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Getting into debt has become a cultural rite of passage for most South Africans. So, should we pay off our debt or save for retirement?
"Can you pay my bills? Can you pay my telephone bills?"Perhaps Destiny’s Child were also trying to figure out where to find extra cash to start saving for retirement. Just like us, mere mortals.
Pay Off Your Past Or Invest In Your Retirement
When asked, someone once told us that they paid their debts according to whoever called first. This (over-indebted) individual obviously did not have enough to go around at the time. But, say they had a bit more freedom to choose, would they pay off their debt? Or grow that cash for retirement? It’s a valid question for any of us. Especially in a ‘financed’ culture, where we’re paying off everything we think we own. More than half of South Africans owe as much (or more) than 75% of their salaries to debt repayments. It comes as no surprise, then, that many people choose to fast-track debt repayments – and delay boosting retirement contributions in the process. But, what you save in interest with this method, you pay in compound interest lost by not saving for retirement. Considering the statistics from our National Treasury that only 6% of South Africans will be able to retire without having to change their standard of living, this is a considerable cost. Steven Nathan, 10X Investments CEO, shared on the 10X blog that the reason for this dire statistic is that people don’t understand the retirement savings industry. He says that it is crucial people understand how retirement funds work in order to achieve a comfortable retirement. Most people underestimate the losses incurred when they delay saving for retirement. An example would be someone who needs to free up some cash short-term and chooses to make a retirement annuity ‘pay up’ instead of cutting DStv for a year. Nathan advises you ask yourself: “How much money do I need to save to have the same standard of living in retirement? Am I saving enough? Am I on track? Am I saving the right way?”
3 Important Considerations
Christo Davel, 22seven CEO, said that where debt and retirement are bidding for priority status in your budget, the question shouldn’t be ‘either/or’.“The practical solution is to find money. We believe that there is almost always some money to be found … it may be R100 a month or R1 000. Once you know where it is, then you can think about the ‘debt or retirement’ question practically.”Financial adviser, Bray Creech, recently shared on the Citizen Times (a subsidiary of USA Today) that implicit in the ‘debt or retirement’ question, is that you are paying all of your minimum monthly loan payments (obviously). He advises that there is no one-size-fits-all answer, but emphasises some important considerations to make.
1. Know How Much You Owe
“…Make a list of all your debt. For each loan, jot down the following: how much you owe right now, your interest rate, and your minimum monthly payment,” advises Creech.He advises you focus on those loans with an interest rate of 10% or greater.
“Assuming you’ve made your minimum monthly loan payments, pay off the highest after-tax interest rate debt first. If that’s credit card debt at 17%, for example, then by paying that down you’re effectively getting a 17% return on your money. … In contrast, getting a 17% return on your money through investing is difficult, high-risk, and anything but guaranteed,” he adds.
2. Take Advantage Of Benefits
Besides retiring comfortably, there are other added benefits in saving for your own retirement. For example, SARS offers a rebate on your retirement contributions equal to the rate you’re taxed (up to a maximum of 23% of your income). That’s what we call a ‘cash money’ incentive… in hip hop terminology. Word. But, some employees have an even greater incentive. A company that offers to match the contributions on your company retirement plan. As in, what you contribute to your retirement, they match.“If, for example, your employer offers a 100% match on the first 3% of your contributions, then you should contribute 3% of your salary into your retirement plan. Why? You’re earning a 100% return on that portion of your retirement account contributions,” says Creech.
3. Don’t Set Yourself Up For Failure
Creech confirms that, according to behavioural finance research, we’re more inclined to save and invest on auto-pilot. In other words, debit orders, stop orders, or automated payments from your bank account.“That way, you don’t have the pain of writing a check or sending a payment each month.”This applies to paying off your high-interest credit card, as well as contributing to your retirement. He also says some people respond to the psychological benefit of seeing debt disappear more quickly and prefer to pay their loans with the lowest balances first.
“While you may pay more interest with that approach, if it helps you stick with a plan, then stick with it,” he concludes.