We received a great listener question we thought many of our listeners and readers could relate to: should I use my retirement savings to pay off my credit cards? The following question has been edited into a Q&A format and some details have been changed to keep the listener’s information anonymous. Let us know what you think in the comments below, or if you have a question that needs answering, visit the home page and click the ASK P&B button!
Q1: Do y’all have a specific episode where you talk about balancing current debt versus long term savings (e.g., credit card debt versus retirement)?
A1: Unless you’re currently living paycheck-to-paycheck or circumstances are immediately dire, I prioritize retirement savings before credit debt payments. For example, if I have 20% to save, I would allocate it in this manner: 10% for retirement; 5% for emergencies and 5% for debt. If I want to pay down my debt first or already having an emergency fund, I would save at least 10% for retirement and 10% for debt but I always put something towards retirement, and I do it first.
I speak about this in more detail on my website at DebtFreeOrDieTrying.com/Budget. In short, you will always retire. Debt payments are more immediate. In other words, you have your entire life to pay off debt; whereas, you only have your entire working years your life to save for retirement. Assuming you don’t work until death does you part, your working years will be shorter than your lifespan (we hope). Additionally, since many IRA accounts can be funded pre-tax, you maximize your money by putting money towards retirement in a pre-tax account and using your net income (take home pay) to pay down debt.
Q2: Was thinking of using $15K as a bailout on my credit cards and rolling the $5K in an IRA. Thoughts? At 29, I’m more concerned about current financial health (e.g., credit score and short term savings) than generational wealth and long term savings. The amount of student loans I’m looking at doesn’t make me value the 20K in retirement much.
A2: I’m going to disagree for a few different reasons or, at a minimum, please take the following into consideration before deciding to withdraw your IRA.
Consideration #1: To early withdraw your IRA you have to pay a tax penalty. Consult with a CPA or research the penalty you’ll pay for the tax year withdrawn. The holder of your IRA should be able to speak to this in exact detail as well. The main point is that you will be giving your own money away by paying a penalty fee, which means you won’t net the entire $15,000, or you’ll have to withdraw a higher amount to both cover the penalty and net $15,000. I never like giving my hard earned money away, especially to fees.
Consideration #2: I’ll be honest, I’m not a fan of option #2, but I want you to beware of all the options available to you. Instead of withdrawing your IRA as income, consider a personal IRA loan (often called a 401k loan). In this scenario, if the option exists through your employer or IRA-holder, you loan yourself $15,000 against your IRA. These loans are usually low-interest and while you’ll lose out on some compound interest during the payback period, at least you will replenish your IRA. Essentially, you will be paying yourself versus a lender or bank.
Why All This Matters
You don’t want to make an immediate decision to get through this year that may haunt you for the next 10, 20, 30 years. Let’s say you have approximately $20,000 in current retirement savings. Even if you didn’t add another penny and it grew at a conservative rate of 5% over the next 30 years, it would be worth about $86,000 after 30 years (not adjusted for inflation) thanks to compound interest. I recommend using a few ‘retirement savings’ calculators to better estimate the impact of a withdrawal today on your income in 30-years (retirement). Lastly, we shared an article from Business Insider in our weekly newsletter that shows the impact of compound interest, These 3 Charts Show The Amazing Power Of Compound Interest.
Marcus Garrett is one-half of the Paychecks and Balances podcast, an auditor, and author of Debt Free or Die Trying: How I Buried Myself in Over $30,000 in Debt and Dug My Way Out By Age 30. You can follow him on Twitter @PayBalances and Facebook: PaychecksAndBalances.