There are no two ways about it -- credit card debt is a killer.
Many credit cards charge 20 percent, 25 percent, or even more. If you’ve triggered a penalty APR, due to a late payment, for example, you might have a rate as high as 29.99 percent.
The average American household had $6,354 in credit card debt at the end of 2017, according to Experian.
At 25% APR, that $6,354 would grow to a staggering $77,341 over 10 years if you didn’t make any payments -- or end up in court. And that’s without making any additional purchases.
Needless to say, that kind of rapid debt accumulation can wipe out any household financial plan.
So, if you’ve got investments that can pay off your debt, is it worth it to sell them to pay down your credit card debt?
It’s a bit of a double-edged sword. Yes, paying off credit card debt, especially at exorbitant interest rates, is important.
But, isn’t saving for retirement and a sound financial future equally important?
Yes, without a doubt.
To figure out the answer for your personal financial situation, you’ll have to do some analysis -- and some math.
Here’s a guide to help you get started.
Save on Interest Charges
The main reason to think about paying down credit card debt is to save money on interest charges.
Many cardholders are not even aware of the amount of interest they’re being charged every month, or how rapidly it can compound.
One of the sneaky ways that credit card issuers avoid this subject is by listing a “minimum payment” amount on monthly statements.
Some cardholders simply pay this minimum balance due every month without even looking at the amount of interest that was charged to their account.
In some cases, the minimum payment amount might not even be enough to cover those monthly interest charges.
A simple example can highlight this danger.
Let’s say you have $10,000 in credit card debt on a card charging 25 percent interest annually.
In the first month, you’ll be charged $208.33 in interest.
If the card has a minimum payment requirement of 2 percent of your balance, your amount due after the first month would be $204.17, or 2 percent of $10,208.33.
But, if you pay $204.17 on a $10,208.33 bill, your balance would end up at $10,004.16.
Even paying the minimum amount due, your total balance would still go up.
If you’re not paying attention, you might feel like you are paying your debt down, when in reality, it is still going up.
Thus, it’s important to pay that debt off as soon as possible, before it skyrockets out of control.
However, this doesn’t mean you should immediately run out and raid all of your investment accounts.
Other variables may affect your decision. For starters, different types of accounts may trigger taxes and penalties if you liquidate them.
You’ll also have to consider the damage done to your long-term savings, and the costs involved in liquidating investments in these accounts.
Here’s a look at the consequences of selling off investments to pay credit card debt in various accounts.
Your 401k plan is a long-term, tax-deferred retirement account that carries restrictions as to when you can access the money.
In most cases, you can’t take money out of your 401k account until you’re age 59 ½, unless you become disabled or if you “separate from service” after age 55.
An exception is if you have a financial hardship, which is demonstrated by an immediate and heavy need.
The IRS gives examples of financial hardship, including the following:
- Certain medical expenses
- Costs for buying or repairing a principal residence
- Educational fees and expenses
- Payments necessary to prevent eviction
Burial or funeral expenses
Unfortunately, credit card debt is not specifically enumerated as a financial hardship on this list. You might want to talk to your plan sponsor or tax adviser for clarity.
The problem with 401k distributions, even for hardships, is that you’ll pay ordinary income tax on what you take out. If you’re under age 59 ½, you’ll also owe a 10 percent early withdrawal penalty.
If you’re in the highest tax bracket, this can mean that you’ll pay out more than 50 percent of your distribution in taxes and penalties, which can negate any benefit you get from taking out money to pay off your credit card debt.
If you can’t (or don’t want to) take a 401k distribution, you may be able to take out a loan against your account.
The IRS permits 401k plan participants to borrow up to 50 percent of their vested account balance, up to $50,000.
You’ll be charged interest on the account, just as with a traditional loan, but your payments will go right back into your account.
You don’t have to demonstrate financial hardship to take money out of a traditional IRA.
However, a traditional IRA suffers from many of the same pitfalls as a 401k plan when it comes to taking distributions.
You’ll owe ordinary income tax on the money you take out of your IRA.
Plus, if you’re under age 59 ½, you’ll owe the 10 percent early withdrawal penalty.
You can’t borrow money from an IRA, so if you want to use that money to pay down your debt, you’ll need to take a distribution.
As with a 401k plan, however, the taxes and possible penalties usually outweigh any benefit you’d receive from using that money to pay down your debt.
Another factor to consider is that it can be hard to replace any money you take out of an IRA, as the IRS caps the size of your annual contributions -- just $5,500 as of 2018, with an additional $1,000 allowed if you’re at least age 50.
Thus, if you have to take a large IRA distribution to pay down your credit card debt, it may be difficult to impossible to replace all of the funds you take out.
A Roth IRA might be a better option for credit card debt payment than a traditional IRA.
As long as you’ve had your Roth open for at least five years and are over age 59 1/2, you can take out your contributions and earnings tax-free.
However, you’ll still have to weigh the benefits of paying down your debt versus the consequences of raiding your retirement savings. And, you’ll still face the same 10 percent early withdrawal penalty if you’re under age 59 ½.
As with a traditional IRA, you can’t take a loan against your Roth IRA, so a distribution is the only way to go.
When it comes time to rebuild your savings after you deplete your account for debt repayment, you’ll have to abide by the same IRS contribution limits as with a traditional IRA.
A taxable account doesn’t have the restrictions on withdrawals that retirement accounts do.
The danger in liquidating investments in these types of accounts is that may have to pay tax on any profits you earned.
If you’ve held an investment for one year or less, you’ll pay the same tax rate on your sales as you do on your income.
However, if you’ve held your investment for longer than one year, you’ll benefit from lower capital gains tax rates. In some cases, this rate can be as low as zero percent.
This can make a taxable account a good source of funds for paying down debt.
Hurting Your Future Retirement
Let’s say you decide to sell your retirement investments to pay off your credit card debt.
Mathematically, it might seem to make sense. After all, you might be giving up an investment with an expected 5 or 10 percent return to pay down debt costing you 20 percent or more.
However, you’ll also have to factor in how removing those investments from your retirement plan can be equally devastating.
Let’s say you have $20,000 in your retirement accounts, $20,000 in credit card debt, and that you’re 25 years old.
If you plan to retire at age 65, that means you have 40 years for your investments to grow.
Further, let’s assume you could earn a 10 percent return on those investments, which is the average U.S. stock market return over the long haul.
That means that by age 65, your $20,000 would grow to $905,185.
However, if you take that money out at age 25 to pay off debt, you’ll have to start from scratch again.
If it takes you 5 years to replace that $20,000, you’ll only have 35 years for that money to grow.
At the same 10 percent annual return, your $20,000 would only grow to $562,048.
That means that at retirement you’d have about $340,000 less than if you had left the money in your account starting at age 25!
That’s a pretty big deficit. Certainly, it’s a lot larger than the $20,000 in credit card debt you paid off at age 25.
Of course, playing with numbers like this can be tricky.
For one thing, there’s no way of knowing exactly what interest rate you’ll achieve on your investments. But there’s a black-and-white percentage that your credit cards would be costing you.
Plus, if you had left your $20,000 in debt accumulating starting at age 25, it would mushroom to far more than the amount you’ve given up in your retirement accounts.
It might seem like there is no “win-win” scenario if you’ve got a lot of high-interest credit card debt.
Either your debt will mushroom out of control, of you’ll be depleting some of your long-term savings.
But there are ways that you can have your cake and eat it, too.
Tips to Help Out
Paying off your high-interest credit card debt while maintaining your retirement savings takes discipline.
But, if you make it a priority, you can both pay off your debt and invest for the long term.
The first step is to make a budget.
Financial advisers often say to “pay yourself first.” This means that before you pay any of your bills, you “pay yourself,” either in the form of money directly into savings or money to pay down your debt.
This ensures that every time you get a paycheck, some of that money is being saved. If you only put aside money at the end of the month, you’re likely to find that you don’t have any money left for savings.
Another good way to corral your credit card debt is to get a lower interest rate.
In many cases, you can accomplish this with a simple phone call to your card issuer.
You can also ask for zero-interest balance transfer offer. If your card issuer isn’t willing to make such an offer, find a credit card company that will.
You may have to pay a one-time fee of 3 or 5 percent, but this is a far cry from the 15 to 25 percent you may already be paying on your cards.
One more option is to consolidate your high-interest credit card debt with personal loans at a lower interest rate.
They don't require any collateral and are generally considered a strong option for helping borrowers get out of debt.
You'll be able to choose the amount that you need and the repayment term that best fits your monthly budget.
There’s no clear-cut answer for whether you should sell your investments to pay credit card debt, because everyone’s financial situation is different.
But there’s no way around the fact that having a lot of credit card debt is a financial anchor.
If you’ve got investments that you can liquidate to pay off at least some of your credit card debt, you should at least consider that option.
Before you make any major financial moves, get all of the facts.
Find out how much you’re paying in interest on your credit cards. Compare that to how much you’re earning on your investments.
When making your calculations, don’t forget to include the taxes and penalties you may face if you’re planning on taking money out of your retirement accounts.
If your money is in a taxable account, factor in the capital gains taxes you may owe.
After you have all the information, run the numbers. In most cases, you’ll want to get out of debt as soon as possible.
If you find that the math makes sense and you decide to liquidate your investments, build up your savings again as rapidly as you can.
And avoid getting back into debt at all costs!