Credit Card Debt and a Roth IRA

Posted by: Sophie H. | Jan 07,2008


I’ve written here before about what to do when you’ve got some extra spending money at the end of every month.  Should you pay down your credit debt so that you don’t have to incur interest down the line during retirement, or should you put that money towards a 401(k) plan.  It’s pretty hard to argue with a 100% matching fund on a 401(k) plan.  This will outpace what you lose to interest on credit card interest.  

What about a Roth IRA?  A Roth IRA is trickier because the interest rate on an IRA may not be very high.  You could have a 15% APR on your credit card and an 8% return on your IRA account.  Say that you have an extra $200 to add to a Roth IRA or a credit card bill.  It will take you around five years to pay off a $15,000 paying $200, give or take – in short it’s a long-term prospect.  In that amount of time, adding $200 to your Roth IRA, you could net over $20,000.  In that amount of time you’ve cut your credit card bill while also adding capital to your retirement account.  It appears to be win-win, even if it took longer to pay off your credit card bill.  

However, let’s look at the alternative.  You pay all that money towards your credit card bill ($300 extra over the $200 you’re normally paying).  The result is that you could get of debt faster, bringing your balance to zero, and from that point onward you could put the money towards your Roth IRA account.  Basically it comes down to your credit card interest being higher than the interest on your IRA.  You stand to make money paying off high-interest credit debt first.  

My recommendation is that you do both: pay off high interest credit card debt AND invest in a Roth IRA.  Five years down the line, you’ll be very happy that you’ve put at least something into your retirement account.  You’re still going to be using your credit cards every year, so you could be carrying a balance for years to come, even well past the day of retirement.  So waiting to be entirely debt free is not entirely realistic.  You also can’t be sure that your income is going to stay at the exact same level, so you want to have the safety net of a retirement account built up very early on.  

The answer: be aggressive about paying off credit card debt but don’t totally ignore a Roth IRA account either.  

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