The ability to retire early often means saving aggressively during your working years to ensure you have enough income for the extra years you’ll be spending in retirement. This is one of the major tenets of the Financial Independence/Retire Early, or F.I.R.E, movement, which has been gaining traction in recent years. Finding extra income to put toward savings, either by cutting costs or earning more, is another major component of the philosophy — as is having little to no debt.
But household debt now stands at $14.56 trillion in the U.S. So if you’re like the millions of Americans who carry a credit card balance, a mortgage, or have student loans, you may be wondering if early retirement is a possibility. The answer may be yes. By carefully reining in your debt, you’ll have more money to devote to savings, and you can even use some F.I.R.E strategies to help you get there.
Taking Stock of Your Debt
It’s important to get an idea of your overall debt before you can start chipping away at it. Sit down and take stock of your debts by gathering credit card bills, personal loans, student loans, and other statements.
Organize your debts into categories. List each debt, its balance, loan term, minimum payment, and interest rate. Alternatively, use Tally to help you track what credit card debt you have, the balance owed and how long it will take to pay it off.
Keeping track of your interest rates is particularly important because it helps give you an idea of which balances are costing you the most money to carry. Add up your debt in each category, and then add the categories together to get your debt total. Now that you have a clear idea of how much debt you’re dealing with, you can start to develop strategies to tackle it.
Examining Your Budget
Finding funds to make extra payments can go a long way to paying off your debt quickly. Start by digging into your budget. Add up your fixed monthly expenses, such as rent, utilities, loan minimums, and insurance premiums. Subtract that total from your after-tax income, and the difference represents your discretionary spending. This is the pool of money you can use for non-essential things, including savings, eating out, or entertainment.
Your discretionary income is also the part of your budget where you can find wiggle room to fund extra debt payments. You may choose to take a cue from F.I.R.E. adherents and cut way back on discretionary spending, such as eating out, taking a vacation, or nonessential clothing items, and use that money to make extra payments on your debt. Or you can find a way to boost your income by taking a higher-paying job or devoting extra time to freelance work.
Decide how much you are able to devote to paying off debt and build that figure into your budget. The most important part of budgeting is sticking to it, so find a budgeting strategy that works for you. For example, consider using the 50/30/20 rule, which allocates 50% of take-home pay to needs, 30% to wants, and 20% to financial goals, such as paying down debt and saving.
Which Debts to Pay Off First
Once you’ve found the funds to make extra payments, it’s important to decide which debts to tackle first. There are a few important considerations. First, you may want to focus on your highest-interest rate debts, which typically are from credit cards. These balances cost you the most to carry, so paying them off will save money on interest rate payments and can free up even more money to devote to financial goals.
You should also consider whether your loan gives you certain tax benefits. For example, if you carry student loan debt you may be able to deduct your interest payments. For the 2020 tax year, student loan borrowers may be able to deduct the lesser of $2,500 or the total amount of interest paid during the year. The amount that can be deducted is phased out depending on the tax filer’s yearly adjusted gross income. Tax deductions can make it less expensive to carry certain debts, potentially giving you the opportunity to focus on your more expensive loans.
Strategies To Pay Off Debt
When it comes to paying off your debt there are two strategies you may want to consider. The avalanche method suggests you pay off your debts from the highest interest rate to the lowest. Every month, make the minimum payment on each debt, but put any extra money you can toward the highest interest rate loan. Once your first debt is paid off, use that money toward paying off your next highest interest rate loan, and so on down your list. Using this method can save you money on interest in the long run and potentially get out of debt faster.
The debt snowball method, on the other hand, focuses on debts from lowest balance to highest. You may end up paying a bit more in interest using this method. But by devoting extra funds to smaller debts first, you’ll be able to knock a couple off your balance sheet quickly, which can feel really good. This, in turn, can help you build momentum, which may keep you committed to the process.
Focusing on Savings
When you’ve paid off your high-interest rate loans, you can begin to focus on saving for retirement. Take another cue from F.I.R.E. participants and save as much as you can. If you haven’t already, set aside three to six months’ worth of expenses in an emergency fund, which can help protect you from going into debt again should an unexpected expense pop up, like a medical bill or car repair.
Carefully weigh paying off your lower interest debts versus investing. If you believe your potential returns will be higher than your loan interest rates, it may make sense to invest rather than pay those loans off early.
Make use of tax-advantaged retirement accounts. Max out your 401(k) if you can and, at the very least, save enough to meet your employer’s matching funds if they offer them. If you’re self-employed or want to save even more, consider using a traditional or Roth IRA to save for retirement.
If you’re ready to get on the path to early retirement, Tally can help you choose a debt payment strategy, track and pay off your cards in one place, and pay off your debt faster. As you take control of your debt, you’ll be taking control of your future, setting yourself on the path to accomplishing your financial goals.
Want to retire early? Learn how Tally can help you meet that goal.