Stopping 401k to pay debt?

[jd68]

I just want to deal with one scenario here. Let's ignore any other factors for now. I'd like to pay off my student loans totaling around $110k as quickly as possible, or at the very least knock out the two high interest ones as quickly as possible, those two also have the highest balance.

I currently contribute 3% to my 401k and get a match. That amounts to approx $160/mo averaged over the year.

Currently the target loan is $30,264 at 13.375% on 15 year repayment. Payment is around $400/mo. min and only been paying for a few months. Paying minimum I would be done in Dec 2026 after paying over $40k in interest.

If I add that $160/mo to it, which after taxes would be ~$128, it would be paid off in 2019 paying $19k in interest.

I can realistically throw another $300/mo or so at it with no effect on quality of life or savings/EF. With only $300/mo extra it would be paid off Jan 2017, paying $11.5k interest.

Doing both ($428/mo) would have it paid off in Dec 2015, paying $9k interest.

---Second high interest loan---
At that point the whole payment could then be thrown into the next highest interest loan of $35k at 11.625% for a total payment of $1,248/mo beginning Jan 2016 when that loan would have a balance of $31,032.26 after paying only the minimum to that point, having cost $16k in interest up to that point with a projected total cost of $40k.

This would make the second loan paid off in Oct 2017 instead of Dec 2026. Total interest cost on it would be $19k instead of the original $40k.


At this point my remaining loans would have an interest rate ranging from 4.5% - 6.8% so I would resume 401k contributions to get my full match, funnel the rest into the remaining lower interest debt. After becoming debt free, aside from mortgage, I would assume it would be time to max out 401k contributions in the following years, which would still be cheaper than paying those loans but investing in myself.

Just a scenario I was considering. Thoughts on stopping 401k contributions (but leaving existing investments alone) to expedite debt repayment and lower monthly debt related expenses more quickly? Is this a good or bad idea? Why?

[mndtrp]

Stopping contributions to your retirement now would result in you missing out on several years of compounding. You have the cash flow to do both, and you could also put any bonuses or tax returns towards your debt.

Also, you state once your student loan is paid off, you would put the money towards your retirement. I know your plan is to buy a house. How likely are you to actually put more towards your 401k, as opposed to putting it towards your house?

[Greebo]

If it's really going to take 5 years to pay off those loans - if you're going to get no raises, etc during that time, then I would go ahead and contribute to the 401k - don't miss that much compounding - and then focus on the loan debt.

[hmcart]

dont stop the 401 k. I did and I regret is now. I started back about a year ago. You dont want to miss out on that.

[jd68]

I'm still young, so several decades until retirement. This early in the game I'm thinking losing the compounding may be the lesser financial loss than paying the interest on those two high interest loans.

By doing this possible plan, of not contributing to my 401k until October 2017 I would be saving $52k in interest on student loans. I would lose $11.5k company match, plus $4,709 in returns compounded at 4%. So total of roughly $28k lost over 7 years, $16.5k would be free money. Year to date I've lost almost 10%, so I've been LOSING money. I have the money in low-medium risk funds offered under the plan.

So I'd be sacrificing $28k from the 401k over 7 years, vs paying $52k in interest on the loans. At year 7 I'd have about $850-ish/mo freed up from those two loans. Assuming my current pay (in 1-2 years I expect to be making at least another $15k, let alone 7 years from now), at that point doing just the minimum to get the match, contribute 6% and get 5% match, would cost me $3,774/yr or $315/mo... Leaving $535 to spend on the other loans or anything else.

After all loans are paid, maxing out my 401k each year would cost little more than my current student loan minimum payments. I'm thinking an IRA or other investments might be a better use of that money at that point though, for greater flexibility. Just contributing enough to 401k to get the maximum match (free money). If I maxed out my 401k to "catch up" I'd be looking at 22% contribution for under 3 years to be where I would be at over the course of those 7 years + additional contributions and earnings at 4% over the 2-3 years to catch up.

As for actually putting the student loan payments towards retirement after they're paid off as opposed to home improvements... I find that quite likely. I don't want to be in this state forever, 10-15 years and I might think about moving somewhere with a lower cost of living and warmer climate. No sense putting a fortune into a home I won't be staying at until I die. Just maintain and any big ticket improvements would only be when major items fail and need to be replaced. I won't be getting married until this debt is paid in full. In my current financial state no woman in her right mind would consider me marriage material. Well maybe if she was rich and I was just that charming or interesting, but I'm not so that won't happen.

The numbers, when run this way, seem favorable to this plan of just attacking and catching up on retirement afterwards. Even contributing to retirement at a lower rate than my student loans I'd have "extra" money for fun things or other projects and still be able to contribute many times what I'm contributing now... So it would still seem to be a benefit to quality of life sooner, and to increasing retirement savings.

What about a more optimistic projection of the market? Is that feasible? What would your more optimistic rate of return be and where would that put me in each scenario? Do you think my math is no good and I'd actually be losing money by going this route? I don't mean to be a pain with all the scanarios and numbers... I'm just trying to make the best plan for myself, which is the numbers look good I will stick to.

[ladytoysdream]

Glad you did the number crunching.
My first initial thought was that you would be ahead by paying the student loans off first. The faster you pay off the loans, the sooner you can get back to 401 thinking.
But with the economy the way it is, maybe you will have to rethink your long range 401 plans.
You push the pencil a lot....that is a good thing

[monkeywrangler71]

Are you considering how much those missed 401k contributions would have continued to earn for the next 40 years?

Never fall into the trap of thinking that you have lots of time to save for retirement. The earlier you start, the less you have to put in. Put off retirement savings and you will find yourself at 40 years old before you can blink, needing to contribute 40% of your income for the rest of your working life just to catch up.

You never get a second chance to start saving early. Find something else to cut.

[jd68]

ladytoysdream, I just want to be sure I make a plan based on numbers and not hearsay. Lots of math, but it's kind of fun actually.

monkeywrangeler71, with my numbers there is no lost 401k contributions or income, as it would be made up in years 7-9 for less than I'd be applying towards my student loans for those first 7 years. That would put me caught up on my 401k by year 9 assuming my income stays the same, less if (when) it increases. Unless my reasoning is wrong, having the same amount in the 401k at year 9 is irrelevant of how it got there, but I'd be saving tens of thousands in interest on the student loans in the meantime?

[jd68]

Just quick math off the numbers I mentioned previously it looks like $10k-$20k ahead (interest avoided) by year 9 when 401k is where it would be if I continue like I am now, but I'd have two loans totaling $65k knocked out that I'd have 6 years left if I paid minimums and continued as I have been the past few months.

[ladytoysdream]

ladytoysdream, I just want to be sure I make a plan based on numbers and not hearsay. Lots of math, but it's kind of fun actually.

I have a math brain. I like playing with numbers myself.

I am trying to push the pencil all different ways, so the hubby can early retire at 62 from his full time job. It's not going to be easy but it's what the man wants. I want a workable plan based on solid numbers. He's already dreaming about working part time

[Telephus44]

If you want to play around with a savings calculator, I use this one:

Compound Savings Calculator

FWIW, I still think it's a lousy idea. Compound interest is more powerful towards the end, it's easy to discount it in the beginning and harder to play catch-up later. Of course, personal finance is just that - personal. My personal financial goals are wealth building. It appears that yours are more debt avoidance.

[Greebo]

I'm still young, so several decades until retirement. This early in the game I'm thinking losing the compounding may be the lesser financial loss than paying the interest on those two high interest loans.

No, the compounding goes on and on, while the interest gets smaller over time. The reason one stops the 401k in TMMO is for motiviation - but even DR OCCASIONALLY tells people that will take more than 2 years to get out of BS2 to keep investing (2 yrs 1 day he'll say suck it up but much longer and he'll start to change position)

By doing this possible plan, of not contributing to my 401k until October 2017 I would be saving $52k in interest on student loans. I would lose $11.5k company match, plus $4,709 in returns compounded at 4%. So total of roughly $28k lost over 7 years, $16.5k would be free money. Year to date I've lost almost 10%, so I've been LOSING money. I have the money in low-medium risk funds offered under the plan.

11.5k+4709 after 5 years is the starting point to figure out what you would lose long term giving up 5 years of investing. You're 26. In 5 you'll be 31, so assuming retirement age of 70 (thank you Federal Debt) that's call it 40 years of investing time your 401k won't be building on top of that 16209, which amounts to $80,000 lost.

Now if you adjusted your 401k to be positioned in funds which have higher rates of return over the long haul (but which may be more volatile, which you can handle at your age), say you go to 8% average over 40 years (that could be up 20 down 16 from year to year, its the long term that matters though), then you're up to $393k lost.

Since you're ONLY putting in 3% to get the match, and since it IS 5 years, I think your better option is - adjust your contributions into more aggressive funds and keep investing 3%. Long term the losses will cancel out. Remember, retirement is the LONG game. Looking only 5-7 years out is still short term in finance.

In my current financial state no woman in her right mind would consider me marriage material.

You're kidding, right? Being broke now isn't nearly so important to a woman (a WOMAN, not a GIRL) as where you're headed.

You should ask Ceashels what MY financial position was when we met.

What about a more optimistic projection of the market? Is that feasible? What would your more optimistic rate of return be and where would that put me in each scenario?

4% is just keeping up with inflation. Even in this down economy in my aggressive funds, while dodgy the last couple years, the long term return rates are still better than that. One of my funds was founded in 1990 and since then has averaged 12% a year over the LIFE of the fund, even though the last 5 years are down, that's a reflection on the market not the fund. Give the market a few more years to rebound (housing is still in a bad way right now, foreclosures still at a peak thanks to adjustable mortgages coming due) and we'll see more regular gains again.

In many ways, buying into the market now is getting in while the stocks are on sale.

[Ceashels]

You should ask Ceashels what MY financial position was when we met.

It took quite a while for Greebo and I to put our finances on the table. But once we did and he found out I wasn't going to run away, we laid out a plan of attack on his debt. There were several bumps, pot holes and ditches along the way and it wasn't until Dave Ramsey that we were really able to balance life and not just pay down the debt but make the most of our savings.

If I were materialistic or a spender I would have looked at his finances and thought "He can't afford me" but that never entered my head. "He can't afford himself," that's was a different story. LOL But as an adult, saver, I could see the potential of what the future could hold and I was willing to work for it with him.

As a partner in life I wouldn't be worried about the amount of student loan debt as much as I would be concerned with consumer debt and spending/saving habits.

The "right" woman isn't going to turn you away because of debt but will work with you to help you get out of it. And I would hope that you wouldn't turn the "right" woman away because she had student loans either.

So be careful, you might find the "right" woman who is in her "right" mind and live and love happily ever after working towards shared goals.

[jd68]

No, the compounding goes on and on, while the interest gets smaller over time. The reason one stops the 401k in TMMO is for motiviation - but even DR OCCASIONALLY tells people that will take more than 2 years to get out of BS2 to keep investing (2 yrs 1 day he'll say suck it up but much longer and he'll start to change position)


11.5k+4709 after 5 years is the starting point to figure out what you would lose long term giving up 5 years of investing. You're 26. In 5 you'll be 31, so assuming retirement age of 70 (thank you Federal Debt) that's call it 40 years of investing time your 401k won't be building on top of that 16209, which amounts to $80,000 lost.

I don't understand this, because in year 9 I would have the same amount in my 401k as if I continued contributing as I am now and paying the debt more slowly. At that point I would have made up for the lost compounding over those years of not contributing, while avoiding $52k in interest. Subtract the lost earnings from the 401k over those ~8 years, and I'd still have paid in the ballpark of $10k-$20k less out of pocket at year 9... But would have my 401k at the same dollar amount as if I had continued my current 3% contribution, and would still be paying student loans for another 6 years if I did the bare minimum on those. If I was getting a 14%+ return then it would make sense.

I guess what I'm not understanding, is how does contributing more slowly to 401k over 8 years vs. not contributing but adding some huge contributions at the end affect the return on those investments (dollar amount) I would get in year 10? I think that dollar amount would be the same in year 10, given the same total fund balance at year 9. If I'm right on that, then this plan of attack could save me $10k-$20k in interest. If I'm wrong, then there is another set of numbers that might negate that $10k-$20k savings.

Now if you adjusted your 401k to be positioned in funds which have higher rates of return over the long haul (but which may be more volatile, which you can handle at your age), say you go to 8% average over 40 years (that could be up 20 down 16 from year to year, its the long term that matters though), then you're up to $393k lost.

Since you're ONLY putting in 3% to get the match, and since it IS 5 years, I think your better option is - adjust your contributions into more aggressive funds and keep investing 3%. Long term the losses will cancel out. Remember, retirement is the LONG game. Looking only 5-7 years out is still short term in finance.

Interesting, as I've thought about this too. Some of the people who have had their money in more aggressive funds have lost a lot more than 10% that I've lost this year. This isn't relevant at my age though? Take the discounted stocks and don't worry about the losses for now? I'm not a gambler, but I have considered it may be a better option, as I'm far from retirement. I don't really want to give up the free money of the match, but even considering the free money and the growth it still looks cheaper to forfeit that. Unless of course the market makes a strong rebound in 4-6 years, then I would have shot myself in the foot and catching up would take longer than 2 years. Predicting the future isn't easy.

[Greebo]

I don't understand this, because in year 9 I would have the same amount in my 401k as if I continued contributing as I am now and paying the debt more slowly. At that point I would have made up for the lost compounding over those years of not contributing, while avoiding $52k in interest. Subtract the lost earnings from the 401k over those ~8 years, and I'd still have paid in the ballpark of $10k-$20k less out of pocket at year 9... But would have my 401k at the same dollar amount as if I had continued my current 3% contribution, and would still be paying student loans for another 6 years if I did the bare minimum on those. If I was getting a 14%+ return then it would make sense.

Compounding gets better and better the longer its in play and the higher the rate of return.

Forget 14% - even going from 4% return to 5% return you'll see orders of magnitude increases in the numbers you get from compounding. You may only be getting 4% now but I bet your 401k can be adjusted to be in more aggressive funds which have higher highs and lower lows but a higher OVERALL long term return rate.

But for compounding to work the money MUST BE THERE.

Meanwhile your student loan debt has a decreasing cost as you continue to pay it down. As the balance lowers each month, the interest cost each month also lowers, so more and more of your fixed payment amount goes to principal.

I guess what I'm not understanding, is how does contributing more slowly to 401k over 8 years vs. not contributing but adding some huge contributions at the end affect the return on those investments (dollar amount) I would get in year 10?

Junior's Clubhouse - very simple example but makes the basic point

With compounding, given enough head start, someone coming in later making even larger payments can often not "catch up" to where the person who started early, like at your age, ends up.

I think that dollar amount would be the same in year 10, given the same total fund balance at year 9. If I'm right on that, then this plan of attack could save me $10k-$20k in interest. If I'm wrong, then there is another set of numbers that might negate that $10k-$20k savings.

Try your numbers with 5%. Even better, show your work - PM me and I'll give you my email and you can send me your spreadsheets. I'll look over what you're doing and see if you're missing anything. Right now with this prose discussion and only soft numbers its very hard to really do forecasting beyond the basic - but I still wager your better interests lie in investing early - given the 5 year delay otherwise.

Interesting, as I've thought about this too. Some of the people who have had their money in more aggressive funds have lost a lot more than 10% that I've lost this year.

Nah they haven't - not unless they sold and got out.

They - *I* - lost relative VALUE. I still have the shares. The value of the shares will go up again - and meanwhile my quantity of shares is still increasing thanks to investments and dividend re-investments.

LOSSES AREN'T REAL until you sell the shares. Neither are gains for that matter.

This isn't relevant at my age though? Take the discounted stocks and don't worry about the losses for now?

They're not really relevant at any age, unless you're at the point where you're selling.

I'm not a gambler, but I have considered it may be a better option, as I'm far from retirement. I don't really want to give up the free money of the match, but even considering the free money and the growth it still looks cheaper to forfeit that. Unless of course the market makes a strong rebound in 4-6 years, then I would have shot myself in the foot and catching up would take longer than 2 years. Predicting the future isn't easy.

You're still thinking short term.

LONG term - you're 26 so call it 45 years - this is what the market is going to do:

(DOW 1900-2009)
There are some big ups and big downs, sure, but OVER ALL the market grows, and your compounded returns in the market - especially getting in early at your age - will grow phenomenally.

What you want to look for in your 401k are funds that have long histories - Inception dates > 10 years old - with GOOD rates of return *since inception*. In this market, that may mean that the 10 and even 5 year numbers suck, but the INCEPTION rate gives you a better idea overall of what to expect *long* term.

You're looking at 40+ years before you touch this money - you can afford to let it bounce around a bit - but getting the shares now means you're in "on the cheap" as it were.

I mean - unless you think that in 40 years the entire US economy will collapse, we'll have no businesses developing new products, no services, etc. But if that happens, well, no amount of cash on hand or eliminated debt is going to matter anyway.