Is it better to max out retirement accounts, contribute to your kids’ 529 plan or make extra mortgage payments?
More often than not, once you’ve reached your 30s, your responsibilities grow exponentially.
At this point in your life, you may find yourself with a mortgage, a couple of kids — and increasing concerns about saving enough money for retirement.
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These competing financial priorities can be a real headache, and it can be hard to know which one to prioritize first: retirement, mortgage, or college funds for the kids.
If you find yourself in a similar situation, here's how to go about deciding where your hard-earned dollars should go first.
Focus on saving for retirement
An AARP survey found that one in five Americans aged 50+ have nothing saved for retirement, while more than half (61%) worry they won’t have enough money to support them in their golden years.
To avoid falling into this cohort in the future, many financial experts recommend that their clients start setting aside money as early as possible.
After all, the earlier you start saving, the more compound interest kicks in and works its magic.
In addition, start contributing to a 401(k), if available, and benefit from an employer-match for your contributions.
Depending on your employer, it could provide a 25%, 50%, or even 100% return on investment. You’re not likely to find that return anywhere else.
As a general rule of thumb, the younger you are, the more you should consider prioritizing your retirement savings over paying off your mortgage.
Your kids can take out a loan for their education or you can downsize your home if the mortgage becomes too daunting; however, you can’t live off Social Security alone so your retirement savings should be robust in order to ensure happy and secure golden years.
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Pay off high-interest debt
Once your retirement savings have had time to grow, consider paying off high-interest debt as you're likely going to get a better return on your money than with any other investment.
This is a good rule of thumb since you’ll want to maximize your return on investment, and the ROI on early debt payoff is simply the interest saved.
Let’s say you have a high-interest credit card debt that's currently charging you upwards of around 9% or 10%. It’s time to get serious about paying it off ASAP.
The Federal Reserve reports that, as of May 2024, the average credit card interest rate was around 21.51%. High interest can accumulate quickly and affect your credit score while also making it harder to pay off your principal.
Aggressively paying off your highest interest debt first is called the avalanche method. You work toward paying off your largest debt while still making the minimum payments on your other credit cards or loans. Once that debt is gone, you move on to the debt with the next highest interest rate, and so on.
If that seems too daunting, consider the snowball method, which focuses on paying off the smallest debts first in the hopes that these small early wins will motivate you to pay the rest off faster.
Saving for the kids and tackling your mortgage
If you've got your retirement set up, then saving for your kids’ college tuition should be your next goal.
Student loans are a huge financial burden for younger adults. If you can spare your kids this additional financial stress, you can set them up for a better future.
Investing in a 529 plan offers you tax savings to do that (the specific rules depend on your state). These state-sponsored tax-advantaged plans come in two main types: education savings plan and prepaid tuition plans.
However, if your kids decide to forgo college, the funds in the 529 can also be used for some vocational training.
Devoting your funds to a college savings plan rather than paying larger chunks on a mortgage makes good sense for a few reasons:
Mortgage rates are typically lower than the rate on student loans
You can claim a tax break (with some conditions) for the interest you pay on your home loan if you itemize when filing your taxes
Fixed mortgage rates will stay the same regardless of the economy or housing market, but education costs will only continue to escalate
Even many wealthy Americans take out mortgages because there's little reason to tie up all of their cash in an illiquid asset when there are affordable, tax-advantaged ways to borrow.
Therefore, unless you're in a unique situation, such as being stuck in a subprime mortgage with a very high rate, paying off your home loan ahead of schedule doesn’t make sense.
That means that, as you balance your financial goals, you should breathe a sigh of relief that extra payments on your home loan can be taken off your list.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
