Paying Off Credit Card Debt Vs. Funding Your 401k
Posted by: Staff Writer | Jul 21,2007
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Everyone always makes a giant fuss over saving for retirement. You have to wonder if it's more important than paying off credit card bills. You've heard those statistics touting the great big fortune you'll be worth in your old age if you sock away money today. Saving for the future is a solid idea.
However, let's look at the real numbers and see if it ever makes sense to delay paying off credit card debt in favor of feeding the 401k.
Interest Paid is Money EarnedFirst, take a look at what your interest rate is on your credit card. If it's somewhere around 15 percent that would be average for most Americans. This means that paying off your credit card bill is equal to earning a 15 percent return. That's a pretty hard return to match in the investment market. In fact, most 401ks average about an 8 percent return.
Of course, the other side of the argument is that employers match the money you deposit into a 401k, which is an immediate 50 percent return on your money. That sees pretty good until you realize that the credit card interest is on-going - it happens every month - while the retirement money only happens one single time.
Paying Off Debt and Contributing SimultaneouslyThe next thing to consider is whether it pays to try to both at the same time, that is to pay off the credit card while you're funding the 401k. Once again, the answer is that it's better to take care of your credit card first. Here's why.
If you're splitting the money you have available each month to either pay off your credit card or invest, then the half you are sending to credit card company is going to compound interest for twice the amount of time (since you're paying half it will take you twice as long to pay off the debt). Ultimately, you will come out behind.
Even Considering Pre-Tax DollarsThe last argument in this battle has to do with the fact that the money put into 401ks goes in before taxes. This means that it takes more cash earned to pay off a credit card debt than it does to contribute to a 401k. However, even considering these numbers, if you do the math you'll see you still come out ahead by paying off your credit card debt first.
Credit Card Debt WinsCredit card debt ends up costing consumers more of their income than most people realize. The benefits of paying off this debt even outweigh contributing to your retirement, which is also important. However, all of this argument is moot if you pay off your credit debt just to run back up again.
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