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Should I Pay Off My Credit Cards or Max Out My 401k?

In the unending “pay off debt first or start investing” debate, I’ve learned about a small wrinkle:

If your employer matches your 401k contributions, you earn an instant 100% bonus on every one of those dollars. In the worst of scenarios, your credit card company is charging you interest in the high 20s.

The Big Disclaimer: None of this is intended as advice, nor should anyone reading make large life decisions based on this content or subsequent discussion. I’m just starting a conversation here; each person should evaluate his/her own unique needs and circumstances before making any important financial decision.

In other words, in cases where you haven’t reached your maximum employer match, the math tells you to prioritize 401k contributions ahead of paying off high interest credit card debt. Once you’re getting every matched dollar you can from your employer, the math says to throw the next dollar at your credit card debt.

That’s the strict math, but what might change the equation and tip the scales back toward a full focus on the credit card debt?

If a person can’t make the required 401k contribution and keep all bills paid and debts current – the math doesn’t matter. They can’t afford to “buy” the matched dollar from their employer.

If that same person is pushing every extra penny to credit card debt, and views the freed up credit card availability as his “emergency fund,” redirecting the money to their 401k for the sake of the match could create excess risk in his finances.

Sure, they could borrow the money back out of his 401k, but that carries its own risk:

  • They lose investment growth on the dollars borrowed from the 401k.
  • The loan has to be paid back with post-tax dollars (which means the payments will reduce his take-home pay).
  • If they leave their current job, the full 401k loan could be due within 60 days, creating a situation where they still have the credit card debt, still has no emergency fund, and now has to come up with the money to pay off the 401k loan.

Although I don’t have any credit card debt, here’s how I would approach this problem:

If I were snowballing credit cards with extra money, I’d prioritize matched 401k contributions ahead of paying off debt. You just can’t beat an instant 100% ROI.

But, I’m working on the major assumption that the hypothetical borrower has broken the borrowing habit – maybe even closed/cut up the credit cards – before heading down this path.

This is all on my mind because I recently had a friend go through this process. He was snowballing his credit card debt and realized he was leaving money on the table by NOT getting his full match. He reallocated snowball money to get the full match, then did a consolidation loan through Lending Club to pay off his credit cards (and get a much lower interest rate). For him, it’s a big win in terms of interest NOT paid and interest earned.

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Should I Pay Off My Credit Cards or Max Out My 401k?