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!