Should I Contribute to My 401k or Pay Off My Credit Card Debt?

Add to your 401k or pay credit card debt? Which comes first?

It’s been nearly seven years since the financial crisis swept through the nation, yet two-thirds of Americans said they still feel haunted by its effects in the way they work, live, save and spend, according to a study from Allianz Life Insurance Co. Many of the 2,000 baby boomers and Gen X-ers studied also said they had lower confidence in their ability to achieve financial security.

For workers who hold credit card debt, which is more likely to lead to a secure future: diverting what would’ve been their retirement plan contribution and paying off that debt instead or making their 401k plan a priority? Here are some pros and cons associated with each of these money moves.

Read: Retirement Fund or Emergency Fund? Which Do I Save For First?

 The Pros of Paying Off Credit Card Debt First

  • It will eliminate often high and non-tax deductible credit card interest rates.
  • Bringing your credit card balance to zero will improve your credit score, which will help you to get a lower interest rate if you’re in the market to buy or refinance a home. Your credit score can also be a factor when you apply for a job or buy auto insurance.
  • It will free up money for saving, investing and building wealth.

 And the Cons

  • It will divert money away from your retirement savings goals and perhaps set you up for a frugal lifestyle in retirement.
  • It will deprive you of the tax deduction that you’d receive from your 401k contribution if you paid your debt first.
  • Diverting funds away from your 401k plan in order to pay down credit card debt could cause you to miss out on your company’s matching contributions.

 The Pros of Contributing to Your 401k First

  • You will be building a retirement nest egg. Younger workers have the gift of time when it comes to their ability to amass wealth. Failing to take advantage of that time horizon is a lost opportunity you’ll never get back.
  • You will receive a company match on your contributions, which is free money and an instant return on your deferrals.
  • Money contributed to a 401k is done on a pre-tax basis, saving you money at tax time.
  • The money will be put into your retirement savings and out of reach for unnecessary spending.

 And the Cons

  • Money not diverted to paying off credit card debt will cause you to pay high credit card interest rates that last much longer.
  • The interest rate on your credit card is probably higher than the return on your 401k. So your credit card interest rate might be 15 percent, but it’s likely that the return on your portfolio will be well below that.
  • Carrying high credit card debt decreases your financial security. Diverting money away from paying off these cards delays your route to financial freedom.

Katie Brewer, a certified financial planner and president of Your Richest Life Planning, a virtual financial planning firm for Gen X and Gen Y, said it was best if people could pay down debt while also building up their assets. She said people might want to consider cutting their spending by eliminating monthly cable or subscriptions, for example, and taking on temporary work to get more income.

“Once you start to make room in your budget, make sure you are (contributing enough to) at least get the match on your 401k,” she said. “If you are contributing more than the match to your 401k plan and you are working on credit card debt, you might think about temporarily reducing your 401k contribution to allow more take-home pay to put toward credit card payoff. If you reduce your 401k contribution, make sure to put a reminder on your calendar to adjust it back.”

Related: America’s 3 Biggest Money Fears — and How to Overcome Them

Jeff Rose, a certified financial planner and founder of Alliance Wealth Management, is also the author of the Good Financial Cents website. He said there were lessons to be learned when workers contribute to their retirement plan. So they shouldn’t pay off credit card debt at the expense of saving for retirement.

“They should do both, even if it’s only putting the minimum amount in their 401k,” he said. “This way they get familiar with their 401k and how the markets work. It might not be a lot toward their retirement, but it will be a valuable lesson learned in understanding how to read a 401k statement and a good introduction into mutual funds.”

Strategies to Eliminate Credit Card Debt

  •  Curb your spending. What you save in cutting out expenses can be put toward reducing your credit card debt.
  •  Consolidate high interest credit card debt onto a lower interest card via a balance transfer.
  •  Find a reputable credit counseling agency to get help with your spending.

You can’t become a 401k millionaire if you’re not contributing to your plan. According to Fidelity Investments, about 72,000 participants in their plans had a balance of $1 million or more at the end of 2014. What was the common thread among them? They contributed a significant amount of their salary faithfully to their 401k.

If you are in deep credit card debt, devise a plan to pay it off. Keep your spending under control. Contribute as much as you can to your 401k. Put your financial security first.

Related: How to Trick Yourself into Paying Off Your Credit Card Debt