‘It seems to be a better idea financially to just put it in retirement and take on a loan’: I’m debating between saving for future expenses or maxing retirement savings. What’s the smarter move?

Hi Money Minder,

Retirement Savings vs. Cash Savings: What’s the Best Move?

Ever wonder when it makes sense to take on some debt just to make sure you’re maxing out your retirement savings?

Take my situation, for example. I know I’ll probably need to replace my car in about 5 years. I could save the cash in a High-Yield Savings Account (HYSA) and pay for it outright, or I can throw that cash into my retirement fund now and just take out an auto loan later.

So, let’s break it down. If the stock market is raking in 10% growth per year, and your savings account is giving you 5% (but remember, you’re paying taxes on that), and your car loan would be at 5% interest, doesn’t it make more sense financially to stash your cash into retirement and take out the loan when the time comes? I’m guessing the same logic works for stuff like water heaters or HVAC systems too.

What’s your take on this?

Cheers,
Future Planner

Response from THE MONEY MINDER:

Sure, here it is:

Hello There,

Congratulations on considering your financial options so carefully! It’s clear you’re weighing your choices wisely, which will pay dividends in the long run.

Balancing retirement savings with short-term financial needs can indeed be a challenging task. To address your query, let’s start by clarifying the principles involved and then dive into the specific mechanics based on your example.

In general, prioritizing retirement savings is crucial since these funds grow tax-deferred and compound over the years, which can significantly enhance your financial security in the future. Given that the stock market’s historical average return is around 10% and assuming your retirement investments perform similarly, it does provide a strong incentive to maximize contributions to your retirement accounts.

If we juxtapose this against the scenario of taking an auto loan at 5% to replace your car in five years versus saving the money for the car in a High-Yield Savings Account (HYSA) with a 5% annual return (pre-tax), it appears more beneficial to funnel those funds into retirement. The difference in potential returns between the stock market and a HYSA, even after adjusting for taxes on interest earned, still tilts in favor of investing in the market.

However, practical considerations must also be taken into account. Taking on debt always comes with uncertainties, including your ability to obtain favorable loan terms and the state of the economy at that time. Financial advisors often recommend maintaining an emergency fund and keeping some liquidity to address immediate needs without resorting to high-interest debt.

Considering the specific context of your planned expenditures, a blended approach could be the most sensible. For example, split your monthly savings intention: allocate a notable portion toward your retirement account to harness the higher long-term growth potential while also setting aside a portion in your HYSA to cover the anticipated cost of the car. This ensures you’re not fully reliant on borrowing and reduces the impact of potential loan interest. The balance between the two can be adjusted based on the market performance, your personal risk tolerance, and other financial obligations.

Ultimately, diversification and a well-thought-out strategy will minimize risk and maximize your financial stability.

Wishing you the best with your planning and investments!

Best Regards,
THE MONEY MINDER