How do I calculate the benefit of contributing to 401K vs paying off consumer debt?
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I have a ~$15,000 loan with a 6% interest rate.
My company matches half of my 401K contributions up to 6%, and I am in a 25% tax bracket. I currently contribute 15% of my income to my 401K.
How do I calculate whether it's better to pay more toward the loan, or put more into the 401K?
My rough attempt at the math:
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X. Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save 0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
But I'm not sure if I'm making good assumptions.
united-states taxes 401k calculation debt
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up vote
1
down vote
favorite
I have a ~$15,000 loan with a 6% interest rate.
My company matches half of my 401K contributions up to 6%, and I am in a 25% tax bracket. I currently contribute 15% of my income to my 401K.
How do I calculate whether it's better to pay more toward the loan, or put more into the 401K?
My rough attempt at the math:
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X. Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save 0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
But I'm not sure if I'm making good assumptions.
united-states taxes 401k calculation debt
New contributor
Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago
add a comment |Â
up vote
1
down vote
favorite
up vote
1
down vote
favorite
I have a ~$15,000 loan with a 6% interest rate.
My company matches half of my 401K contributions up to 6%, and I am in a 25% tax bracket. I currently contribute 15% of my income to my 401K.
How do I calculate whether it's better to pay more toward the loan, or put more into the 401K?
My rough attempt at the math:
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X. Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save 0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
But I'm not sure if I'm making good assumptions.
united-states taxes 401k calculation debt
New contributor
I have a ~$15,000 loan with a 6% interest rate.
My company matches half of my 401K contributions up to 6%, and I am in a 25% tax bracket. I currently contribute 15% of my income to my 401K.
How do I calculate whether it's better to pay more toward the loan, or put more into the 401K?
My rough attempt at the math:
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X. Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save 0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
But I'm not sure if I'm making good assumptions.
united-states taxes 401k calculation debt
united-states taxes 401k calculation debt
New contributor
New contributor
edited 2 hours ago
Chris W. Rea
26.2k1586174
26.2k1586174
New contributor
asked 4 hours ago
JETM
1085
1085
New contributor
New contributor
Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago
add a comment |Â
Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago
Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago
add a comment |Â
2 Answers
2
active
oldest
votes
up vote
3
down vote
accepted
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X.
Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save
0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
With the 401k contribution there is an up-front tax savings, but the withdrawals will be taxed as ordinary income, so it doesn't make sense to ignore the tax on the 401k altogether.
At the end of the day, it's primarily about the employer match and the performance of your 401k. Your 401k could easily do better than the 6% interest rate on your loan, but the 6% interest is guaranteed. Giving up the 50% employer match to clear up debt at 6% interest makes no sense. What might make sense is reducing your 401k contribution to 6% to maximize the employer match and using the rest to pay down the loan.
Any analysis about which is mathematically better will hinge on assumptions about future tax rates, potential 401k growth rates, and number of years before you start withdrawing from your 401k. Personally, 6% is a significant enough rate that I would like to have it off my books sooner than later, even if the market is performing a little better than that, it's a sure 6%.
add a comment |Â
up vote
1
down vote
You are forgetting the company's match - that gives you an immediate 50% gain, which beats anything else, even ludicrous credit card interest rates.
Otherwise, you are right - once you take advantage of the maximum employer match, pay off your credit cards first, and don't rack them up again. Then start saving the max in 401k, then pay off consumer credits. And don't make any new ones.
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
add a comment |Â
2 Answers
2
active
oldest
votes
2 Answers
2
active
oldest
votes
active
oldest
votes
active
oldest
votes
up vote
3
down vote
accepted
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X.
Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save
0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
With the 401k contribution there is an up-front tax savings, but the withdrawals will be taxed as ordinary income, so it doesn't make sense to ignore the tax on the 401k altogether.
At the end of the day, it's primarily about the employer match and the performance of your 401k. Your 401k could easily do better than the 6% interest rate on your loan, but the 6% interest is guaranteed. Giving up the 50% employer match to clear up debt at 6% interest makes no sense. What might make sense is reducing your 401k contribution to 6% to maximize the employer match and using the rest to pay down the loan.
Any analysis about which is mathematically better will hinge on assumptions about future tax rates, potential 401k growth rates, and number of years before you start withdrawing from your 401k. Personally, 6% is a significant enough rate that I would like to have it off my books sooner than later, even if the market is performing a little better than that, it's a sure 6%.
add a comment |Â
up vote
3
down vote
accepted
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X.
Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save
0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
With the 401k contribution there is an up-front tax savings, but the withdrawals will be taxed as ordinary income, so it doesn't make sense to ignore the tax on the 401k altogether.
At the end of the day, it's primarily about the employer match and the performance of your 401k. Your 401k could easily do better than the 6% interest rate on your loan, but the 6% interest is guaranteed. Giving up the 50% employer match to clear up debt at 6% interest makes no sense. What might make sense is reducing your 401k contribution to 6% to maximize the employer match and using the rest to pay down the loan.
Any analysis about which is mathematically better will hinge on assumptions about future tax rates, potential 401k growth rates, and number of years before you start withdrawing from your 401k. Personally, 6% is a significant enough rate that I would like to have it off my books sooner than later, even if the market is performing a little better than that, it's a sure 6%.
add a comment |Â
up vote
3
down vote
accepted
up vote
3
down vote
accepted
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X.
Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save
0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
With the 401k contribution there is an up-front tax savings, but the withdrawals will be taxed as ordinary income, so it doesn't make sense to ignore the tax on the 401k altogether.
At the end of the day, it's primarily about the employer match and the performance of your 401k. Your 401k could easily do better than the 6% interest rate on your loan, but the 6% interest is guaranteed. Giving up the 50% employer match to clear up debt at 6% interest makes no sense. What might make sense is reducing your 401k contribution to 6% to maximize the employer match and using the rest to pay down the loan.
Any analysis about which is mathematically better will hinge on assumptions about future tax rates, potential 401k growth rates, and number of years before you start withdrawing from your 401k. Personally, 6% is a significant enough rate that I would like to have it off my books sooner than later, even if the market is performing a little better than that, it's a sure 6%.
Suppose $X goes to a 401K. After a year this grows to ~1.07 * $X.
Profit is ~0.07 * $X
Suppose rather that $X goes towards debt. I lose %25 to tax. I save
0.06 * %X on interest. Profit is 0.06 * $X - 0.25 * $X. Therefore it makes more sense to invest in the 401K.
With the 401k contribution there is an up-front tax savings, but the withdrawals will be taxed as ordinary income, so it doesn't make sense to ignore the tax on the 401k altogether.
At the end of the day, it's primarily about the employer match and the performance of your 401k. Your 401k could easily do better than the 6% interest rate on your loan, but the 6% interest is guaranteed. Giving up the 50% employer match to clear up debt at 6% interest makes no sense. What might make sense is reducing your 401k contribution to 6% to maximize the employer match and using the rest to pay down the loan.
Any analysis about which is mathematically better will hinge on assumptions about future tax rates, potential 401k growth rates, and number of years before you start withdrawing from your 401k. Personally, 6% is a significant enough rate that I would like to have it off my books sooner than later, even if the market is performing a little better than that, it's a sure 6%.
answered 3 hours ago
Hart CO
24k15872
24k15872
add a comment |Â
add a comment |Â
up vote
1
down vote
You are forgetting the company's match - that gives you an immediate 50% gain, which beats anything else, even ludicrous credit card interest rates.
Otherwise, you are right - once you take advantage of the maximum employer match, pay off your credit cards first, and don't rack them up again. Then start saving the max in 401k, then pay off consumer credits. And don't make any new ones.
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
add a comment |Â
up vote
1
down vote
You are forgetting the company's match - that gives you an immediate 50% gain, which beats anything else, even ludicrous credit card interest rates.
Otherwise, you are right - once you take advantage of the maximum employer match, pay off your credit cards first, and don't rack them up again. Then start saving the max in 401k, then pay off consumer credits. And don't make any new ones.
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
add a comment |Â
up vote
1
down vote
up vote
1
down vote
You are forgetting the company's match - that gives you an immediate 50% gain, which beats anything else, even ludicrous credit card interest rates.
Otherwise, you are right - once you take advantage of the maximum employer match, pay off your credit cards first, and don't rack them up again. Then start saving the max in 401k, then pay off consumer credits. And don't make any new ones.
You are forgetting the company's match - that gives you an immediate 50% gain, which beats anything else, even ludicrous credit card interest rates.
Otherwise, you are right - once you take advantage of the maximum employer match, pay off your credit cards first, and don't rack them up again. Then start saving the max in 401k, then pay off consumer credits. And don't make any new ones.
answered 4 hours ago
Aganju
18.9k22973
18.9k22973
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
add a comment |Â
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
If you think about it a while, an endless cycle of 18% debt would undermine even a 100% match over a long enough period of time. For a 50% match vs 6% debt? I agree 100%, donâÂÂt miss the match.
â JoeTaxpayerâ¦
4 mins ago
add a comment |Â
JETM is a new contributor. Be nice, and check out our Code of Conduct.
JETM is a new contributor. Be nice, and check out our Code of Conduct.
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Is 6% the maximum that they'll contribute, or the maximum contribution of yours that they will match?
â Hart CO
4 hours ago
@HartCO They will match up to 6% of my contribution at 50%.
â JETM
4 hours ago
So they'll pitch 3% max, I always struggle with best way to phrase 401k match.
â Hart CO
4 hours ago
Also, is your loan a fixed 6% or variable rate?
â Hart CO
3 hours ago
@HartCO Fixed rate.
â JETM
3 hours ago