Many Americans face a perplexing financial dilemma - managing an average credit card debt of over $7,300 while also trying to contribute to a 401(k) retirement plan. About two-thirds of Americans admit that this debt dilemma obstructs major life decisions.
One approach is to prioritize clearing credit card debt by reducing or stopping 401(k) contributions. However, this strategy may cause you to lose out on your employer's contribution matches and other long-term growth opportunities offered by the retirement plan.
If your employer provides a 401(k) match, maintaining retirement contributions is usually the more prudent choice in the long term. Early careerists especially benefit from the compounding effect of invested retirement funds. Conversely, continuously holding high-interest credit card debt could become increasingly costly.
To illustrate, consider a scenario where your employer matches 401(k) contributions up to the value of $3,000 per year. This value significantly tops the roughly $1,700 annual interest payable on an average credit card debt of $7,500. Should you redirect $250 monthly from your matched 401(k) contributions towards your credit card debt payment, you may lose approximately $110,000 in compounded gains over thirty years.
Things get complicated if your employer doesn’t offer any 401(k) matching. In this situation, you’re stuck deciding between a credit card debt accumulating 20% interest and a self-funded 401(k) growing by potentially 6.5% per year. Although it may seem beneficial to pay off the high-interest debt first, this decision doesn't factor in the compounding effect of your retirement investments.
Credit card interest can be harsh, hence paying off balances is a smart move. But that doesn't necessarily mean withdrawing from your retirement fund. It might be a better idea to find other ways to pay off card debt.
Another possibility is to split your contributions equally between debt payment and retirement savings. However, this strategy might work against your long-term financial goals, especially if your employer matches 401(k) contributions.
Clearing your credit card debt can better your credit score, provide emotional relief, and potentially free up cash for future savings and investments. So, it’s essential to evaluate your options carefully and make informed decisions about balancing debt payments and 401(k) contributions.