Pay down low-interest debt or save for retirement?

Question

I'm in my mid-forties, very low retirement savings, high debt, recovering slowly with a new stable salary. I need to get my finances fixed so that I'm not working full-time on my 70th birthday nor living in a trailer park.

Previously
I had zero credit-card debt but I was laid-off and I've made mistakes.

Had a house with a manageable mortgage and increasing salary. I extracted equity via a refinance, later had to sell the house, didn't/couldn't re-buy, so I had to pay IRS & state taxes due to the house's increased value but ... refinance, so no cash at the sale.

Had a decent 401(k) account, rolled over to IRA and made mistakes with stocks. (I now only invest in a low-cost lifecycle fund).

Numbers
IRS debt total = 15% of my gross annual income. On a payment plan with 3% interest. Even at the high minimum payment, it will require 5 years to payoff.

credit card debt total = 20% of my gross annual income. It's on 0% offers which expire ~mid-2018. Paying the minimums since it's 0% and I already paid the 2-3% fee. I've shifted that a couple times to new 0% offers. Rates are going up.

monthly outflow = ~55% of my monthly take-home (too high): rent, food, insurance, debt payments, misc

emergency savings = ~3 months expenses saved

401(k) funding = 5% of gross annual income to get employer matching

401(k) savings = less than my total debt

Questions
- Do I pay off the IRS debt ASAP because of the high monthly payment, or consider 3% low enough and keep saving?
- Do I save as long as I can keep shifting the credit card debt to 0% offers (AKA "leverage"), or do I pay off the 0% card debt first because the IRS 3% rate won't increase?
- My wife is re-graduating in months. Should her new income (60% of mine) be focused to pay off the low-interest debt, or targeted 100% into retirement (401(k), IRA), or some percentage?

Answer 1

First, congrats on the progress you are making in your desire to move forward.

Keep in mind, members come from different backgrounds, and there's not a black/white right/wrong answer here. Only our suggestions on how you should proceed. Most important, I invite you to read other Q&A here with the debt tag to see some great examples of this.

You have a matched 401(k). In your plan, this should be the highest priority. Getting an instant 100% return beats even paying off 18% card debt, so long as your plan includes paying off that debt inside of 4 years.

I'd use every extra cent to pay down the credit card. As you acknowledge, it's a bit of a ticking time bomb. You've done a good job having it cost just the 2-3% fee, but still, there's the risk the next offer won't get approved and you're back at 18%+. You don't give numbers, but I'd imagine that if you pay what you can now, and then use the new income from your wife to kill that card, you'll do it before the zero period is over.

Last - with just the 3% IRS debt, I'd still hold off on that, just pay monthly. Personally, I'd rather build up my savings. Get the 3 month savings buffer to 9-12 months, and perhaps even bump the 401(k) deposits to the maximum percent allowed. Do that for the first year your wife has her new job, then see where you stand, and pay off the IRS after that.

You have about 20 years to save for a secure retirement, the 10% rule is behind you, you need to try to save as much as 25-30% of your new combined income. I hope you can do that and still enjoy the next 20 years. Try to find the right balance.

Answer 2

There's lots of different ways to approach this, but to answer your specific question about whether to pay the IRS debt or increase retirement savings, I'd say "neither": you should pay down the credit card debt first (consider the temporary 0% rate a nice accelerator to your efforts).

Since you already have the emergency fund in place and are getting your full employer match (nice work!), you can apply what you have available for debt repayment using the "Snowball" method of debt-paydown:

You pay the minimum on everything except for one (usually your highest-interest debt, though in this case I'd still suggest the credit card)

Once the first one is paid off, you take the amount you had been paying on that one, and apply it to the next-highest rate debt (not sure how many credit cards you have, but the IRS debt would be in line after those)

Lather, rinse, and repeat

Edit from JoeTaxpayer - The Snowball article Andrew linked offers an online calculator. A great one that knows better than to have you pay off zero (or low) rate debt before 18% debt. It says "snowball" but goes with the best way to save on interest.