Author Topic: IRA vs credit card debt  (Read 1316 times)

Cowspot28

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IRA vs credit card debt
« on: November 05, 2016, 01:55:58 PM »
Hello,

My MIL age 52 has abt $22,000 in credit card debt with interest rates from 0-25%. She has also been investing in an IRA (not sure if traditional or Roth). She makes abt $60,000/year single filer. She has asked for assistance with a financial plan. My thought is that there is no situation where investing in the IRA is better than paying off the debt at those high interest rates, correct? Would it make sense to withdraw the amount she has already contributed this year to pay off debt or to withdraw the contributions if she does have a Roth and the money has been in the account for 5 years? I don't think it would make sense to withdraw if traditional due to having to pay taxes+ penalty. I just wasn't sure if this is the best plan since she will lose out on the tax benefits of the IRA this year if she does this. She is also working on a budget and lowering expenses overall, but I don't think she understands the impact of such a high interest rate. Thanks for your help.

Grizzly Dad

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Re: IRA vs credit card debt
« Reply #1 on: November 05, 2016, 02:16:56 PM »
Very much depends on the rates on the credit card debt to do the complete math. For now, I'll assume the rates are in the 20% range and work from there.

1. Payoff vs. Additional - At your mother's tax bracket and at 20% rates paying off the debt is almost certainly better than putting money into an IRA. A 20% guaranteed return is going to trump just about anything.

2. ROTH - Definitely better to pay off the debt than to keep after tax money tied up. No question about where the better return is.

3. Pull money out of traditional - with the additional 10% penalty this starts to become a tougher call. I would leave it in.

However, I'll add one big caveat to all of this. None of this will matter if she ends up right back in the same place a year from now. Then she will have liquidated here investments but then also be stuck with another CC bill she has no ability to pay. Pulling money out is a smart decision only if you know you're on a sustainable path going forward. If your mother is not and will only end up with more unpayable debt in a few years all this advice is somewhat moot.

frugaliknowit

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Re: IRA vs credit card debt
« Reply #2 on: November 05, 2016, 02:41:53 PM »
Very much depends on the rates on the credit card debt to do the complete math. For now, I'll assume the rates are in the 20% range and work from there.

1. Payoff vs. Additional - At your mother's tax bracket and at 20% rates paying off the debt is almost certainly better than putting money into an IRA. A 20% guaranteed return is going to trump just about anything.

2. ROTH - Definitely better to pay off the debt than to keep after tax money tied up. No question about where the better return is.

3. Pull money out of traditional - with the additional 10% penalty this starts to become a tougher call. I would leave it in.

However, I'll add one big caveat to all of this. None of this will matter if she ends up right back in the same place a year from now. Then she will have liquidated here investments but then also be stuck with another CC bill she has no ability to pay. Pulling money out is a smart decision only if you know you're on a sustainable path going forward. If your mother is not and will only end up with more unpayable debt in a few years all this advice is somewhat moot.

+1 And:  In the event she spends an EXTREMELY low percentage of her take home pay, she might be able to simultaneously paydown the debt AND fund an IRA, or better yet kill the debt first (so interest accrual stops), then start funding the IRA.  Not likely.  Do you know her budget/spend ratio?

Frankies Girl

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Re: IRA vs credit card debt
« Reply #3 on: November 05, 2016, 02:45:55 PM »
Totally my opinion:

Any debt over 10% should hit hard and is the equivalent of hair on fire debt - this is horrible and should be eliminated ASAP and prioritized over anything other than bare bones living expenses. So if it was me, I'd stop investing and pay every penny towards the over 10% debts, then likely ease back once I was down to the 10% and under debts to start adding back a small amount towards investments.

If she's maxed her IRA, but has 20% cc debts...(and some of the more savvy investor/numbers folks correct me if I've said anything wrong) I just don't know that I would pull that money back out, even though logically it might make the most sense, because you can't get that back in there once it's gone (which is what bothers me personally). But in her case, if she's got the money in there as a Roth to pay off all of the 10% and above debts I think it may be the best move. NOTE: if it is a traditional IRA (and it probably should be ?) then taking any money out now would be at a 10% penalty (and same for taking growth out of the Roth - Roth contributions can come out penalty free, but not the growth part without paying) - so that would then be a big NO to removing any money from there.

An IRA max per year is $5,500 and with her income she technically should have been able to max it no problems and still pay off her debt unless she's in a high cost of living area, but in that case she's still spending much more than she can afford if she's wracked up over a third of her yearly salary on CC debt.

The big deal after paying all this off is making she she never gets back into this situation again. You can help her now, but unless she's willing to really change everything about how she spends and saves, she's destined to end up in the same shape again. She needs also to really get a handle on how to budget and stop spending money she doesn't have.

Good luck!
« Last Edit: November 05, 2016, 05:21:29 PM by Frankies Girl »