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Should I max out my 401(k) contributions or make principal payments on student loan debt?

I am 25 years old and currently putting about $6,000 per year into my 401(k). Between my wife and I, any extra income goes towards principal payments on $90,000 of student loans. Should I max out my 401(k) contributions for a certain number of years to boost the size of my 401(k) while I am still young instead of putting it toward the extra principal payments on the student loans? Or should I continue to put the extra income towards the student loan principal and keep my 401(k) contributions how they currently are?

College Tuition, Debt, 401(k)
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July 2018

Congratulations on a great start to your retirement! Paying off your loan has a lot of benefits. But does your plan offer a match on your contributions? At $6K you are likely getting any match, but make sure you understand the specifics going forward as you get raises and promotions. There are various formulas, but any match is essentially free money. Maximize your match first. Make sure you are considering any retirement plans your wife has access to. Consider your benefits collectively as well as independently.


Here are some other important reasons and related concepts that dig into your question, that may improve your financial health and retirement planning.

As your debt is paid off, mentally partition and budget those payment amounts towards retirement savings or long-term purchases on things such as a down payment on a home.

Paying off loans improves your debt to income ratio which can improve your credit scores and ability to get better home and auto loans and better rates on credit cards.

Paying off debt is like earning the loan rate with zero risk. For example, take a 4% loan making only minimum payments, but there is money for savings or larger payments. You could place the extra money into a CD, but it will be practically impossible to get a risk-free return of 4% or higher. Therefore, you earn less than the loan is charging in interest. If you place the extra money into the markets or other risky assets, you may make a higher total return or a lower return than 4%. These higher risks are hard to justify versus Zero Risk because you could have equivalently earned 4%. Your net risky assets earnings after interest accruing in the loan are only the return over 4%.

Make sure you have an emergency reserve. Early withdrawals on your 401K face income taxes and a 10% penalty. There are cases where you can take a loan from your 401K but is rarely wise to do so. 3 to 6 months of your monthly spending needs should be in reserves. Explore things like CD’s if you don’t like the cash in your checking or savings account to earn a bit more interest.

Does your 401K plan have a Roth option? If your tax bracket is relatively low, consider some or all of your contributions into a Roth. You lose the current tax reduction, but don’t pay taxes on future withdrawals. (Employer matches are still regular 401K.) Working with a Financial Planner who does ongoing tax analysis can be of great benefit because your tax efficiencies can change over time between saving on taxes now or later. A Comprehensive Financial Plan has a lot of other benefits as well.

Hope this helps you build a better future! Happy to answer any further questions.

David Nash, CFA,CFP®


July 2018
July 2018
July 2018
July 2018