing: Whether to pay down mortgage debt or increase savings.

Financial planners typically offer a straightforward answer based on math. They say you should try to save more for retirement even if you have a mortgage with another 10 years or more on it if you can reasonably expect to earn a higher return on your savings than the rate on your mortgage.


The Center for Retirement Research at Boston College typically assumes a 4 percent return for a well-diversified portfolio, so using that figure, someone with a dozen years left on a 3.5 percent fixed-rate mortgage might try focusing resources on savings instead of scrambling to own the home free and clear.

“I am not a great fan of paying down mortgages, especially in today’s environment,” says David Mendels, a certified financial planner at Creative Financial Concepts in New York City. “You can lock in a 30-year mortgage at 3.5 percent or less.”

(MORE: The Retirement Gamble We’re All Making)

How Star Trek Fits In

Call the calculation the Spock solution: rational and logical.

But I’d say that if you have only a few years left on the mortgage, get rid of it.

There’s essentially no mortgage deduction tax break left, since by this point, your payments are now almost all principal. Friends of mine who participate to the max in their employer’s 401(k) accelerated their mortgage payments toward the end of their loan just to be finally free of the bank. Good for them.

Problem is, not everyone is a Spock. Some of us are much more like Dr. McCoy, driven by our emotions.

Because of that, sometimes psychology matters more than numbers.

The thought of going into retirement with a mortgage of any size around your neck can be frightening, even depressing.

“The debt is causing a lot of stress for some retirees,” says Steven Raymond, certified financial planner at Navion Financial Advisors, in Davis, Calif. “They want to get out from under the obligation.”

If you’re approaching retirement and Raymond’s description sounds like you, get rid of your mortgage if you can, no matter how small it may be. It’s worth removing this source of stress.

Why I Favor Spock Over McCoy

Now that you’ve seen the Spock and McCoy arguments, who’s right? Math or emotions?

I favor Spock because you can’t know for sure what return you’ll get on your money going forward, although I lean toward low-return assumptions for managing a well-diversified portfolio with a conservative tilt as you age.

This doesn’t mean McCoy is wrong, though.

Put it this way: It’s a safe bet that boomers will confront another recession and bear market before they retire or soon after. Because of this, I’d recommend taking advantage of the growing economy and stock market to follow through on the finance strategy that will let you manage through the next downturn without panic and (too much) fear.

The time to establish a strategy and start acting is now.

Photograph of Chris Farrell
Chris Farrell is senior economics contributor for American Public Media's Marketplace. An award-winning journalist, he is author of the books "Purpose and a Paycheck:  Finding Meaning, Money and Happiness in the Second Half of Life" and "Unretirement: How Baby Boomers Are Changing the Way We Think About Work, Community and the Good Life." Read More
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