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It’s no secret that I love reading about personal finances on Reddit (r/personalfinance). Recently, a 33 year old posted a question about paying off student loan debt. He wants to pay off his $47K student loans by 40 and he makes about $71K.
He can afford to pay an extra $944 per month ($1300 per month) to pay off the student loans by March 2021 (estimated 3.5 years). In my response to him I recommend that he temporarily stop investing 15% ($888 per month) into his 401K and add it to the student loan payment. By paying $2188 per month) the debt will be cleared by October 2019 (1 year).
His response to me was “I am already behind on my retirement at my age so I can’t afford to completely stop contributing.” While I understand society tells us we must invest in retirement immediately, I know from experience that delaying the 401K contribution by one year will not result in a lifetime of poverty in retirement for the guy.
Why I didn’t invest in my 401k for 5.5 years
At 26 I decided not to contribute to my 401k and passed on the employer match of 5% (after 1 year) to focus on becoming debt free. Dave Ramsey advises readers and listeners to temporarily stop contributing to their retirement while getting out of debt. While the advice sounds crazy, it’s not. If you follow than plan, debts are paid off within 2-3 years.
Trust me when I tell you I though it was crazy advice the first time I heard it, but it works out. It’s not as detrimental to our financial future as people think.
Since I don’t have all the details to calculate Mr. Reddit’s situation I will use my own as an example. I will compare the outcome of both decisions, taking and not taking the match, to see what the projected overall impact is for my financial future.
- Age = 26
- Salary = $71,500
- Employer Match = 5% or $298 per month (after year 1)
- Max Retirement Contribution = 15% or $894 per month
Scenario #1 – Get the Match
Following Mr. Reddit’s approach I would have started contributed 5% of my income ($298 per month) to take advantage of my employer match at the age of 27 (company doesn’t match during 1st year). Since I had debt and no emergency fund, I would only contribute enough to get the match for 11 years. This is how long it would take me to pay off debt and build 3-6 month emergency fund. Finally, in year 12, I would start to maximize my retirement by increasing the contribution to 15% ($894 per month) to my retirement.
With this approach it is projected that I would hit $1M at age 54 and $3,250,777 by age 67.
Scenario #2 – Skip the Match & Pay the Debt
I didn’t contribute to the 401K during the six years it took me to pay of my debt and build my 3-6 months living expenses. In year 7, (32 years old) I started investing 15% ($894 per month) into my retirement and taking advantage of the math.
With this approach I am projected to hit $1M at 55 years old and $2,979,397 at 67.
By choosing to become debt free in the early years and not taking advantage of the employer match it is projected that I will away from $271,380 at age 67. I don’t know about you, but when I am sitting on $3M, $271K isn’t as big of a deal.
Today it may seem like you are walking away from so much money by not taking the employer match at every step on the journey to financial peace, but in reality the impact on you retirement is small. A few more things to keep in mind that are not taken into consideration:
- You will get raises which will increase your monthly contributions over time.
- You will have additional discretionary fund to invest in other wealthy building opportunities, like real estate, franchises, your own business and much more.
Don’t let this be the variable that keeps you up at night. Get rid of the debt, so that when something negative happens you do not have to worry about necessities like food, housing, transportation and clothing.
What do you think? Did you think the difference between the approaches would be bigger or smaller? Which approach are you most likely to take?