Trying to think about your financial future while paying down past debt can be daunting. But doing both isn't impossible.
Illustration by Marta Ryczko

Save for Retirement vs. Pay Off Debt: What Should I Do First?

Wealthsimple Work provides employers with a modern financial wellness benefit for employees.

Planning for your financial future can be overwhelming on a good day. It can be even more overwhelming when you’re also working to pay down debt at the same time. This leads to Canadians asking themselves if they should save for retirement or pay off debt.

It’s a tough question to answer. Do you pay off all your debt first? Do you focus on the future and double down on saving for retirement?

While there is no one-size-fits-all solution, there is a way that you can do both. 

Here’s what you need to know.

The State of Debt and Retirement of Canadians

If you’re struggling with debt and retirement planning, you’re not alone. Canadians today are having a harder time building wealth than any generations before them. A large factor in that is the larger levels of debts — saving for tomorrow can seem daunting when there’s so much to pay back today.

In fact, Canadian Millennials hold more than twice as much debt as any other generation. The debt-to-after-tax ratio for Millennials in 2016 sat at 216%, versus 125% for Gen-Xers in 1999.

What’s causing this? There’s a few factors, including:

  • Rising costs of education

  • Increasing cost of home ownership

  • Rapidly growing amounts of credit card debt

With so many factors, it’s no wonder Canadians are struggling with debt. And as a result of high debt levels, retirement planning seems even more far off for the average person. As of just last year, a quarter of Canadians felt it would “take a miracle” to retire financially secure. The factors leading to this concern for Canadians include:

  • Financial impacts of COVID-19

  • Inflation

  • Low interest rates 

  • Cost of health care  

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Save for Retirement or Pay off Debt? 6 Steps to Do Both

So with debt rising and retirement seeming unattainable, what can you do today? Do you save for retirement or pay off debt? 

You can do both. And even if you start small both, it's valuable to tackle debt and saving at the same time. Why?

The reason to start early on both is actually very similar — interest. However, interest on debt works against you, where interest gained on retirement savings is working for you!

Think of a credit card. If you miss a payment or pay late, interest will be applied. The more you have on a credit card, the more interest costs you each month. This applies to all debts with interest on them. The sooner you pay them off, the less interest you have to pay off.

Now flip this for retirement savings. If your retirement savings are in an investment, they're likely to grow. The earlier you start saving, the more time the money you put in has to grow. This is why saving early is key. You want the money in that account to have time to compound interest.

So it's important to do both — and here’s where to start.

1. Look at your debts

There are so many different mindsets about saving and debt. The way each person views debt will vary, which is why there is no one right answer. Some people have the “pay yourself first” mindset — the idea that all debt isn’t the same, and you can afford to carry some (vs. pay everything off before saving for retirement). 

On the other end of the spectrum, you may view “all debt as bad.” This is the idea that you should pay off all your debts before saving for anything, retirement included. 

No matter which side of the debate you land on (and it’s likely somewhere in the middle), the first thing you want to do is evaluate your debts. This will help you determine how much actually has to be paid down and what is the most pressing, based on each interest rate.

Some common debts you’ll want to look at include:

  • Car loans

  • Student loans

  • Credit card debt

  • Lines of credit

  • Mortgages

Once you know where your money needs to go for repayments, you can build a budget that lets you tackle them one by one.

2. Build a budget

It’s important to bring up here that there is no one-size-fits-all solution for debt and savings. Your budget and retirement savings plans are going to look different than your friends, family, or colleagues would — that’s totally okay. 

Once you have your mandatory monthly expenses built into your budget (food, housing, phone, and internet, for example), you can divide some of the “leftover” money between paying down debt or saving for retirement. 

Determining the split of that remaining money is where your mindset around debt ( mentioned above) comes into play. If you’re uncomfortable putting aside a larger amount of money for retirement until your debt is paid down, put more towards debt. On the other hand, you can put more of that chunk of money towards retirement if you’re okay carrying a little more debt longer. 

When determining what debt to pay first, remember to review how much interest is on each of your debts. This will guide you on what to prioritize to pay down — you want to pay any debts that carry a high interest rate down first. A credit card with 20% interest will be at the top of the list, versus a student loan that sits around 4% interest on outstanding balances. However, make sure you pay the minimum balance each month on all debts. 

3. Set up a dedicated retirement account 

Having a dedicated account for retirement makes it easier to save for retirement and pay down debt at the same time! 

It’s okay if you start with putting small amounts in a Registered Retirement Savings Plan (RRSP) in order to allocate more towards debt — even a few dollars put aside for retirement every pay cheque starts to add up.

But it’s especially important to have those dollars you budget for retirement going into an entire separate account for two major reasons:

  • Accounts specific for retirement savings offer you tax benefits in the long run

  • You won’t be tempted to spend money you aren’t seeing! 

You can also reallocate some of the money you’re using to pay down debt to your retirement savings as the debt numbers go down. The $400 you’re putting towards credit card debt every month, for example, can be reallocated towards retirement when that debt is lowered or paid off.

4. If your employer offers a GRSP, get signed up

Your employer may offer a Group Retirement Savings Plan (GRSP) as part of your total compensation. If this is the case, get signed up as soon as possible.

A GRSP is very similar to an individual RRSP, but allows you to have money deducted directly from your pay cheque and put into your GRSP. This money goes into investments you select. Having the deposit taken directly from your pay cheque can be hugely beneficial when trying to save — you can’t spend money that never goes to your chequing account! You can also receive tax benefits by directly contributing to your GRSP.

There are typically two types of GRSPs: matching and non-matching. With a non-matching plan, employers do not contribute anything to your GRSP. Employees are solely responsible for contributing to the account on a voluntary basis. Set an amount that you’re comfortable coming off your pay cheque each pay period and it will be deposited directly into your GRSP. 

A matching plan is a type of plan where employers will literally match what you put in, either dollar for dollar up to a certain amount (you put $1 in and the company puts $1 in) or a percentage of every dollar (you put $1 in and the company puts $0.50 in). If you want to start small in your retirement saving efforts and focus on paying down your debts, maxing out your employer matching is the best way to get started. Don’t miss out on what is potentially a 100% return!

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Remember, it’s a great idea to contribute to both a matching or non-matching GRSP, whichever type your employer offers. Contributing even a little bit at a time is a great starting point for retirement savings.

5. Build on retirement savings as debt goes down

Did you know that the contribution limit (the amount you can donate into a specific account annually) for GRSPs in 2021 was $27,830? Any unused contribution room from previous years also rolls over to the next year. 

This means you have a lot of room to save for retirement each year. As you pay down your debt, you can reallocate that money towards retirement savings and increase the amount that you contribute each pay cheque. 

6. Make a plan that works for you

This is such an important part that it had to be emphasized again — make sure this is a plan that works for you. 

For some, saving can seem daunting when you have outstanding debts. If this is you, start by focusing most of your attention on debt repayment and only a small amount on retirement. For others, future planning takes precedence. If you’re on this side of things, you might be prioritizing certain debts and paying minimums while putting most of your money away in retirement (or other) savings.

If your plan isn’t personalized for you, it may be harder to stick with it.

Save for Retirement or Pay Off Debt? Why Not Both?

Deciding to save for retirement or pay off debt doesn’t have to be an either/or situation — you can do both. At the minimum, make the most of employer matching on your GRSP (hello, free contributions!) while using the rest of your monthly leftover money to pay down debt. 

But how you do both, and at what balance, depends on your personal circumstances. When you take the time to find the right balance for you to save and pay down debt today, you will only put you in a better financial position tomorrow.

Emily works to create exceptional client experiences as a client success manager at Wealthsimple Work. Emily supports clients by rolling out GRSP programs and ensuring employers and employees have all the resources they need to be successful.

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