Credit card debt

We Do the Math: Save for Retirement or Pay Off Credit Card Debt?

Should you save for retirement or pay off credit card debt? If you’re carrying a card balance, you may be wrestling with whether to put all your resources into attacking the debt, or start building your retirement nest egg while you slowly pay off debt.

Which one will give you a better net worth? There’s no simple answer. For some people the situation may warrant clearing credit card debt first; for others, it’s better to start investing right away. To figure out which scenario is better in a given situation, we’ll need to do some math. Don’t worry, we’ll show you how to do it in a few easy steps.

Step 1: Gather important numbers about your debt and your retirement plan

First, look through your credit card statements and accompanying information to pull up the following numbers:

  • Credit card debt. You’ll find this on the front of your credit card statement.
  • Credit card interest rate, or APR (Annual Percentage Rate). You’ll find this further down on your statement, in a section labeled “Interest Charged” or something similar.
  • Minimum payment. You’ll find this in your card’s terms and conditions, under a discussion about how minimum payments are calculated. It will probably be a percentage, but there may also be a flat sum.

Next, consider any retirement plan you are enrolled in or have available. What is the average annual return? You can identify past returns by reviewing your retirement account statements. For example, your 401(k) plan account may list your annual return. Note that past returns don’t guarantee or predict future returns, but we’ll use the average annual return as a proxy for future returns in this case, knowing that if our portfolio takes a long-term downward turn, our calculations will change.

Finally, how much extra do you have in your monthly budget that you could put toward credit card payments, retirement investments, or both?

Follow along as we consider a hypothetical debt situation and retirement opportunity. Let’s say there’s $500 in our monthly budget, which equals $6,000 annually ($500 x 12 months = $6,000) to put toward debt or retirement.

Currently, the balance on our credit card is $5,000. Our APR is 22%. Our minimum monthly payment is 3% of our outstanding balance or $25, whichever is greater.

Our employer offers a 401(k) plan. For the sake of keeping this illustration simple, we’ll say our employer doesn’t match employee contributions and we choose to make taxable contributions with a Roth designated account within the 401(k).

In reality, you might choose instead to make tax-deductible contributions to a traditional retirement account. With a Roth 401(k) there are no immediate tax benefits, which makes our calculations simpler and therefore better suited for this purpose.

We’ll say the default investment in our 401(k) is a target-date mutual fund with an average annual return of 6.3% since its inception. We know that future performance is unpredictable. But to run the numbers for the retirement vs. debt decision, we’ll apply an annual return of 6% to our retirement account.

We’ll look at the retirement account and credit card balance after five years to compare the two choices: 1) making minimum payments on our card balance so we can start investing right away, or 2) putting all our extra money toward our credit card debt before we consider retirement investing.

In both scenarios, we’ll assume that we won’t make additional charges on our credit card. In addition, we’ll contribute to our retirement account when we have money available to invest.

Step 2: Calculate net worth if you prioritize retirement savings over paying off credit card debt quickly

In this scenario, we’ll see what happens if we only make minimum payments on our credit card so that we can get started investing for retirement right away. Your credit card statement should state very clearly how long it will take to pay off your balance if you make minimum payments.

You can also find an online calculator to help you with these calculations. Here’s the information we’ll enter for our example (you can put in your own numbers from your real-life situation):

  • Current credit card balance: $5,000
  • Annual percentage rate: 22%
  • Proposed additional monthly payment: $0

Who Pays When Loved Ones Leave Debt Behind?

Losing a loved one — a parent, spouse, or sibling — is difficult enough. But what if your loved one left mortgage, auto loan, or credit card debt behind? Will you now be responsible for paying those bills?

In most cases, no. Creditors can’t force you to cover the unpaid debts of loved ones who have died. But the money that your loved ones owed might cut into or even eliminate any inheritance that was meant for you or other survivors.

What usually happens

When people die, the money they owe creditors — everyone from their mortgage lender, to their auto loan providers, to their credit card companies — is collected from their estate. The estate in this case is defined as the money and assets owned solely by the deceased.

This might mean that the house your parents owned has to be sold to pay off any mortgage debt they owed. Their car might have to be sold to pay off credit card or other debts.

Whatever is left after these debts are paid off remains in the estate of the deceased. If your parents wanted to leave money behind for their children and grandchildren, the amount they wanted to bestow will be reduced by however much they owed creditors at the time of their death.

It can get more complicated

Of course, that’s the most basic course of action. In reality, money matters can get more complicated after the death of a loved one.

This is especially true when you lose a spouse. In most states, you won’t be responsible for any debt that your spouse left behind when he or she died, as long as the debt was accrued in your spouse’s name alone. If both you and your spouse share a credit card or a mortgage, then you will be responsible for making payments on that debt after your spouse dies.

If you live in what is known…