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Author: drcpa Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75523  
Subject: IRA Contribution vs Debt Paydown Date: 4/13/2003 11:43 PM
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Greetings,

I have the option to contribute the full $3k for 2002 to my Roth IRA, however I will have to carry a balance of about $2k on my credit card in order to do so (APR of approx 10%). I estimate that I would be able to pay down the balance on the card within 3 months. Does it make sense to make the full 2002 contribution, to make a partial contribution to allow for faster debt paydown, or fully pay off my card now and contribute whatever's leftover? Also, I participate in a 401(k) plan through my employer which I contribute to at 6% of my income (the maximum percentage at which my employer will match 25%). I could increase the 401(k) percentage to make up for whatever missed contribution to the IRA (although I would not reap the benefits of the tax free income on the Roth). What do you think? Looking forward to some suggestions.

Regards,

DrCPA
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Author: Mark0Young Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 36130 of 75523
Subject: Re: IRA Contribution vs Debt Paydown Date: 4/14/2003 1:03 AM
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I have the option to contribute the full $3k for 2002 to my Roth IRA, however I will have to carry a balance of about $2k on my credit card in order to do so (APR of approx 10%).

Do you currently have credit card debt and the 2002 Roth IRA contribution would delay paying it off? If so, is the credit card debt a regular thing for you, or was this from a rare, unexpected expense?

Or do you mean that you would have to take a cash advance from the credit card? Note: credit card cash advances may have fees, the interest will start on the day of the cash advance (unlike after the grace period for purchases made on a paid-off card), and often cash advance has a higher interest rate.

At 10% APR, paying off that credit card and keeping it paid off would probably be a better long-term approach. Historically, domestic large caps have returned a shade above 10% (10.6% for 1926-1998), and that is before friction (trading costs or mutual fund expense ratios) and before taxes. Of course, no one really knows what the next 10, 20, or 30 years will bring, so one has to take a pragmatic approach and keep consumer debt to the minimum and then take prudent risks.

I am inclined to suggest that you skip the 2002 Roth IRA contribution, and, once you have the credit card debt paid off, increase your 401(k) contributions to compensate. If you expect your retirement marginal tax rate to be roughly your current working marginal tax rate, the $3,000 you contribute to your Roth today and take out in retirement tax free would be about the equivalent of the after-tax withdrawal in retirement if you contribute $4,110 pre-tax to your 401(k) (so it would reduce your take-home by about $3,000). (The $4,110 is assuming 27% marginal tax rate: $4,110 pre-tax would have about $3,000 net after taxes. For this comparison, I am ignoring SS and Medicare taxes, which would be taken out, whether the 401(k) contribution is made or not.)

I would also be concerned about the credit card debt. Ideally, one would be saving some money from each paycheck to build up an Emergency Fund that one can use for unexpected expenses, plus savings for non-monthly predictable bills so one can pay bills off in cash rather than having to resort to carrying a credit card balance.

"If your outflow exceeds your income, your upkeep will be your downfall."

The majority of American families are in prison, not of concrete and bars, but in a $8,940 cell of embossed digits and magnetic stripes. Those cards keep many Americans separated from Financial Independence and, worse, the average American household pays $1,000/yr rent on that cell.


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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 36132 of 75523
Subject: Re: IRA Contribution vs Debt Paydown Date: 4/14/2003 12:38 PM
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Agree with Mark. It makes little difference, but I'd skip the Roth for now and up the 401(k) contribution for this year. Then you can always do a partial Roth conversion and get the same effect as the Roth if you choose. The only caveat is if you think you'll lose your job in the next few months you might want to do the Roth now. A bird in the hand...

To put a different spin on Mark's comment that "The majority of American families are in prison, not of concrete and bars, but in a $8,940 cell..."

America's chronic spenders keep the economy humming and us employed. If everyone started saving as much as many of us do, the result would be a severe depression. Being a saver in a nation of spenders is the best possible scenario.

Nick







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Author: buzman Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 36134 of 75523
Subject: Re: IRA Contribution vs Debt Paydown Date: 4/14/2003 6:55 PM
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Yeah, I agree.

Pay off the credit card & increase your 401k contribution to make up the difference.

Just be sure your asset allocation is suitable for the amount of risk you feel comfortable carrying.

buzman

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