Welcome to Ask Lacey, an advice column in which accredited financial counselor and MilMo founder Lacey Langford answers your pressing financial questions. Have a question for Lacey? Submit it here.
Dear Lacey: I have $19,000 in credit-card debt with a 20% interest rate but want to contribute to an IRA. I haven’t started saving for my retirement yet. Should I pay off my credit card before I start putting money in my IRA? Or should I invest and make minimum payments on my credit card?
In this situation, paying off debt should be your top priority. With a 20% interest rate, even if you have a positive return in your Individual Retirement Account (IRA), it probably won’t beat the 20% you’re being charged. Look at it this way: If you invest in an index fund earning 6% on average but are charged 20% in credit-card interest, you’re still losing 14%. You’d have to earn more than 20% on your investment to come out ahead of your credit-card interest, which isn’t likely without significant risk. That’s why it’s usually better to eliminate your debt, or at least reduce it, before investing in long-term savings such as your IRA.
That said, there’s more to this decision than just math. Sometimes, peace of mind outweighs the numbers. Money can be emotional. It’s scary not to have anything saved for your future, especially if you feel you’re already behind. To reduce your anxiety, you can put most of your extra cash toward paying down debt and a small portion toward your retirement savings -- something like an 80/20 split. It’s a hybrid approach. If you have an extra $300 monthly, $240 can be paid extra on your credit card, and $60 can be invested in your IRA. By doing it this way, you’re addressing your financial challenge of high-interest, credit-card debt while still taking small steps toward your long-term savings.
Something else to consider is the opportunity cost of waiting to invest. The earlier you start contributing to a retirement account, the more time your investments have to grow, thanks to the power of compound interest. Even small contributions now can make a big difference over decades. For example, if you invest just $50 per month and earn a 6% annual return, you could have more than $23,000 after 20 years. If you save $50 monthly for 30 years, you will have in excess of $50,000! That’s why it’s a little bit of a compromise to start with even small retirement contributions while tackling your debt.
At the same time, paying off your debt quickly will free up more money for your future self. Currently, you’re earning and saving money for two people -- for yourself and your 80-year-old self. If you’re not spending less than you make and investing for the future, you will not have the quality of life you want when you’re 80. So you are right to want to start saving money in a tax-advantaged retirement account, such as the Thrift Savings Plan (TSP), a 401(k) or an IRA for your future self. Focusing on paying off debt first will help you reach the goal of saving in an IRA sooner. Focusing on eliminating high-interest debt is a critical step that, once you complete, will allow you to shift your energy and resources to building wealth and securing a comfortable future.
To maximize your progress, consider reviewing your budget. Budgeting isn’t everyone’s favorite thing, but knowing how much of your money is coming in and out each month can cut unnecessary expenses to free up more cash to pay down debt and build retirement savings. You can also look into ways to lower your interest rate, such as transferring the balance of your high-interest-rate credit card to a card with a 0% introductory APR. Or if you’ve been paying your bills on time, call your credit-card company and ask them to reduce your interest. It doesn’t hurt to try. Trying these two things alone can save you money on interest and help you pay off your debt faster.
Most importantly, the best approach to paying down debt and saving for retirement is one that aligns with your financial goals and gives you peace of mind. When you prioritize debt repayment while making small, consistent contributions to your retirement, you can address your current challenges without neglecting your 80-year-old self. This balancing approach of working on both simultaneously sets a good foundation for long-term financial health and peace of mind.
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