At Dollars and $ense Financial Coaching, I receive calls all the time from people looking for a quick way to get rid of their credit card debt. I had a couple call me this week and ask if they should cash in their SEP IRA in order to retire $54K in credit card debt. That would be the worst thing in the world they could do. With the 10% penalty on top of their tax rate (probably 25%), they would have had to withdraw $73K from their $103K balance, which is their only retirement savings. The couple is in their 40’s, so let’s assume they have 25 years to retirement. The scenarios are that they leave the SEP IRA alone and work on their debt, or they withdraw from the SEP IRA and pay off the debt now.
Scenario #1 – Leave the SEP IRA in place.
Beginning Balance – $103K
Rate – 11%
Number of Years – 25
Ending Balance – $1,399,303
Scenario #2 – Withdraw $73K from the SEP IRA now and pay off the debt.
Beginning Balance – $30K
Rate – 11%
Number of Years – 25
Ending Balance – $407,564
This leaves a STAGGERING difference at the end of 25 years of $991, 739 – almost a million dollar mistake.
Let’s add a couple of variables to both scenarios. Let’s assume for scenario 1 that they decide to work hard, take extra jobs, live on rice and beans and find another $1000 per month to put towards the debt, retiring the debt in approximately five years. Then we’ll assume that this gives them an extra $1000 per month to invest at the end of the five years, so they add $1000 monthly for the next 20 years.
Beginning Balance – $103K
Rate – 11%
Number of Years – 5
Balance at 5 years – $173,561
Regular deposit – $1000 monthly
Rate – 11%
Number of Years – 20
Ending Balance – $2,207,848
Ahh… so you ask what if they pay it off now and immediately begin saving the $1000 per month. Here’s how that one plays out.
Beginning Balance – $30K
Regular deposit – $1000 monthly
Rate – 11%
Number of Years – 25
Ending Balance – $1,848,440
Even under this plan, they have an extra $359,408 at retirement by sacrificing now to win.
If you have questions about your particular scenario and would like to run the numbers, contact us to set up an appointment.
