Card credit debt reduction solution

A plastic-poisoned retirement

If there is a sacred rule in personal finance, it's that anyone with an employer-sponsored retirement plan, such as a 401(k), should put as much money into it as is practical. That's why I felt anxious recently when I found myself questioning the wisdom of maxing out on 401(k) contributions.

It's well known that the burden of funding retirement is shifting from companies to individuals. Because 401(k) plans let you automatically invest in a tax-deferred account by reducing your take-home pay, and because many companies add "matching" funds, the plans often are the only way workers can save enough for retirement. That message is being heard. More than one third of the money streaming into Fidelity mutual funds, for example, is going into 401(k) accounts.

What threw me isn't the cash being funneled into 401(k)'s--it's the simultaneous borrowing frenzy. By whipping out their credit cards again and again, consumers have saddled themselves with a record amount of revolving debt, totaling more than $450 billion, including balances on bank cards like MasterCard and Visa, retail store cards and bank lines of credit. According to RAM Research, a Frederick, Md., card-tracking firm, consumers are paying interest on 78 percent of that debt. And despite the card companies' numerous if temporary "teaser" offers of low interest rates, the average rate charged is between 17 and 18 percent per year.

A losing race. Let me put it another way: We are funding our retirements with credit cards. That is what's happening if you maintain a credit balance and contribute to a 401(k). It's a losing formula, because there is no way that gains on the investments in 401(k) accounts can consistently overtake interest rates on credit cards. One solution is to spend less so you can pay off your credit debt faster. You might also lower your interest rate; issuers will often do that if you tell them you're thinking of transferring your balance to a lower-rate card.

Or many 401(k) plans let you "borrow" from your account to pay off debts (or for other reasons) and use paycheck deductions to put the money back in. You avoid the tyranny of high credit-card interest, but the idea of taking money out of an all-important retirement kitty chills me. Timothy Cunningham, a money manager and co-author of an insightful new book on retirement investing, Pay Yourself First, told me bluntly that he thinks borrowing from a 401(k) is "stupid, except in emergencies" such as paying for medical treatment.

Another strategy is one I am loath to suggest. It is to reduce your 401(k) contributions until you pay off your credit card debt. I asked Kevin McCabe of the New York employee-benefits firm Moyer & Ross to figure out what you'd gain by using $100 of salary per month in four different ways: as a pretax 401(k) contribution with a typical employer match of 50 cents per dollar; as a pretax contribution with no match; as an after-tax contribution; or as payment on a credit card bill charging the average 17.8 percent interest. McCabe assumed an income tax rate of 28 percent, an investment gain of 8 percent per year in the 401(k) account and a credit card balance of $2,500, which is about average.

His conclusion: Keep contributing pretax money that gets matched. After one year, your contributions would be worth $1,880, including investment gains, as opposed to shaving $938 off the year-end balance on your card account. You'd be ahead by the difference, or $942. Pretax contributions without an employer match are worth continuing as well; you'd be ahead by $315. But your contributions can't win out year after year--you must eventually pay off the card debt or you will fall behind.

Making after-tax 401(k) contributions, though, doesn't seem to make sense when you have high-interest debt, because you'd be behind by $36 after just one year.

I said "doesn't seem to make sense" because we're humans, not robots. If you cut any part of your 401(k) contribution, you'll be tempted to simply spend the difference. Think twice about cutting even your after-tax contributions, and let your pretax contributions be. You'll need them someday.