Pay down debt or buy that mutual fund?

Focusing solely on paying down debt in the short term could get younger Canadians to retirement sooner, says the 2024 Mercer Retirement Readiness Barometer, released on Tuesday.

“In today’s economic climate with elevated interest rates, a sample 30-year-old with $30,000 of personal (non-mortgage) debt could retire one year earlier with $125,000 more in savings if they focus entirely on paying off debt within 10 years, before shifting their focus to saving for retirement,” the report said.

Splitting disposable income between saving for retirement and paying down debt, for the entire period until retirement at age 65, would mean taking three times as long to pay the debt off, the report said, leaving less time to make larger contributions to retirement savings. As a result, the 30-year-old would have to save longer to accumulate enough funds to retire.

The analysis assumed that:

• the worker earns $70,000 a year,
• applies 5% of their income to either paying down debt or saving for retirement, and that
• the interest rate on the debt was higher than the expected rates of return of their investments (10% versus 6%).

The report defined retirement readiness as a 75% probability of not running out of money before death if an appropriate level of income was maintained throughout retirement (including government benefits), which was 66% of the 30-year-old’s pre-retirement income, or $46,200.

For baby boomers, higher interest rates make purchasing an annuity more advantageous, the report said.

Based on January 2024 pricing, a 65-year-old who used $500,000 in savings to buy a single-life annuity could have a lifetime income of $26,000 per year in today’s dollars, the report said — $3,500 per year higher than if they chose to invest the funds conservatively (40% equities and 60% fixed income, switching to 20/80 at age 80).

In either scenario — younger worker or retired boomer — financial literacy is key to success, the report said, because people need to understand how to navigate their options.

When CBC reported that it went undercover at the banks and asked for advice on paying off $17,000 in credit card debt versus investing a $50,000 inheritance, the branch advice was to pay off a portion of the debt and invest the rest in commission-generating mutual funds.