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In a recent question Should I dump my savings into my student debt?, there was push back from a member regarding the strong advice to save to the match.

Is there ever a time to not deposit to the match, and pay other debt off faster?

(To those not familiar with the 401(k), it is a US retirement account, which often has a feature where the employer will 'match' the deposits of the employee, up to a certain level. For example, my employer matched up to the first 6% of my income. By the end of the year, if I have deposited 10% of my salary over the year, I would see a total 16%, as 6 was matched.)

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    Are we assuming everyone lives to retirement age here? Not living long enough to retire strikes me as a good example of a situation where a 401k doesn't make sense, regardless of matching. – HopelessN00b Aug 19 '16 at 6:45
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    @HopelessN00b Then you should also assume that not everyone will live long enough to pay the debt off, meaning it sometimes would be best to invest in life insurance. – Dmitry Grigoryev Aug 19 '16 at 11:42
  • No, in my answer, I only project out to the point in time where the loan would have been paid early. The implication is we'll ignore tax going in and out, so in the first case, below, you are in year 6, and instead of zero debt, you have $50,346 in the 401(k), and just $23,636 in debt. Age here doesn't matter. Nor does mortality. – JoeTaxpayer Aug 19 '16 at 12:16
  • I think the wording of the Question & Answer can be modified to apply more broadly, as many jurisdictions would have similar programs. Because the biggest differences of these programs would be tax implications, which are avoided in this Q&A, the end result would generally be the same regardless. – Grade 'Eh' Bacon Aug 19 '16 at 17:24
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    It is reasonable to not contribute to your 401k if you cannot make minimum payments to your other debts. Where your monthly expenses equal your income... – GER Aug 19 '16 at 17:47
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The original question was aimed at early payment on a student loan at 6%. Let's look at some numbers.

enter image description here

Note, the actual numbers were much lower, I've increased the debt to a level that's more typical, as well as more likely to keep the borrower worried, and "up at night."

On a $50K loan, we see 2 potential payoffs. A 6 year accelerated payoff which requires $273.54 extra per month, and the original payoff, with a payment of $555.10.

Next, I show the 6 year balance on the original loan terms, $23,636.44 which we would need to exceed in the 401(k) to consider we made the right choice.

The last section reflects the 401(k) balance with different rates of return. I purposely offer a wide range of returns.

Even if we had another 'lost decade' averaging -1%/yr, the 401(k) balance is more than 50% higher than the current loan debt. At a more reasonable 6% average, it's double. (Note: The $273.54 deposit should really be adjusted, adding 33% if one is in the 25% bracket, or 17.6% if 15% bracket. That opens the can of worms at withdrawal. But let me add, I coerced my sister to deposit to the match, while married and a 25%er. Divorced, and disabled, her withdrawals are penalty free, and $10K is tax free due to STD deduction and exemption.)

Note: The chart and text above have been edited at the request of a member comment.

What about an 18% credit card? Glad you asked -

enter image description here

The same $50K debt. It's tough to imagine a worse situation. You budgeted and can afford $901, because that's the number for a 10 year payoff. Your spouse says she can grab a extra shift and add $239/mo to the plan, because that' the number to get to a 6 year payoff.

The balance after 6 years if we stick to the 10 year plan? $30,669.82. The 401(k) balances at varying rates of return again appear above. A bit less dramatic, as that 18% is tough, but even at a negative return the 401(k) is still ahead. You are welcome to run the numbers, adjust deposits for your tax rate and same for withdrawals. You'll see -1% is still about break-even.

To be fair, there are a number of variables, debt owed, original time for loan to be paid, rate of loan, rate of return assumed on the 401(k), amount of potential extra payment, and the 2 tax rates, going in, coming out. Combine a horrific loan rate (the 18%) with a longer payback (15+ years) and you can contrive a scenario where, in fact, even the matched funds have trouble keeping up. I'm not judging, but I believe it's fair to say that if one can't find a budget that allows them to pay their 18% debt over a 10 year period, they need more help that we can offer here. I'm only offering the math that shows the power of the matched deposit.

From a comment below, the one warning I'd offer is regarding vesting. The matched funds may not be yours immediately. Companies are allowed to have a vesting schedule which means your right to this money may be tiered, at say, 20%/year from year 2-6, for example. It's a good idea to check how your plan handles this.

On further reflection, the comments of David Wallace need to be understood. At zero return, the matched money will lag the 18% payment after 4 years. The reason my chart doesn't reflect that is the match from the deposits younger than 4 years is still making up for that potential loss. I'd maintain my advice, to grab the match regardless, as there are other factors involved, the more likely return of ~8%, the tax differential should one lose their job, and the hope that one would get their act together and pay the debt off faster.

  • Wouldn't another answer be simply that it is advantageous to take the match and then immediately withdraw it? Say you are in the 35% tax bracket. Employer matches first 10k of savings. You put 10k into the 401k, your employer puts another 10k in. You immediately withdraw it, pay 35% + 10% penalty so 7k in taxes + 2k penalty. You end up with 11k cash in hand vs 6.5k if you just took the original 10k as income. Now you can pay off your loan by 11k instead of 6.5k. – David Jacobsen Aug 19 '16 at 12:54
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    @DavidJacobsen Two things prevent this. First is 'vesting period' the other is the early withdrawal penalties. Each company typically has a vesting period for every deposit, or for the account as a whole. So if you leave the company before the vesting period ends, you do not take the unvested balance with you. The penalties are fairly severe for early withdrawal. The withdrawal counts as income for the tax year when it is withdrawn, AND there is a 10% penalty in addition. So in a 25% tax bracket, you end up paying 35% of the withdrawal in taxes and penalties. – Xalorous Aug 19 '16 at 13:11
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    @JoeTaxpayer Also, there's the fact that you can't take money from your bank and put it in your employer matched 401(k). The money has to enter through a payroll deduction. Additionally, they typically implement the matching percentage based on the payroll earnings for the pay period. So, if you earn 1000 in a week, and they match 6% per pay period, they'll match $60 in that week. So even if you deposit the entire check into 401(k), they'll only match $60. So you can't deposit half your check for 3 or 4 months then none of it the rest of the year and receive 6% of your salary in matching. – Xalorous Aug 19 '16 at 13:27
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    @JoeTaxpayer In the credit card example, the debtor starts with a net worth of $-50k. The debtor has two investment choices assuming he will dedicate the same amount regardless of the option he chooses: A) repay his credit card at the 10 year rate ($901) and invest the balance ($239) with 100% match in his 401k OR B) repay his credit at the 6 year rate ($1140). In A), at the end of 6 years, the debtor's debt is now $30,670 and he has accumulated $41,384 in his 401k (assuming 6% ROI) giving him a net worth of $10,713. In B), the debtor has paid his debt off and has a net worth of $0. – Eric Aug 22 '16 at 1:05
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    @JoeTaxpayer I think this is where you get your comparison between the debt remaining and the accumulated value. It was not clear to me without doing the numbers myself that your base case (Plan B) is that all debt will be paid off so to do better than this with Plan A, the debtor must reach a positive "net worth" by earning more than debt remains a the end of 6 years. – Eric Aug 22 '16 at 1:09
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Whether or not it is logical probably depends on individual circumstance.

When you take on (or maintain) debt, you are choosing to do two things:

  1. Pay a fixed cost for immediate cash flow
  2. Restrict future cash flow in exchange for immediate cash flow

The first is clear. This is what you describe very well in your answer. It is a straightforward analysis of interest rates. The fixed cost of the debt can then be directly compared to expected return on investments that are made with the newly available cash flow. If you can reasonably expect to beat your debt interest rate, this is an argument to borrow and invest. Add to this equation an overwhelming upside, such as a 401k match, and the argument becomes very compelling.

The second cost listed is more speculative in nature, but just as important. When you acquire debt, you are committing your future cash flow to payments. This exposes you to the risk of too little financial margin in the future. It also exposes you to the risk of any negatives that come with non-payment of debt (repossession, foreclosure, credit hit, sleeping at night, family tension, worst-case bankruptcy) Since the future tends to be difficult to predict, this risk is not so easy to quantify. Clearly the amount and nature of the debt is a large factor here.

This would seem to be highly personal, with different individuals having unique financial or personal resources or income earning power.

I will never say someone is illogical for choosing to repay their debts before investing in a 401k. I can see why some would always choose to invest to the match.

  • Excellent explanation. Many people forget about risk when just looking at the interest rate numbers. But if I lose my job tomorrow, I'd have rather spent a short amount of time aggressively paying down debts (reducing "future cash flow to payments") than having a little bit fatter 401k. A key here is aggressively for a SHORT amount of time. It's sort of ridiculous to skip out on investing in your 401k for 6 or 8 years to get out of debt. – Ogre Psalm33 Aug 30 '16 at 13:27
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If your plan permits loans, deposit enough through the year to maximize the match and then take a loan from the plan. Use the loan portion to pay your student loan. Essentially you have refinanced your debt at a (presumably) lower rate and recieved the match. You pay yourself back (with interest) through your payroll. The rates are typically the prime rate + 1%. The loans are subject to a lesser of 50% vested account balance or $50,000 provision.

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    You got it. When I've suggested this, I've been attacked for suggesting the loan. But, as you know, you just captured a match and only borrowed those free dollars. Doing it for the student loan may be fine, but using it to wipe out 18% debt is brilliant. While changing the bad habits that got you there, of course. – JoeTaxpayer Aug 19 '16 at 21:07
  • I can't see why one would not provided the plan allows loans. For some background, I am a consulting actuary in corporate retirement. – Joseph Zambrano Aug 19 '16 at 23:54
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The other answers assumed student loan debt -- and for that, it's rarely worth it (unless your company only offers managed plans w/ really bad returns, or the economy recovers to the point where banks are paying 5% again on money market accounts)

... but if it's high rate debt, such as carrying a credit card debt, and the current rate of returns on the 401k aren't that great at the time, it would be worth doing the calculations to see if it's better to pay them down instead.

If you're carrying extremely high interest debt (such as 'payday loans' or similar), it's almost always going to be worth paying down that debt as quickly as possible, even if it means forgoing matching 401k payments.

The other possible reason for not taking the matching funds are if the required contributions would put you in a significant bind -- if you're barely scraping by, and you can't squeeze enough savings out of your budget that you'd risk default on a loan (eg, car or house) or might take penalties for late fees on your utilities, it might be preferable to save up for a bit before starting the contributions -- especially if you've maxed your available credit so you can't just push stuff to credit cards as a last resort.

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    Well, I did do the 18% math. And would agree that loanshark level debt is worth paying off first. – JoeTaxpayer Aug 19 '16 at 15:59
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Some have suggested you can put the money in the 401k then take a loan to pay off the student loan debt. Some things to consider before doing that:

  • Check your 401k plan first. Some plans allow you to continue paying on a loan if you leave the company, some do not. If you have to change jobs before you pay back the 401k loan, you may only have 90 days to completely pay the loan or the IRS will treat this as an early withdrawal, which means taxes and penalties. If you don't have another job lined up, this is going to make things much worse since you will have lost your income and may owe even more to the government (depending on your state, it may be up to 50% of the remaining amount). There are ways to work with some student debt loans to defer or adjust payments. There is no such option with a 401k plan.

  • This may change your taxes at the end of the year. Most people can deduct student loan interest payments. You cannot deduct interest paid to your 401k loan. You are paying the interest to yourself though.

  • It may hurt your long term growth potential. Currently loans on 401k loans are in the 4% range. If you are able to make more than 4% inside of your 401k, you will be losing out on that growth since that money will only be earning the interest you pay back.

  • It may limit flexibility for a few years. When people fall on hard times, their 401k is their last resort. Some plans have a limit on the number of loans you can have at one time. You may need a loan or a withdrawal in the future. Once you take the money out for a loan, you can't access it again. See the first bullet about working with student loan vendors, they typically have ways to work with you under hard circumstances. 401k loans don't.

  • Amortization schedule. Many 401k loans can only be amortized for a max of 5 years, if you currently have 10 year loans, can you afford to pay the same debt back in 1/2 the time at a lower rate? You will have to do the math.

  • When considering debt other than student loans (such as credit cards), if you fall on hard times, you can always negotiate to reduce the amount you owe, or the debt can be discharged (with tax penalties of course). They can't make you take money out. Once it is out, it is fair game.

Just to clarify, the above isn't saying you shouldn't do it under any circumstances, it is a few things you need to evaluate before making that choice. The 401k is supposed to be used to help secure your financial future when you can't work. The numbers may work out in the short term, but do they still work out in the long term? Most credit cards require minimum payments high enough to pay back in 7-10 years, so does shortening that to 5 (or less) make up for the (probably early) years of compounding interest for your retirement? I think others have addressed some of this so I won't do the math.

I can tell you that I have a 401k loan, and when things got iffy at my job for, it was a very bad feeling to have that over my head because, unlike other debts, there isn't much you can do about it.

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    A nice comprehensive answer. I'd agree 100%, know the rules of the plan. And run the numbers for worst case scenario. I deposit $4000 (net cost $3000) see a (vested) match, and borrow $4000 to pay my cards. I lose my job the next day. On the $8000, I owe $2800 tax and penalty, and still have $1200 cash. Add up the numbers, I still turned $3000 into $5200. I also would maintain there's a difference between taking a 401(k) loan and planning in advance to make deposits I otherwise wouldn't, and borrow the matched half back. – JoeTaxpayer Aug 20 '16 at 22:57
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One situation where it would be prudent not to contribute would be if expenses are so tight that you cannot afford to contribute because you need that cashflow for expenses.

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    A +1, as this might be the case, but as I commented elsewhere, to capture the matched funds, I'd find a way. Some time back, I followed a blogger who wrote "Deliver Away Debt", the guy delivered pizzas, got minimum wage but good tips. Old cliche - when there's a will, there's a way. I am coming from this position - retired pretty early, at 50, and when I look at our retirement balance, over 1/3 is from the matching funds. There's either a budget item to cut, or a way to raise a few extra thousand each year. – JoeTaxpayer Aug 19 '16 at 22:27
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    @JoeTaxpayer Sometimes life happens. This situation is definitely one to shorten as much as possible. – Xalorous Aug 22 '16 at 16:01

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