I love to interact with my readers/subscribers. So don’t hesitate to send in a question and ask me to post about it. Personal Finance Resources is all about helping you with your home finance situations. In this post, we are going to address a few questions posed by one of you, on the topic of Retirement Savings vs Paying Down Your Debt. Here is the email communication:
“I happened to stumble upon your extremely valuable info while researching methods to pay off my credit cards. Don’t know if you’ll have time to answer my question, but here goes: I’m 28, have $20,000 cc debt (@ ~15%), and approx $50,000 in a Traditional IRA and Roth IRA accounts. Do I take the penalty and pay off the CC? I no longer have any need for CC now that I’m out of school, so I’m not worried about this situation reoccurring. Problem is, that compound interest down the road is just so tasty! I figure the future money to be gained is greater than the cc debt with interest, but I need to repair my 611 credit score so i can at least think about buying a house and getting a business loan within a reasonable period of time. Any suggestions?
I’ve been thinking about this one for some time now and your help is greatly appreciated. I am working and will be in the 25%, possibly 28% tax bracket, and have been paying $400 to $500 a month in credit card payments. I’m not sure what my penalties for early withdrawal would be, but if I can invest those $400/month into my accounts instead of losing it to the credit card companies, I think I will be able to compensate for the loss. As it stands now, I have not been able to, nor will be able to put any new funds towards my investments with these current credit card payments. What would be my total withdrawal (including penalties) if I were to pay off the credit cards completely, or would it be wiser to pay off 75% of the credit card debt and continue to pay smaller credit card payments while adding small amounts to my retirement funds? I figure there is a good cost/benefit ratio, but my extreme desire to purge myself of the credit card parasites has clouded my reasonable judgment. “
The first, and from what I can deduce as the most important question posed here is whether or not to take a tax penalty and pay off the credit cards. If you read my post on Credit Card Secured by Roth IRA, you will notice that in addition to paying income tax on an IRA withdrawal, you will also likely be penalized with an additional 10% tax. So in this case, the total tax on a withdrawal might be as high as 38%. So, to be able to pay off the $20,000 owed to credit cards, a withdrawal of between $30,000 – $33,000 would have to be made. That would be the better part of the IRA account held.
The positive side of this equation is that the $400-500 a month spent in credit cards could be put into the retirement fund as an investment for the future. But it would take at least 4-5 years to replenish the money withdrawn from the retirement account.
The simple fact of the matter is, we need to put our money where it will earn us the most (or cost us the least). If it were not for the serious tax implication of early retirement withdrawal, it may be better to pay off the credit cards, depending on how great your return is on your investments. If it is less than the 15% being spent on credit card interest, than it would make sense.
The Personal Finance Resources Solution(s)
If possible, I would attempt to work out a secured or unsecured loan with my bank at a lower rate of interest. Try to get it down to 10% or less. If you had a house, this would be an excellent situation to use a Home Equity Line of Credit. If you are unable to obtain a consolidation loan, then use the debt stacking method to maximize your payments over the offending credit cards. Then I would stop any contributions to my retirement account, stop going out to eat, cut the cable TV off for several months, and put the maximum amount of money possible into paying off the debt.
With regard to repairing your credit score (611 should be enough to obtain an FHA loan for a house, by the way), credit card companies are mostly interested in a continuous stream of punctual payments. So paying off the cards now would help your credit score, but long term, you will build your credit better if you make some payments. I am not saying to make minimum payments, but make several months of large (as large as you can) payments to increase your credit score while getting the balance down.
I hope this solution was helpful. Consider signing up for my RSS feed so that you don’t miss out on any of the upcoming personal finance issues and solutions.
There are quite a few adverse effects of cheap insurance. They might be a temporary debt help, but what is the use of such help that will in turn contribute to more debt piling. This consequently contributes to public debt. Turning to such resort is a common occurrence amongst people who work at home. True, that there are edges to best work at home, but ones oft left ignorant.