Dear Dave: My wife and I are both 25 years old, and we’re working on Baby Steps 4, 5 and 6. I have a 401(k) through my employer, and she has a pension. Currently, we’re falling short of the 15 percent of income you advise putting toward retirement. Should we get IRAs, or start stocking money away in her pension?
Dear John: I wouldn’t put money into a pension. For one thing, when you die after putting money into a pension, in most cases it dies with you. Number two, when you put money into a pension, you’re going to get about a six percent rate of return in the current environment — maybe even as low as five percent. You’re not making much on it while you’re alive, so I don’t advise putting money in pensions. We let employers put money in pensions, if they want to. That’s a nice benefit, but I wouldn’t add to it.
I would do a couple of Roth IRAs, and max those out. Then, max out whatever you’ve got at work that you own. Of course, when you’re vested in a pension, you own it. That much is true. But still, I don’t advise adding to pensions, buying years up, or any of those kinds of things.
There are a few examples out there where that kind of thing works mathematically to your benefit, but they’re very hard to find. Out of all the years I’ve been in this business, I can count on two hands the number of times I’ve seen it work out.
So no, I wouldn’t do more with a pension where you add to it yourself, especially at such a young age.
Dear Dave: I’m new to you and your plan. Why do you want people to pay off the debt with the smallest balance first, instead of the one with the highest interest rate?
Dear Courtney: Simply put, because personal finance isn’t all about math. Personal finance is only about 20 percent math. The other 80 percent is behavior.
We list debts in the debt snowball in order of the smallest to the largest balance, putting as much as possible toward the smallest while paying the minimum payments on the others. The reason, as I mentioned earlier, is behavior modification. It helps you see yourself making a dent in your debts.
It’s easier to change bad habits when you see quick results from your efforts to eliminate negative behaviors. Paying off the smallest debts first, instead of the debts with the highest interest rates, will give you quick wins that will help keep you motivated. It provides proof that you can succeed and become debt-free!
Follow Dave on the web at daveramsey.com and on Twitter at @DaveRamsey.