An individual retirement account is a savings vehicle that is outside of your employer's 401(k). It lets you put away money for later in life, while giving you a tax break today, so it can be an important piece of your overall financial plan. Under current rules, you can put a max of $5,000 every year into your IRA, or 100 percent of your taxable income if it is less than $5,000. Although setting up an IRA doesn't have any direct impact on your credit score, it can have some side effects on your overall borrowing ability.
Your IRA and Your Credit Score
An IRA is a savings account, which is an asset. Your credit score includes only loans and other debt, therefore, your IRA won't show up on your report or affect your credit score, either positively or negatively. Your score will reflect your history of debt repayment and your total amount of debt. The best way to get your credit score higher is to pay your debts on time and don't max out those credit cards.
Getting a Loan
When you apply for a loan, especially a large one like a car loan or mortgage, the lender will look at your whole financial scene. Your IRA will count as an asset and show the lender that you know how to save money, so it's often viewed as a good thing. If contributing to your IRA is causing you to maintain high credit card debt, though, the lender will see that, too. The more debt you have in relation to your assets, the more likely it is that you could get declined for a loan.
Borrowing for Your IRA
There are times in your life when it might make sense to borrow money to contribute to your IRA. If you know that you will be able to pay back the loan in a short period of time, and you would not otherwise be able to make your annual contribution on time, getting the tax deduction may more than offset the interest you pay on the loan. Always pay back the loan on time to keep your credit score high.
Balancing IRA Contributions and Debt Paydown
If you're carrying around high debt levels, especially consumer debt like credit cards, it often makes financial sense to pay down the debt before contributing to retirement plans. If you're not sure about crunching the numbers, you can enlist the help of an accountant or financial planner to put together a debt reduction strategy that works for you. The first step is to write down all your debt balances, along with the interest rate and repayment terms on each. Focus on the debt with the highest interest rate first, and budget a reasonable amount each month to start paying it down. Although IRA contributions will grow as they are invested, the growth likely won't be at as high a rate as your debt is. For example, if you're paying 21 percent interest on your credit card, you would get a guaranteed 21-percent after-tax return on your money by paying it down. You likely won't see that kind of action in your IRA.
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Writer Bio
Angie Mohr is a syndicated finance columnist who has been writing professionally since 1987. She is the author of the bestselling "Numbers 101 for Small Business" books and "Piggy Banks to Paychecks: Helping Kids Understand the Value of a Dollar." She is a chartered accountant, certified management accountant and certified public accountant with a Bachelor of Arts in economics from Wilfrid Laurier University.