Conventional wisdom says you should pay off your credit cards before saving for retirement. While it’s generally true you should pay off high-interest credit card debt as quickly as possible, there are a few situations where retirement savings should come first. Let’s look at the benefits of each approach.
Benefits of Paying Off Credit Cards First
Credit cards usually mean high-interest debt, and the longer you take to clear it, the more you’ll pay in interest. Here are some key reasons why you should pay off credit cards first:
- High-interest credit card debt can be hard to make a dent in. If you’re not making more than the minimum payment on your credit card, compounding interest means your balance will barely budge. Even if you never use the card again, you will end up making payments for a long time.
- If you’ve got credit card debt, your finances might be strained. High credit card debt is usually an indicator that you’re living above your means. You should get your spending and budget under control before investing in retirement.
- High-interest debt rates are usually higher than market returns. If your credit cards carry a 25 percent interest rate, but a retirement fund is likely to only earn about 8 percent per year in the market, that’s a whopping difference of 17 percent that you’d be missing out on by saving for retirement instead of paying down credit cards.
Benefits of Saving for Retirement While Paying Off Cards
Still, saving for retirement is critical, and there are several reasons why you might wish to do so even if it takes you longer to pay down high-interest cards. Among these are:
- 401(k)s and other retirement vehicles carry tax benefits. You can contribute to 401(k)s and certain other retirement plans using pre-tax dollars, thereby reducing your adjusted gross income and overall tax burden. This frees up extra cash for other purposes, such as credit card debt repayment.
- The earlier you start saving for retirement, the better. Delaying retirement savings means missing out on months or years of compound interest. The longer you wait, the more likely you’ll end up pinching pennies in your 50s as you try to catch up on retirement savings. Compounding interest allows even people who never make big salaries to end up with comfortable nest eggs—but only if they start saving early.
- Saving for retirement builds good financial habits. Socking money away for retirement is not only essential to your financial future, but it also helps you develop better money habits today. In doing so, you’ll learn how to budget better and address the sources of your debt. Plus, retirement accounts are usually difficult to raid (they often carry fees and penalties for early withdrawal). These extra hurdles discourage you from accessing this cash until you actually need it for retirement.
Special Situations May Help You Decide
Deciding whether to pay off credit cards or save for retirement first is a complex, personal issue. However, there are some special circumstances that suggest a clear direction:
- Your employer offers a 401(k) match. A retirement savings match is free money. Even if you have high-interest credit cards, save at least the minimum required to get your full employer match, or you’re leaving money on the table.
- Your credit cards have low interest rates. If you’re able to carry or transfer your credit card debt on low or zero percent APR cards, then it makes sense to save for retirement while paying these off, since your low interest rates mean debt won’t snowball quickly—assuming you’re not making new purchases that add to existing debt. (See: When to Do a Balance Transfer to Pay Off Credit Card Debt).
- You’re age 50 or older. If you’re 50 or older, savings are critical because you’re that much closer to retirement, and have less time to save or allow money to compound. Plus, savers 50 or older are allowed extra catch-up contributions to their retirement plans.
- You’re buying a house or applying for credit. If you’re applying for a mortgage or other forms of credit in the foreseeable future, you’ll want your credit card balances low, and your credit score as high as possible.
Paying off credit card debt and saving for retirement are both important financial goals. Often, they can even be achieved simultaneously. Regardless of which one you pick, commit today to setting aside extra cash each month to achieve your financial goal.
Janet Alvarez is the news anchor for WHYY/NPR and the Executive Editor of Wise Bread, an award-winning consumer education publication focused on helping consumers make smarter credit choices. Provided by http://www.americasavesweek.org