Roth or CC payoff? That is the Question

[Skylark]

I have $3000 ready to be transferred to a Roth account. This came from a dedicated savings stream of $400 a month.

Due to car repairs and general spending, I have $4000 in CC debt, with a stream of $500 a month dedicated to paying it off, and we are trying not to use the CC's. I think the CC finance charges are about $60 per month.

Off in the future, my house needs a new roof, that will cost between $5000 and $10,000, and I need to save for that. I hope to have the roof done next spring and pay cash, with help from home equity if necessary. Also I would like to adequately fund an emergency savings to use instead of CC's for things like car repairs, etc. that we need that are not covered in the monthly budget.

It is August, I still have 5 months to accumulate for the Roth.

Would you payoff the CC debt or put the money in a Roth?

 

[unclemick]

I'm a heretic - that ain't your money - it belongs to some mythical person (an ER) who will materialize in the future. "Time in the market, NOT market timing." Once a tax deferred year passes - it's gone - time and tide - yadda, yadda.

During our working years - maxed every tax deferred plan availible preferably auto deduct.

WHAT was left - was the paycheck. And yes - CC discpline was lost and recovered many a time along the way - vacations, car/house repairs, etc.

That 'pay yourself first' always ticked me off - mainly because if I let myself think it was mine - being in New Orleans - Bon Temps Rollere - let the good times roll!

 

[BigMoneyJim]

I believe you can buy into a 2004 IRA through April 2005, can't you?

Other than that, my first impulse was to say pay down the CC, but I just came off a 3-year crusade (2 years of my 5 were just "effort", not "crusade") against CC debt so I may not be objective.

 

[mickeyd]

I would pay $3K to the CC debt. The next $1000 also goes to wipe all of the CC debt out. Then start building up your much-needed emergency fund since you clearly will be needing it. If you need to charge stuff in the future you can always go back to the CC.

 

[charlie]

Hi Skylark,

At $60/mo it looks like you are paying about 18%
interest on your $4000 debt. Pay it off as fast as
you can then build up your emergency fund to about
6 mo of living expenses. While doing all this, max
out your 401k if not already doing so. Then you
should fund the ROTH with anything left over. I
agree with unclemick in principle, but you need to
build the foundation first.

Cheers,

Charlie

 

[azanon]

Pay off CC debt before retirement accounts, then put together a short-term savings fund for irregular expenses (say 5-10K dollars if you bring in 100K/year).  I dont recommend the often quoted 3-6 months living expenses, cause for me (who's just middle class), that'd be 20-30K dollars.  

A lot of people forget that money placed in Roth funds cant be withdrawn without penality for any reason because the money has already been taxed; perhaps the best benefit of all of Roths.  Only the interest cannot be withdrawn except for qualifying reasons.

* The only exception to what i said in paragraph 1 would be if you have a company 401(k) plan or similar that matches dollar for dollar; which is effectively 100% return on your money immediately. Or heck, even 1 for 2 (50%). Either is much better than even an erosion of 18% on a credit card.

 

[bongo2]

If you have $900 to invest every month (including what you are using to pay down your CC), then you should be able to both pay off the CC in short order, and fund your tax advantaged accounts (assuming you are already fully funding your 401k, if available). In this case you will be slightly better off if you pay off the CC first and then fund the Roth, but the difference in your wealth 20 years from now will likely be small.

The more important thing is what will work for you psychologically over the long term. Is it important for you to have all your credit cards paid off and never use them again like BigMoneyJim, or is it important to you to be always working towards a retirement fund like unclemick? Which plan will you actually stick with? If you will fall back into debt periodically, then you should follow the unclemick plan. If the dicipline of never using credit will allow you to better control your spending, then pay off the debt. Either way, don't worry about it. It is more important to be moving in the right direction then to pick the absolute most efficient path. And who's to say that the market won't go up or down 20% in the next two months making that Roth decision a big win, or a big loss? You can't know, so don't worry about making the wrong choice.

 

[Beachbumz]

Both Unclemick and BigMoneyJim are correct. Once you don't fund your Roth for 2004 you never get that chance again, however it appears that you have enough time to pay off your credit card and save the additional funds for the Roth by the April 15, 2005 deadline. That is your best bet.

You definately need an emergency fund as well, but if you had to, you can withdraw your contributions to the Roth without penalty anytime, so these funds are not out of your reach in an emergency. (Of course the value could have dropped below your original contribution amount.)

 

[Skylark]

Thanks for the replies, I appreciate the thoughts on this little dilemma.

I want to get money into my Roth account, no compromises!

I want to pay off the CC's as soon as possible, no compromises!

Resources are limited. Solomon raises his sword.

Here is my current position:

Put the money into the Roth account. Take the $400/month stream that was going to the Roth fund, and put $250 toward CC payoff, $100 toward emergency savings, and $50 toward monthly consumption.

This rationale is based on suspicions that my future self will find more things to spend money on and the Roth might never get funded. It would be more efficient to pay off the CC's but I would rather shelter the $3000 in an account which I cannot easily raid.

Thus preventing behavioral weakness is a more important factor than economic efficiency in my case.

So it is written. So shall it be done.

 

[BigMoneyJim]

Thus preventing behavioral weakness is a more important factor than economic efficiency in my case.

Very very well put. I wanted to say that but couldn't find the words to fit it in less that three pages of typing. I think that's what bongo2 was driving at, too. You summed it up well. I think this is a very important factor for all financial planning.

My recent debt reduction would've been more economically efficient if I had paid more towards 401(k) and less towards debt reduction (tax paid vs. interest paid over payoff period, not to mention opportunity cost of tax-deferred earnings), but I've never doubted for my behavior and psychology paying off the CC's ASAP was the best thing.