401k Match Trumps Debt Repayment

Bankrate notes that you should take a 401k match before paying off debt (in this case, they're talking credit card debt). As if the reason isn't totally obvious, here's why:

You may be paying 13 percent on your credit card, but you're earning 50 percent on the typical company match.

Let's see -- which is better -- a 50% return or a 13% return? ;-)

For some of us, the issue is even more glaring. Anyone out there get a 100% match? Many do.

Yeah, I'm a big believer in paying off all kinds of debt, but there are better options that have to be exhausted first, and getting the full employer match on a 401k is a major one. Even when I was paying off my mortgage a decade ago, I still put as much as I could into my 401k first. Not only did I get the match, but that money has now been working for me for ten years and it's grown into a sizeable chunk of change. I plan to let it sit for a couple more decades -- it should REALLY be a nice sum by then.

For more thoughts on 401ks, retirement, and debt, see these posts:

• Five Reasons You'll Love a 401k

• Nine Keys to a Great Retirement

• Seven Ways to Boost Your Retirement

• Paying Off a Mortgage Versus Investing

Comments

[Brandon Barkley]

I get 100% match on the first 6%.

[Free From Broke]

If you get 100% match you are getting better than 100% return - you also get the tax advantage! A good company 401k is really all sorts of bonus money for you.

[Traciatim]

I also get a 100% match on 6%. It's also instantly vested. Anyone in my company not taking this deal needs their head examined.

[Geoff]

I get a 100% match on my first 7%.

Dave Ramsey would tell me to halt retirement contributions while paying off my car (2.9%). That is why Dave Ramsey is an idiot.

[Santos]

To be fair, Dave Ramsey wants people to get fired up and get rid of debt; and losing a bit of company match for a while might be worth it if it changes the person's behavior pattern (is about psychology not math). By the way, having a new car loan (at any rate) does not scream out brilliance either ;-)

[LC]

@Santos, while I personally would never take out a car loan at any rate (even 0%), you can't really argue with the math when the interest is 2.9%.

@Geoff
I think Dave Ramsey was generalizing and that when he said "pay off all debt" he meant "pay off all high interest debt" (although I am not positive). Since a mortgage is in most cases the lowest percentage rate that someone has, he includes that separately. I would lump into that step any other low interest debt.

[Kevin @ Change Your Tree]

No, Dave Ramsey suggests paying off ALL debt, regardless of interest rate. The interest rate isn't the problem, it's the symptom of poor financial behavior.

I like hearing all these self-certified math geniuses talk bad about Dave Ramsey. If they are such a math genius, why are they paying interest on anything at all??

Dave is not an idiot, he wants to get you fired up to change behavior. He says many times that stopping the match doesn't make mathematical sense, but he still advises it because he wants people to get out of debt fast and not having the match will help light a fire under their ass. Personal finance is 80% behavior and only 20% knowledge.

The bottom line is; if you want to play mathematics, you're an idiot for having debt in the first place.

[Kevin @ Change Your Tree]

Oh but yes, he wants you to be saving for retirement and have an emergency fund and a college education fund in place before you pay off your house.

[Lord]

With 5 year vesting even a 100% match would only amount to a 20% return and you could easily be paying 25% on your card, and that 100% is a one time return whereas that card compounds and would not take too many years to exceed it (5.67 years for 13%).

[Mark]

Carrying a 13% debt for 4 years might cost more than you get in the 50% match. You only get the 50% match the first year, but you pay the 13% EVERY year until you pay off your balance. AND if you only make the minimum payment the debt increases too. (The reverse magic of compounding!) Tax benefits plus the compounding in the 401k change the exact breakeven point, but not the general principle.

[Geoff]

Yes! I knew the Ramsey butt buddies would come out fired up!

FYI - the car loan is a toyota camry. Once you account for some factors buying a used camry/accord/similar (no warranty, previous owners, min. 6% unless you pay cash) nets you zilch compared to buying a new one at low interest. Read a few discussion forums on this topic and you'll find the same consensus. And, with my net worth position, I feel absolutely no qualms about "splurging" on a new camry.

I could pay off the car this afternoon if I wanted to... but why the heck would I when my cash is sitting in a 5.0% online savings account (minimum after-tax advantage, but HUGE liquidity advantage)?

I would borrow a gazillion dollars at a low enough rate (risk-free rate less taxes), and I'd pay the interest with a smile, because I'd park the money in risk-free investments and pocket the difference. Paying off 0% loans early is downright asinine from a mathematical standpoint.

But now I've deviated from the original point which was that blanket statements from Ramsey like "stop your match and pay off your debt no matter what" are dumb. That's my biggest issue with Ramsey, he makes far too many I-know-it-all statements and takes no exceptions.

Stopping my match until I paid off my car could cost me many THOUSANDS of dollars in future investments. Want to know how much interest I'll pay on a 5 year loan at 2.9%??? ~$1600. Total.

[Honest Dollar]

Lord & Mark - I think you're oversimplifying the match to a "one-time return." Remember, this match can be earned every year, for an immediate 50-100% return. Moreover, the money from the match compounds with portfolio returns, so the total return is actually higher than 50% a year.

[Rev]

@Geoff
You sound like your only debt is your car and maybe a mortgage. You are not a Dave Ramsey person. I also am not. But you probably have a good control of your finances and have some self control and a positive net worth. Dave Ramsey is for the people who lack self control and self discipline. That is why blanket statements are made. You (I assume) or I can use a credit card to our advantage I would guess but the people he is trying to help get a credit card and start buying new stuff they don't need and can't afford.

There is no doubt mathematically Dave doesn't always come out ahead, he only comes out ahead when you lack discipline which lots of people do. He has his place and you have yours. To someone with their finances in line his statements can be "dumb" but then again they aren't targeted at you.

I am a software engineer and of my friends who work with me we all make very good money I'd say its about 50/50 for the ones who are high in debt living paycheck to paycheck vs ones who are investing and living within their means.

Those in debt who have incomes of 100k+ that I know are paycheck to paycheck are the people he is helping the ones who haven't built the discipline to live within their means.

Also Geoff you sound like a total homophobic douchebag, no need to be abrasive and bash. If something isn't for you thats cool but its a better alternative for lots of people.

[CHM @ chancefavors]

Gotta go with the 401K match.

Mathematically it seems that everyone agrees this is the right move. Those that support the idea of paying debt first cite the positive psychological benefits of doing so.

What about the positive psychology that comes from preparing for your future by building a nest egg, in a tax deferred account, that is matched by your employer.

Beauty is in the eye of the beholder.

[Lord]

No, it is oversimpifying to assert a match, even a 100% match, is always the better choice. Matches are one time up front; they do not compound at that rate. You can put more money in and it can be matched, but that does not affect money already in the plan. It is hard to beat a match, but some matches are less than they sound and some cards are very hard.

[Jim]

After vesting, 100% match on the first 8% invested.

[FMF]

Lord --

Let's say you have a 401k with a 100% match. If you invest it into an idex fund, you'll earn at least 8% over the long run. So do you really believe that this can be outperformed by a credit card rate -- even one at 20%?

The difference here is 12% a year (and this is a worst-case scenario.) It would take a loooooong time for the debt of the credit card to be worse than the benefit of the 401k.

[FS]

How about 10% automatic?! (No employee contribution required!) Fully vested in 5 years. Who says a non-profit association can't pay well?!

[Traciatim]

Lord, sure can, I'm going to use Canada RRSP rules since I'm not familiar with the 401K/IRA/Roth rules of the US.

In Canada it would work like this:
You have 10K on a credit card at 19.9%
You minimum payment is 200 bucks
It's costing you 166 a month in interest
You have 500 bucks in income you can spare and you want to know if paying the CC or a 6% match is best. Should you minimum-pay the CC and match, or just pay off the CC.
You earn 8% on your money in the investment.

Month 1 ...
Credit Pay Total:
Original Balance 10000 + 166 Interest - 500 Payment = 9666 balance.
RRSP/401K = None
Total Funds= -9666

Match:
Original Balance 10000 + 166 interest - 200 Payment = 9966
RRSP/401K is 300 + 300 so 600 saved.
Total Funds = -9366. PLUS you get a tax refund depending on your salary

Month 2 ...
Credit Pay:
Starting Balance 9666
Interest 161 (rounded up)
Payment 500
Total Funds -9327

Match
Original Balance 9966 + 166 - 200 = 9932
RRSP/401K Balance 600 + 4 + 600 = 1204
Total Funds -8728

and it just keeps getting better and better. Especially since at year end you would now already have a tax refund because your income was reduced by 600 bucks. The reduction will be 3600 by year end, and in Canada if you were making 60K (to get the 300 match) you would get a refund of nearly 1200 bucks off of your tax bill.

I just don't see how you could beat this with any other strategy, matching wins because free money is involved.

[Lord]

It is better to pay off the debt is the interest rate is greater than the sum of investment return plus match divided by vesting period. For a 10% return, 50% match, vesting over 5 years, 10% + 50%/5 = 20%, so paying off debts above 20% would be better. For 100% over 5 years, 10% + 100%/5 = 30%. I don't know if there are cards over 30%, but payday loans certainly are.

[Lord]

Even taking tax deferral into account, say at a marginal rate of 25% over that vesting period and ignoring the taxes still due on it at the end would only raise the interest breakeven point 5%.

I believe 50% and 100% matches over 5 years are most common. Some do vest immediately which makes those a much better deal, but comparing results over the duration of the vesting period give the correct comparison.

[barry b.]

I would pay off the debt. Everything I've learned about debt and finance leads me to the same conclusion. Get rid of all debt IMMEDIATELY, stop using credit, and then do whatever, however you want.

[debtdieter]

This is why I've started contributing 1% pretax to my superannuation fund (Australian IRA) while paying off my debt. It's going to take me at least 3 years to pay it off, and at 38 I really can't afford to wait any longer to start setting myself up in some small way for retirement.

[J Baba]

FMF,

I got a question for you.

If someone is completely debt free meaning they have paid of their mortgage and all other debts, what kind of insurance/protection do they need to put in place to make sure their investments are safe? I know there is something called umbrella insurance. But that is effective only if you have both your home and auto insured by the same company. What if you are getting better rates by insuring your home and auto from different companies? What are your options then except Umbrella Insurance?

Thanks.

[FMF]

J Baba --

I don't think there is an alternative to umbrella insurance. Anyone else out there know differently?

[Fred]

In Florida, some umbrella policies require the insured to hold a minimum liability limit of 300,000.00 on homeowners insurance, and bodily injury in the amount of 100,000 per person 300,000 per accident on all of their vehicles. some companies require higher limits, but two I know of don't care whether it's through one company or not.

[Fred]

In Florida, some umbrella policies require the insured to hold a minimum liability limit of 300,000.00 on homeowners insurance, and bodily injury in the amount of 100,000 per person 300,000 per accident on all of their vehicles. some companies require higher limits, but two I know of don't care whether it's through one company or not.

[Saver]

I'm going with the debt payoff. Not because of Dave Ramsey, but because ultimately Roth IRA's trump 401k's because in 401k's you are still taxed in retirement.

[Nick]

I receive a 140% match. I put in 5%, I get 7%. After that, there isn't a match.

[Derek]

To a previous respondant:
Dave Ramsey fully acknowledges that the math doesn't work on a couple of his ideas (paying off debts smallest to largest instead of highest rate to lowest rate; passing up a 401(k) match) for a different reasons. He's not an idiot. He has a different path to success than some.