What is the best way to pay off a large credit card debt before I retire?
I'm a 61 year old single female with about $45,000 in credit card debt. I owe $170,000 on my house that's worth about $200,000. My annual salary was recently increased to $127,000. My goal is to pay off my credit card debt at least 3 years before I retire. I will retire in about 5-6 years. I have about $250,000 in my 401k. What is the best approach for me?
Before you start thinking about ways to pay off your debt, I recommend that you set a financial/budgeting plan. I would hate to see you pay the debt off and get back into debt right before retirement because your financial foundation is not solid enough. I am sure this brings you stress in your life and it needs to be addressed.
1) Your financial plan should help you find out what is the lifestyle you will be able to afford in retirement depending on the amount of money you have accumulated and the benefits you are able to get.
2) Slowly, during the next 5-6 years, you should adjust your spending to help you get in your retirement reality.
3) Once your plan is in motion, you should have savings to use to pay down your debt. I don't recommend that you use your retirement funds to pay it off. At your salary level, you would need to pay a lot of taxes on the lump sum.
Doing it this way, will help you get a hold of what you need to do financially to help you get prepared for retirement.
I hope this helps.
You can take a loan from your 401k. The loan has to be paid back in 5 years or by the time you retire. If you can handle the payment this will allow you to have the debt eliminated by retirement. If you are currently contributing to your 401k you can lower your contribution to help with cash flow while paying off the loan. But try and contribute enough to get your employer's matching contribution if applicable.
Please review your full budget and make sure to stop adding to the credit card debt. The next step would be to take the difference between your old salary and your new salary and directly use those funds to paydown your credit card debt. Since these are funds that you have not been accustomed to receiving, the theory would hold that it will not be missed income. The straight math, without the accumulation of interest charges, would be approximately $1,250/month for the next 3 years which may clearly be too much to bear, but maybe not depending upon your salary increase. A 5-year plan would place these payments at the $750/month level, once again without the accumulated interest calculations, which may be more realistic depending upon your monthly income.
Taking a loan against your 401k may also be an option depending upon your company plan design. In this scenario, discuss a payment plan with your provider and you would be paying yourself back with interest versus the credit card company which is likely at a much higher rate. Please consider this option as a last resort, as if something happens and you leave that company, the loan, if not repaid, would become income in that year. Oftentimes money extracted from a 401k plan does not make it back in plus, there is the lost income and appreciation from those funds not being invested. Also, compare the repayment of this 401k loan which would come directly from your salary with the approximate amount that you could pay monthly based on a straight payment structure over 3-years $1,250/month; 5-years $750/month or 6-years $625/month.
1- stop adding to your credit card debt
2- take the change in your income and shift 100% of those funds toward your credit card debt
3- then, reevaluate your monthly budget to determine shifting more funds to the credit card payment
4- take it in 6 month intervals as you may be pleasantly surprised by the amount of progess that you will make.
Although you did not state the interest rate you are paying on your credit card debt, for the purpose of this response, I will assume that it is fairly high (i.e., north of 5-6%). As such, the first line of thought from a financial planning perspective is to minimize the interest cost as you pay off the debt.
Since you do not have much equity in your home, refinancing your credit card debt is not an option. However, there are a couple of alternatives that merit consideration.
- Transfer your credit card balance to a new issuer with 0% APR for 12-24 months. Note: Most issuers levy a 3% balance transfer fee, but, you may still be able to find one or two do not. Check them out for yourself and be sure to read the fine print for limitations and restrictions.
These Are The Best Credit Cards For Making Balance Transfer (Investopedia)
- Consider Borrowing from Your 401(k) – Assuming your employer’s plan permits loans, you may wish to consider borrowing $45k from your 401(k) to pay off your credit card debt. Fortunately for you, the maximum permitted loan amount from a 401(k) plan is 50% of the accumulated balance up to a maximum of $50,000. A primary advantage of borrowing from your 401(k) versus other financing options (debt consolidation sites, etc.) is that the interest you will be charged on your 401(k) loan is repaid to your own retirement savings! The plan administrator will provide a repayment schedule that you must follow and that will require you to repay the loan over a maximum of five years. It is important to consider that, if you leave your employer, you may be required to repay the loan at once.
Some planners may balk at this advice, since money you borrow from your 401(k) is no longer invested for your retirement. However, an interesting concept in today's low interest rate environment is to take your loan amount from the bond/cash portion of your 401(k) portfolio, since those assets have limited near term upside anyway. For more on this, see the following links -
- Benefits and Drawbacks of 401(k) Loans in a Low Interest Rate Environment (Journal of Financial Planning)
- Are your clients making the right choice? (Journal of Financial Planning)
- Sometimes It Pays To Borrow From Your 401(k) (Investopedia)
Of course, another great secret to getting out of credit card debt is to not accumulate more if it! Make sure you keep your spending below your net income. Hope this is helpful.
It is great that you are taking steps to increase your retirement savings, and pay off your debts. You have a great income to make some progress on both of these goals. I would pursue them both aggressively, putting all of your excess cashflows toward them. In terms of how to divide your efforts, I would start with 5% in the 401k, and make sure you are contributing at least enough to get any employer matching. Above that, focus all of your efforts on paying down the credit card, which you should be able to do so relatively quickly given your income. After you have paid that off, I would devote all of the savings you have from not making CC payments to your 401k. If it exceeds tha annual limit of 24,000/year (because you are over 50) then you can contribute to an IRA. Hope this helps, good luck!