Getting Personal
Participating in 401(k)
Question: My fiancée has about $40K in student federal loans outstanding and because of that, has yet to contribute to her company's 401k program. I think her company matches dollar for dollar up to $2000 and .50 cents up to $4000. What's the best "financial equation" to use to figure out how much to contribute to the 401k and how much to set up for monthly deductions for her student loan payments? DJ, San Francisco, CA
Answer: The simplest answer is that she should invest enough to take full advantage of the employer match. Warren Buffet, David Swensen, and any other investing superstar of recent decades can't come close to the kind of investment performance recorded by the match. Plus, most of the growth in a 401(k) plan doesn't come from investment earnings but from the match. (And that's why it's doubly devastating when employers reduce or eliminate the match.)
There are additional issues she could consider. For example, she could look at the interest rate she's paying on her student loans. She can put in more money than the match if she thinks she'll do better than that interest rate over time. She should also increase her contributions as her income grows.
Still, for now, the simplest equation is to "invest to the match."
10/20/09 by Chris FarrellSearch
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Comments (1)
October 20, 2009 10:45 AM PT
You can use an online mortgage calculator to find the difference between taking advantage of the employer match and making prepayments on the student loan. I used this one.
Assuming a $40,000 student loan at 8% interest with a 10 year term (without prepayment), if you pay an extra 4000 each year you'll pay off the loan in a little over 5 years and save $10,500.
I read your employer match as: if you contribute 4000, they'll contribute 3000. So over 5 years that is an extra $15,000 in contributions. The interest earned on your 401k contributions should make it even more advantageous.
It would take an interest rate of almost 11% to make the savings on the loan interest equal the additional contributions from the employer match.