Save More For Retirement Or Save For House Down Payment?

I see this question come up a lot from recent college graduates. After you contribute enough to get the employer match in the 401k or 403b plan, should you save more for retirement, or should you save for a house down payment?

The question is asked presumably because the income does not allow one to do both and therefore one has to choose one or the other.

The answer is simple: save more for retirement.

The reason is also simple. Saving more for retirement is investing in one’s future. Saving for a house down payment is saving for increasing consumption in the near term. If someone hasn’t saved enough for retirement yet, he/she hasn’t earned the right to buy a house yet.

It’ll be clearer if we change the question: save more for retirement or buy a new sports car? If one hasn’t saved enough for retirement yet, one is basically using retirement money to buy a new sports car. Sensible people will see one should save more for retirement before buying a new sports car. There’s nothing wrong with buying a new sports car, but not at the cost of saving more for retirement.

Why does buying a house feel differently than buying a new sports car? Both are an upgrade in current consumption: a new sports car is better than a five-year-old sedan; a house is better than a rented apartment.

A house appreciates! Maybe. Now we know it can also depreciate, wiping out your down payment. You get tax deductions! Maybe, but you also pay interest and property taxes. The interest and property taxes may be higher than your rent.

If someone can’t save enough for retirement yet, don’t worry about buying a house. How much is saving enough for retirement? 6% of income isn’t nearly enough. Try at least 20% of gross income. Kimberly Palmer in her book for young adults Generation Earn recommends saving 25% to one-third of one’s pretax income. That includes both saving for retirement and saving for near-term goals such as a house down payment. I agree with that recommendation but saving for retirement has to come first.

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Comments

  1. nick says

    If you ask someone in the financial services industry how much you should save for retirement, they will give you the highest number they think you won’t laugh at. Because they make more money the more you invest.

    In fact, owning a home gets you free rent and social security will cover your basic living expenses. Everything you save on top of that is just icing on the cake. It is hardly necessary to save 25% of income.

  2. Ace says

    TFB – You overlook another reason to prioritize retirement over a house down payment: If necessary, you can borrow a little extra money to buy a house. You generally cannot borrow money to fund your retirement.

    Thus, if your home down payment savings comes up a little short, you either purchase a smaller home or get a bigger loan. If your retirement savings comes up short, you either hope you can delay retirement (which health or other factors may not allow), or you plan on dying earlier (not a strategy I would recommend).

  3. Chuck says

    I agree that a person should meet their annual retirement goals before saving for anything else. The advice to rent a house instead of buying is misleading depending on the individual. In the short run it may be cheaper to rent but if you plan on staying in the same house 10+ years then you are going to be better off getting that loan now. The influencing factors that are usually not included in the rent vs. buy discussion are 1) interest rates are at historic lows, 2) over 10+ years inflation will effectively reduce the monthly mortgage payment, 3) rents can rise every year, 4) the rent has to cover insurance, property taxes and provide a profit for the landlord. So the answer really depends on what kind of person you are. If you want to upgrade every few years then you should be a renter. If you are a buy and hold individual then you should buy that house now.

  4. JG says

    @Chuck +1

    I’m a buy n hold type, so that’s my natural tendency, but even so, there are many less tangible benefits to owning your own place over renting. I can’t imagine ever going back to being at the mercy of landlords for lack of maintenance, ridiculous rent increases, etc.

  5. lurker says

    Chuck, JG,
    I tend to agree with you. I’m an owner.
    However, as with everything, ‘it depends’.
    cost of ownership in CA is generally way higher than renting, still even now in some neighborhoods (like mine) where prices haven’t come down.

    As for TFB’s basic notion though… save 25% (or more!) I do agree.
    At that point you have to really think thru what would be better… buy stocks? funds? an investment property? a property to live in?

  6. Leigh says

    Thanks TFB! You’ve reinforced what I’m doing. I’m saving about 20% of my gross income towards retirement, improving my emergency fund to 12 months expenses, saving for a car replacement in 10 years, and saving for a down payment last. I should reach my down payment goal in 2-3 years, at which point I will probably up the retirement savings to 25%.

    Plus, I’m young (early twenties) and I don’t want to be tied down to a house, so saving for retirement over a down payment is a no brainer.

  7. KD says

    TFB, what are your thoughts about being multi-goal oriented in financial planning over prioritizing goals aka serial goal chaser? If one has credit card debt, high interest car debt or high interest student loans then latter is the way to go. But in absence of these, what would be the way to implement multi-goal financial planning? How to incorporate flexibility in that planning?

  8. Ross @ Go Be Rich says

    There’s so much more money that goes into owning a home than you could probably ever expect to make back through appreciation, such as repairs, insurance, decor, furnishings, lawn care, and other “soft” costs that we don’t think about but really add up. Living in an apartment or renting a house keeps people in the “it’s not mine” mentality, meaning they feel less inclined to spend money on it, since eventually they’ll just be moving out, and they’ll get no benefit from the improvements, except for simply enjoying them while you’re there. This doesn’t mean never buy a house, I mean I defiantly want a house one day, but for a college grad to either buy a house or start investing for retirement? Retirement all the way.

  9. TFB says

    @KD – If one has the money for everything, by all means pursue all goals at the same time. If there isn’t enough money, one has to prioritize.

    1. Get the 401k match
    2. Pay off high interest loans (ideally one doesn’t have them to begin with)
    3. More retirement savings (to 20% of pretax income, use Roth IRA as emergency fund)
    4. Emergency fund

    After these are done, if there’s still money in the budget, it’s certainly possible to pursue multiple goals simultaneously: vacation, car replacement, saving for future child care expenses, child college fund, and home down payment.

    @Ross – I’m an owner. I agree with you on the “soft” costs. Owning will give you a more pleasant lifestyle but renting will cost less in absolute dollars. When you rent, you don’t have to rent as nice or as big a place as you would buy. I just spent some good money repainting my interior walls and baseboards. I had to choose which shade of white for the baseboards and which colors for my walls and the finish (flat, eggshell, …). If I were renting, I would not have cared. It’s a luxury. You spend money on luxuries after other things are taken care of.

  10. Andy says

    TFB: I think 25% of gross income is way too unrealistic. Saving 10% and getting a 6% company match is ample, especially when you are in your 20′s.

    I would love to see an analysis of the savings of PMI. I can see a younger person saving towards a goal of putting 20% down on a house. By doing so, he avoids the cost of PMI so there are real economics to choosing house funding over excessive amounts or retirement savings at that age.

    I would never advocate putting zero into retirement accounts, as that encourages dangerous behaviour later (bad savings habits). But once you are saving a modest amount towards retirement, I can see the economic merit to saving enough to avoid PMI. But once you have achieved the 20% down payment, I see no need to continue piling up the home equity over saving an appropriate amount for retirement.

    Best wishes.

  11. Darwin's Money says

    I think much depends on other factors like future income potential, whether you have a spouse/partner that can contribute, when/whether you’re having kids and more. If you abide by the “retirement” option your entire life, life will pass you by and you’ll be a renter for life. I’m not beguiled by the notion that home prices will always appreciate, but don’t forget, you’re paying taxes anyway by renting (which the landlord passes on), and in a home you’re at least paying down principal.

  12. TFB says

    @Andy – Saving 20% of income for retirement before saving for down payment does not mean one has to pay PMI. It just means it will take more time to save up the down payment and one will buy a home later than otherwise.

    @Darwin – re: life will pass you by and you’ll be a renter for life – The same argument can be made for any other consumption items: iPhone, trip to New Zealand, sports car, private school for child, … All great if you have the money. Not so great if you buy them with your retirement money.

  13. nick says

    It sounds like everyone who says “renting is cheaper” is comparing a cheap apartment to an expensive house. That’s a false comparison. You have to compare apples-to-apples.

    Paying for lawn care, etc. is always going to be far cheaper than paying for rent on a similar-quality rental.

  14. TFB says

    @nick – You don’t have to compare apples-to-apples. A used Honda is not the same as a new Lexus, but it gets you to work just fine. It is cheaper even if it’s not apples-to-apples. The money saved can be used on other priorities.

  15. Andy says

    TFB – I respectfully think that 20% savings for a 22-year old is simply unrealistic and unnecessary. If this guy keeps up that rate until he is 65 years old, he will have more than he needs to maintain his pre-retirement spending. But if he also gets a 401k match, he is saving way too much. Or if his employer also offers a cash value pension, he is saving way too much. Or if he will also qualify for social security, he is saving way too much.

    I am not advocating buying a house too soon, or buying more than you can afford. But I simply feel that 20% is too steep for anybody if they start at age 22….not to mention that it is so unrealistic that the advice will be counterproductive and turn off the 20-somethings to the recommendation. Then you have lost the war.

    Best wishes.

  16. Alison says

    @Andy

    How many people in their 20′s stay long enough to fully vested and get that 401k match? Should people really be counting on that? I consider that gravy since it often takes 4 years to fully vest. The goal percentage should not include that as a certainty and I’m not sure where you are working, but 5% fully vested as a match would be a niiiice benefit and still wouldn’t make contributions WAY too much.

    @TBD and @ Andy

    I think even having the discussion at whether to recommend 10% or 20% is good. You aren’t going to reach people who won’t even put money in to get the 401K match (in theory, if they stay for vesting). I wavered a lot about what percentage to contribute to my 401K this year. After getting a real job after graduate school my income is triple what it was (I got a research stipend in school so I don’t have student debt.) I have not changed my living situation to triple my spending, so I had some decisions to make.

    I originally set my retirement savings at 22%, felt nervous that I wasn’t saving enough for down payment and moved it to 10%. Now it’s 15% because 10% did seem to me too low. I’m 30 and I’ve currently got twice as much in retirement savings than out of it, but the ratio is slowly shifting to get to that down payment. It will take 1-3 years to get to 20% and I decided I’m ok with that.

    Regarding setting a percentage vs. one-time contributions, if I get to the end of the year and there is extra in my rainy day fund, I put that into retirement or possibly some into fun and some into retirement. That adjusts the per paycheck percentage down, but gives me some wiggle room with some money in a place where I can take it out this year if I decide I need it.

    I worked for a financial planner in high school so maybe I’m biased due to seeing a lot of people in their 50′s come in with hardly anything in savings and then want to retire early. I opened a Roth IRA when I was 19 and have been saving for retirement ever since via Roth or 401K when I’ve been in school vs employed.

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