Dave Ramsey advises people to not contribute to retirement accounts while repaying credit card debt. This advise seems sound because credit cards charge high interest rates and your investments may not make 10 or 20%. But is this idea still correct when there is a company match, after all an immediate 50% or 100% return is pretty hard to pass up?

### Your Choices

To simplify a bit I want to look at two choices: You could put $1000 dollars in 401K with a 50% match or you could take the $1000 pay 25% in taxes and put the remaining $750 toward your credit card. After your credit card is paid off you take the monthly payment and contribute that much to your 401K and getting the employer match and a tax deduction. Because of the tax break you can afford to contribute 25% more without lowering your income. After five years which option earns you more?

### And the Winner is…

It depends on the interest rates, but here is a graph that simplifies a lot of complex math:

It turns out that the expected interest rate on the credit card has to be a few percent higher than the expected interest rate from the 401K. I tabulate the numbers below, an example if you expect to get a 6% return on your 401K investment then you should pay off a credit card that is 8.72% or higher.

Interest 401K | Interest Card |
---|---|

1.00% | 3.59% |

2.00% | 4.62% |

3.00% | 5.64% |

4.00% | 6.67% |

5.00% | 7.69% |

6.00% | 8.72% |

7.00% | 9.74% |

8.00% | 10.77% |

9.00% | 11.80% |

10.00% | 12.82% |

### What about 100% Match or 0% Match?

The results are the same- I was actually a bit surprised but the match % cancels out of the calculations. The above chart does not depend on how much your employer matches- or if they match at all!

### The Math

For anyone interested, I can send you a spread sheet with the calculations. It’s a bit of a mess because the solution can’t be solved algebraically. You make an initial guess and do repeated iterations that get an ever improving result.

I am really surprised that the match doesn’t matter. Surely it’s like getting a super-high return on investment (e.g. 50% match = 12.5% return for 4 years, or 5% for 10 years)?

How can it cancel out?

I thought the match would win; working out the math was instructive! The trick is that if you contribute to a 401K today you get a match on your contribution. When you contribute later with money freed up from paying off the credit card it is matched at the same rate.

The equation is of the form:

(1+M)*Y = (1+M)*X

Where M is the matching percentage, Y is the return for today’s contribution and X is the expression for the return from the future contributions. Divide both sides by (1+M) and it drops out of the equation. That works for any M other than -1, but then I don’t think negative 100% matches are realistic cases!

-Rick

Hey Rick,

Thanks for leaving the comment at my website. You bring up an interesting point and it’s definitely got me intrigued. My belief has always been to put enough money to get the match, then to handle any high interest credit card debt. Would it be possible for you to send me your spreadsheet? I feel like I must be missing some information. Thanks.

BE CAREFUL! If you are already saving enough to get your full company match, then this approach will not help you.

This is only applicable to people who are currently not saving enough to get the full match. The trick is that you are foregoing a small company match today, to get a larger company match tomorrow (once the debt is paid off).

If you are saving enough for the full company match today, then you will not be able to use the ‘trick’ of getting a company match on the money you eventually save by not having a CC payment.

Tread carefully, and run your own numbers — always.

BG,

You make a good point- near the match limits the math changes a bit and you will need a bit higher CC rate. I’ll dig up the spreadsheet I used and calculate the interest rates for the LAST $1000 you could contribute. I calculated the first $1000 because it seemed a more likely circumstance… and it doesn’t need a 3D graph to display!

-Rick

Ace,

I will email you the spreadsheet. I was surprised myself- I thought it would require a much higher interest rate to overcome the power of the match. The real trick is that future contributions are matched at the same rate. So until you reach the limits the match % cancels out of the equation.

-Rick