How can I save for retirement while paying off debts?

By Jessica Moorhouse, QAFP, and author of Everything but Money: The Hidden Barriers Between You and Financial Freedom

As told to Ian Portsmouth

Here’s the answer to this week’s reader question.

How can I save money for retirement when I’m trying to pay off credit cards and other debt?
—John

Debt versus savings: Which to prioritize?

Balancing debt repayment with saving for retirement is a common challenge for Canadians. A lot of advice out there suggests there’s a one-size-fits-all solution—namely, aggressively pay off all high-interest debts, followed by low-interest debts, before saving for retirement—but I believe the best approach depends on your situation. Psychology also plays a role. But here’s some guidance on how to help you prioritize your savings and debt goals.

Do you have an emergency fund?

The first step is to ensure you have an adequate emergency fund. In 2023, Statistics Canada reported that one in four Canadians couldn’t cover an unexpected $500 expense, like a car repair. Borrowing money in an emergency often explains how debt builds up in the first place; debt is not always the result of careless spending. So, build a solid emergency fund before thinking about retirement savings or eliminating debt. Of course, you’ll still need to make all necessary debt payments (e.g., monthly minimum credit card payments) while contributing to your emergency fund.

Should you eliminate debt before investing for retirement? 

Maybe.

Generally, your next priority is to pay off high-interest debt, like credit cards and any payday loans. That’s because, mathematically speaking, paying off this expensive type of debt first is more beneficial than paying off lower-interest debt or putting the money into investments. For instance, the 19% to 23% interest you’ll pay on a credit card balance is far greater than a typical return you could expect on your investments. Once you’ve paid off your high-interest debt, you can focus on low-interest debt, such as mortgages and auto loans.

The role of psychology in reducing debt

If you put a solid repayment plan in place, you don’t have to be debt-free before investing for your retirement. This is where psychology comes into play.

For instance, eliminating high-interest debt before you start investing is a reasonable strategy if the debt is small enough to be paid off over a short period, like one or two years. But paying down debt for a long time without making meaningful progress can cause “debt payment fatigue,” a kind of mental and emotional exhaustion that can derail your financial plans and make you question whether it’s worth trying to save for your retirement at all. 

So, even though putting all your available funds toward high-interest debt payments is more advantageous on paper, you could be better off in the long run to invest some of that money and watch your retirement fund grow, giving you a sense of hope for your future.

Similarly, if you have multiple debts, it can be better to pay off the loans with the lowest amounts first, even if they have the smallest interest rates. That’s because you can eliminate the smaller loans pretty fast, which can build a sense of momentum and motivate you to tackle your remaining debts. 

If you have multiple debts with high interest rates that will take a long time to pay off, look at consolidating those debts into a single loan at a reduced interest rate, such as a debt consolidation loan, home equity line of credit or a credit card balance transfer. Just be mindful of any additional fees that apply, like a prepayment penalty.

Start saving for retirement

Whenever you start saving for retirement, automate the process as much as you can. For instance, set up your chequing account to transfer a set amount to an investment account automatically each month. You can also direct your employer to send part of your paycheque into a savings or investment account. By automating contributions to your retirement fund, you reduce the opportunity to use the money for other things.

One of the best ways to build your retirement fund is to take maximum advantage of a pension plan or RRSP (registered retirement savings plan) matching, if your employer offers these. It’s free money and, in the case of RRSP matching, delivers an immediate return on your investment. For instance, if your employer contributes 50¢ to your RRSP for every $1 you put in, that’s an ROI of 50%.

Saving for retirement versus paying off debt

Ultimately, while there is no single formula for managing debt while saving for retirement, this guide should help. The right approach depends on how you think about money as well as your circumstances, including the number, type and cost of the debts you have, and the special savings or investment opportunities available to you. You’ll know you’re on the right track when you’re both making progress on paper and feel that progress happening—which can motivate you to do even more.

Ian Portsmouth is an award-winning writer and editor specializing in business and personal finance. He is based in Toronto.