This is one of the biggest financial questions not just Millennials, but all American’s ask themselves. Should I pay off my debts (student loan, car loan, credit card) or invest for retirement?
Nationally renowned “financial coach” Dave Ramsey has his baby steps, which clearly state to pause ALL retirement contributions until your debts are paid off (everything except for the house).
I agree with most of what Dave Ramsey lays out. Although, I vehemently disagree with passing up any possible 401(k) company match. If your company offers a match, you should 100% take advantage of that first and foremost. Invest the minimum percentage to get the employer retirement match, which is usually dollar for dollar up to 6%, and nothing more after that.
Below are the steps I layout that work best for a Millennial prioritizing their debt payoff versus their retirement investments.
1) Invest in your employers 401(k) plan IF they offer a company match. Invest the minimum amount needed to receive the maximum match (nothing more, nothing less). If your company doesn’t offer a match. Skip to #2.
2) Payoff your debts in order from lowest to highest balance. Ignore the common advice of taking your highest APR and paying that off first. No. You want to see results versus tackling the highest rate (which could be the highest amount as well). Throw as much as you possible can, like an uncomfortable amount of your monthly income, at the lowest debt/loan you have. Pay the minimum on all other debts until the smallest balance is paid in full. Then move on to your second debt and repeat the same process.
3) Once you are debt free, except for your house, contribute to your retirement plan or a Roth IRA. If you have the company match and you’ve already completed step #1, your next task is to now open up a Roth IRA. A Roth IRA is a retirement account where you contribute after-tax dollars so that your investment grows tax free. So at age 59.5 you may withdraw from this Roth IRA and pay zero taxes on your distributions. A huge benefit! You’re allowed to contribute $5,500 into a Roth IRA as of 2016. I would strongly advise to contribute 20% of your gross income towards retirement, including your company match. So if you contribute 6% to your employers 401(k) and receive a 6% company match, you need to place another 8% into a Roth IRA.
4) Once your retirement plan is on cruise control at 20% of your income, invest your remaining available funds into a 529 college savings for plan for your children. Anyone who has had student loans knows that potentially removing that burden from your children is a powerful thing. Your retirement absolutely comes first though because there are no loans to live on in retirement, but you may take advantage of student loans to get your child through college if your savings is lack luster or non existent. If you don’t have children (yet or don’t plan on it) skip to #5.
5) Now is the time to throw all remaining funds you possibly can at your house and get that mortgage paid for. Your debts are paid off. Your retirement is in great shape. Your kids college appears to be virtually paid for. Now is the time to achieve the ultimate financial goal…a paid for house! Work diligently to get that home free and clear so you can finally be financially independent.
6) Invest. Invest. Invest. Now that you are completely debt free and have a paid for house, its time to max out all retirement savings accounts and some. You know officially have no more payments to make to anyone, other than yourself. Continue to make payments…to yourself and invest that money like crazy. The maximum contribution one can put towards their 401(k) annually is $18,000 ($24,000 if you’re over 50). The max for a Roth IRA is $5,500 ($6,500 if you’re over 50). If you’ve maxed both of those out and still have money leftover, open up a brokerage account and invest in a low cost index fund (which you should be doing anyways!).
Follow this plan and you will be more wealthy than you even thought possible.