Real-life choices: Retirement savings vs. debt reduction

I’ve accumulated $3500 and I don’t know what to do with it.

As you may recall, I am carrying the remainder of my credit card debt in the form of a home-equity loan (or HELOC). The current balance on this debt is $15,000 and I’m paying a 9.25% finance charge. I intend to have this debt eliminated by March 2008. It’s an ambitious goal.

In order to make this happen, I’ve had to forego investing in my Roth IRA. I established this retirement account last spring, but only put $650 into it before focusing on the HELOC. Now I have the money to fully fund it, but don’t know whether to do so, or to continue attacking the debt aggressively. There’s a time-pressure to this decision: Roth IRA contributions for 2006 must be completed by April 17th.

On the surface, this seems like a no-brainer. By paying the $3500 toward the HELOC, I’d be saving $26.98 per month in finance charges. That’s a lot of money! But since I intend to have this debt repaid within a year anyhow, my maximum savings is only about $325. There are strong arguments for putting the money into my Roth IRA, despite the lack of a guaranteed return.

Here are the factors that weigh in my decision:

  • Once the funding deadline has passed, I can never put money into the 2006 IRA again.
  • If I fund the 2006 IRA, there’s no guarantee that I’ll have the money to fund an IRA for 2007.
  • If I put the money into the IRA, I will invest in an index fund.
  • By paying down the HELOC, I am earning 9.25% on my money, but it’s a one-year return. That is, after a year the HELOC will be gone and the returns will no longer compound.
  • Though funding the IRA may return less than 9.25% over the next year, the money will continue to compound over time.
  • If something goes wrong and my income declines, I will much rather have paid down my debt.
  • Debt reduction has a bigger psychological payoff than retirement savings. The debt is a burden.
  • In the long run, the IRA is the best choice with regard to taxes.
  • There’s an income ceiling to Roth IRA contributions. If a couple makes more than $160,000/year, they cannot contribute to them. We don’t make anything near $160,000 right now, but we may in the future. And if we do, we’ll no longer be able to add money to our Roth IRAs.

Which one will I choose? I’m going to fund the retirement plan.


I seem to have licked the Debt Monster. I stopped acquiring new debt long ago. Complete debt elimination is so close now that I can taste it. It’s a priority. Debt is no longer a psychological barrier for me, but saving for retirement is. When I think of how little I have saved, I panic. I must start saving, and funding my Roth for 2006 would be an awesome first step.

I moved the money into my retirement account last night. Now I need to decide which index fund(s) to purchase. I thought the decision would be easy. It’s not. Though my account only allows me to purchase exchange-traded funds, there are still dozens of options: QQQQ, SPY, IWM, EFA, VTI, TIP, etc. It’s like alphabet soup.

Note: This is the best choice for me and my circumstances. It’s not necessarily the best decision for everyone choosing between debt reduction and retirement savings. Do what works for you!

More about...Debt, Retirement

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