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
Originally Posted On May 4, 2013


Chris Farrell is economics editor for APM's Marketplace Money, a syndicated personal finance program.

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.

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.”

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.