This Not That: Credit Card Debt vs. 401(k)

If someone asked you what you would do with unlimited money, you might say: Buy a house; buy every item I've been hoarding in my online shopping cart; buy two houses; make a huge donation to the cause dearest to my heart.

You might also answer: Pay off my student loans, car note, save a bunch of money, and have a really nice dinner at least once a month.

If you don't have a ton of money, your biggest concern likely isn't choosing between an international vacation and a series of caviar facials; simply prioritizing needs can be a struggle. Financial dilemmas are a dime a dozen in most people's lives. To help, we'll be tackling issues people often have to choose between in our new series This Not That. Here's how to navigate one of the tricker money issues: aggressively paying down credit card debt, or aggressively saving for retirement.

According to Transamerica, an insurance services and investment firm, the median retirement savings balance among working women is $34,000; and only 12% of working women are "very confident" about their ability to retire comfortably.

Women typically live longer than men, making financial security a more pressing issue for them, but disparities in pay and investing make closing the "gender retirement gap" hard. TIAA finds that women may need to save twice as much as men do to get the same results. That's can be a serious issue for those who are dealing with significant credit card debt.

"Americans had $1.03 trillion in outstanding revolving credit in April 2018, so it's not surprising that this is a question we hear a lot. People are struggling with how to allocate their money in order to achieve both short-term and long-term financial goals," says Jessie Doll, a CFP and TIAA wealth management advisor.

The answer to this depends on your budget. Doll says you need to look at your debt and come up with a plan if you have debt payments (including mortgage, car loan or lease, credit card balances, and other debt) that are more than 35% of your gross income; if you pay your monthly bills late on a regular basis; can only make the minimum payment on your credit card bills; have maxed out your credit cards; have recently been denied credit; and are paying double-digit interest on your debt.

"If your credit card debt has already spiraled to a level you cannot manage, you may need to turn to others for help," Doll adds. "One avenue of help is the National Foundation for Credit Counseling, which provides financial counseling and education to consumers."

Shannon McLay, the founder of The Financial Gym, agrees with Doll. "I've seen too many clients prioritize their 401(k) contributions only to be stressed out from lack of cash or high-interest rate credit card balances that won’t go away," she says. If you have student loan or credit card debt with interest rates over 9%, she advises that you prioritize debt repayment, instead of saving for retirement. "On average, you can expect your retirement portfolio to earn 6% to 8% in investment returns, but if you're paying more than that in interest rates on your debt, then it's not the most efficient use of your money."

If your debt isn't as dire but still takes up more mental and financial resources than you're okay with, comb through your monthly spending. You may decide to cut back on discretionary areas or re-adjust how you divide things up.

Doll says that "saving for retirement when you are young only takes a small amount of money, thanks to the power of compounding interest," where the earnings on your savings are reinvested to generate their own earnings, which also get reinvested to create more earnings, and so on, she explains. She gives the hypothetical example:

Kate and Sarah are each saving $30,000 over 20 years — $1,000 annually (roughly $83/month) for the first 10 years and $2,000 annually (roughly $127/month) for the second 10 years. Each achieves a 6% annual investment return.

Kate starts saving at age 25 and stops at 44. Sarah starts at 45 and stops at 64. Although Kate and Sarah both save the same total amount and earn a 6% return on their savings, Kate ends up with over $110,000 more in retirement savings than Sarah because her money enjoys up to 40 years of growth from compounding, compared to up to 20 years for Sarah's money.

"Since Sarah starts saving later, she would need to save more than three times as much money as Kate to end up with the same size nest egg as her at age 65," Doll says. Perhaps you can't save $80 a month, but if you can make even $20 happen, that's a lot in the long-term.

Additionally, if your job has a 401(k) plan with a match, you can enroll and boost your savings that way. TIAA advises saving 10%-15% of your income for retirement (match included), but if that's a big stretch, consider contributing the minimum amount required to get that bonus from work. You'll be well on your way — with even less work required on your end.

Yes, you want to make sure your future is secure; but it doesn't make sense to be flat broke every week (and charging or borrowing more to float yourself) in the present.

Think about it this way: The faster you pay off the debt that is eating up most of your income, the sooner you can reallocate it to other areas of your life. Redirect the money you put toward credit card debt toward your retirement fund once the former is gone (perhaps with an automatic deduction), and you'll pump up those savings in no time.