Do I have to contribute to my 401(k) or pay off my credit card debt?

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It’s been more than a decade since the Great Recession swept the country, but according to a survey by Allianz Life Insurance Co. Many of the 2,000 Baby Boomers and Generation Xers surveyed also said they were less confident in their ability to achieve financial security. This has only been exacerbated by the coronavirus pandemic and its effect on unemployment in the US

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For employees who have credit card debt, which is more likely to lead to a secure future: deducing what their retirement contribution would have been and instead pay off that debt or pay their 401(k) plan a priority? Here are some pros and cons associated with each of these money moves.

The benefits of paying off credit card debt first

  • It often eliminates high and non-tax-deductible credit card interest rates.

  • Bringing your credit card balance to zero will improve your credit score, which will help you get a lower interest rate if you’re in the market to buy or refinance a home. Your credit score can also be a factor when applying for a job or buying car insurance.

  • It will free up money for saving, investing and building wealth.

Related: 11 Steps to Paying Off Credit Card Debt in 2021

and the disadvantages

  • It will divert money away from your retirement savings goals and perhaps prepare you for a frugal lifestyle when you retire.

  • It will deprive you of the tax deductions you would receive from your 401k contribution if you paid your debt first.

  • Taking money away from your 401(k) plan to pay off credit card debt could result in you missing out on your company’s matching contributions.

The benefits of contributing to your 401(k) first

  • You are going to build a retirement nest. Younger workers have the gift of time when it comes to their ability to accumulate wealth. Not taking advantage of that time horizon is a missed opportunity that you will never get back.

  • You will receive a company match on your contributions, which is free money and an immediate return on your deferral.

  • Money contributed to a 401(k) is done on a pre-tax basis, saving you money on tax time.

  • The money is put in your retirement savings and out of reach for unnecessary expenses.

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and the disadvantages

  • Money not used to pay off credit card debt will leave you paying high credit card interest rates that last much longer.

  • The interest on your credit card is likely higher than the return on your 401(k). So your credit card interest may be 15%, but it is likely that the return on your portfolio will be well below that.

  • Carrying high credit card debt reduces your financial security. Taking money away from paying off these cards will slow your way to financial freedom.

Katie Brewer, Certified Financial Planner and President of Your richest life plan, a virtual financial planning firm for Gen X and Gen Y, said it was best if people could pay off debt while building their wealth. She said people might consider cutting their expenses by, for example, eliminating monthly cable or subscriptions and taking on temporary work to gain more income.

“Once you start making room in your budget, make sure you contribute (enough) to at least get the match on your 401(k),” she said. “If you contribute more than match to your 401(k) plan and you are working on credit card debt, consider temporarily lowering your 401(k) contribution to allow for more at-home credit card payout. (k) contribution, make sure to put a reminder in your calendar to adjust it again.”

Pay attention: 16 Important Signs You Will Always Have Debt

Jeff Rose, a certified financial planner and founder of Alliance Wealth Management, is also the author of the Good financial cents website. He said there are lessons to be learned when employees contribute to their retirement plan. So they are not allowed to pay off credit card debt at the expense of saving for retirement.

“They should do both, even if it just puts the minimum amount in their 401(k),” he said. “In this way, they become familiar with their 401(k) and how the markets work. It may not be much for their retirement, but it will be a valuable lesson in understanding how to read a 401(k) statement and a good introduction to mutual funds.”

Strategies to Eliminate Credit Card Debt

  • Limit your expenses. What you save by cutting costs can be used to reduce your credit card debt.

  • Consolidate high-interest credit card debt on a lower-interest card through a balance transfer.

  • Find a reputable credit consulting firm to get help with your spending.

You can’t become a 401(k) millionaire if you don’t contribute to your plan. According to Fidelity Investments, approximately 72,000 participants in their plans had balances of $1 million or more at the end of 2014. What was the common thread between them? They faithfully contributed a significant portion of their salary to their 401(k).

If you have a large credit card debt, come up with a plan to pay it off. Keep your expenses under control. Contribute as much as you can to your 401(k). Put your financial security first.

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Last updated: July 21, 2021

This article originally appeared on Do I have to contribute to my 401(k) or pay off my credit card debt?

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