Monday, January 21, 2008

Paying Debt & Missing Your Employer Match

If you read Dave Ramsey's Total Money Makeover, one of the things you'll hear him instruct readers to do is this:

...I am a math nerd, and I know the 100 percent match [from employers] is sweet. But I have seen something more powerful — focused intensity. If you are going to be gazelle-intense and do everything in your power to become debt-free very quickly, then stop your retirement plan contributions, even if your company matches them. The power of focus and quick wins is more important in the long term to your Total Money Makeover than is the math.

Here we find yet another instance where Ramsey and I disagree. But on this topic, my disagreement is ... well, relative.

What's that mean?

It means that if someone wants to delay retirement contributions until they've paid off their high (read: double-digit) rate debts, then I can go along with that pretty easily. This assumes, of course, that all extra money does, in fact, go toward debts, and not toward more dining out or a bigger home theater system or whatever.

Sure, missing out on an employer match is yucky. But I do understand when Dave talks about the "power of focus." It's real, and it matters. Postponing retirement contributions with, say, an initial fifty-percent return (supposing the employer matches @ fifty percent) so you can rocketship your way out of twenty-plus-percent interest-rate credit card debt may not make sense in strict mathematical terms, but I can understand doing it. The benefits of paying off high-interest credit-card debt, I would suggest, go beyond strict mathematics.

On the Other Hand...

However, Dave's response to a caller's question this last week — a question very pertinent to what I'm discussing here — about sent me out of my chair.

The call went something like this, as I remember:

Female Caller: Dave, my daughter just graduated from college with a degree in medicine, and she's doing her internship now. She's living at home with her father and I, and honestly, she's been very frugal with her money. Her only debt is student loans, but she has over $100,000 of them. She's earning just under $80,000 per year right now. She has a pretax retirement plan at work, and her employer matches her contributions at fifty percent. She's not yet started putting money in it. Our financial advisor says she should start contributing to it right away, but we've told her that she needs to pay off her loans first. What do you say?

DR: Your advisor is stupid. You know that?

Female Caller: (Laughs) Right. Well, we were thinking—

DR: No, look. She needs to pay the debts. Focus on the debts. Pay them off now. She's making great money; she's living at home with you guys; she needs to get those debts eliminated. At her age — earning that much cash with no expenses, really — forget the retirement plan and the matching. Make her pay off the student loans.

Okay. Deep breaths. Deep breaths.

I don't believe the woman ever told us what rates her daughter is paying on those student loans. But I bet you it's less than ten percent — maybe a lot less. Because the daughter's income is so high, the loan interest probably isn't tax deductible. Let's say she's paying eight percent on those loans.

So Dave's telling her to give up a guaranteed initial fifty-percent return on her investment via her retirement plan in order to speed up the payoff of a sub-ten-percent student loan.

I say this with all due respect:


My Thoughts on "Stupid"

First off, our young graduate's income puts her in (at least) a 25 percent tax bracket. So every $100 that she keeps out of her pretax retirement plan gives her, after taxes, only $75 to put toward her debt.

In the realm of net worth, that's a twenty-five percent haircut right there. "Thanks much!" says Uncle Sam.

Utilize the retirement plan, though, and she gets to keep that money ... and her employer ladles on the gravy, kicking in another $50. This brings her investable, plan-to-retire-with-dignity total to $150.

And keep in mind: For our young graduate, every missed contribution is a guaranteed fifty-percent return on her money which she cannot get back.

It isn't like saying, "Boy, I sure wish I could time-warp back to the late 1980s and invest in Microsoft stock!" Yes, that would've provided a fantastic return on your money. But in the late 80s, Microsoft's stock's meteoric rise was no guarantee — unless, of course, you could read the future.

With an employer match, there's no fortune-telling necessary. The fabulous return — just for setting aside some money — is written in stone.

Here's what I'd tell the caller: Your daughter needs to contribute enough to get the maximum match from her employer. After that, throw everything else at the debt.

At eighty grand a year, Young Grad is making roughly $6,666 per month. She could probably (legally) set aside up to fifteen percent of that, or $1,000 per month, in a pretax retirement plan. Her employer matches her contributions at a rate of fifty percent (up to six percent of income), so she'd need to invest twelve percent ($800) in order to get the maximum match ($400).

Here, in essence, are her choices:

  1. Save $1,200 bucks for the future, or ...

  2. Get $640 bucks to pay for the past.

Tell me again, Dave, since you're so fond of using the analogy: What's that about driving down the road, throwing hundred-dollar bills out your car window?


In my opinion, it isn't the financial advisor here who's "stupid."

Am I way off-base on this?

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— Posted by Michael @ 9:49 AM


I'm on your side. I like the caller's daughter was good about money in college and graduated just with student loans. I also moved back into my parent's house and started working. (The differences in these scenarios are money, I had a lot less debt, but I also made a lot less money.) At the time I started to work at my current workplace they did not have a matching retirement plan in place, but I was hitting my loan repayments hard (I survived on the money I had saved during my grace period of 6 months, overtime and other odd jobs like babysitting and teaching music lessons) but as soon as a plan got announced at work, I started contributing. I haven't stopped and it's been close to ten years now. (The student loans were gone in 4 years.)


Couldn't agree with you more specifically wrt the caller and wrt DR.

That daughter should do both: contribute towards retirement to meet employer match and tackle debt.

You bring up key point missing, which is, at what rate is the student loan debt? 4-6% then what's the rush? 18-22% then that's definitely a more urgent priority.

DR gets the "get out of debt" message right, but he oversimplifies in his message.


I absolutely agree, but most 401k plans have a match UP TO a limit, in my case it's 50% match up to 3% of salary, so if her 401k is like many others she'll not get $400/mo in gravy.


I agreed with your view 100% when I heard this originally and I still do.

This "free" money was an instant raise - parents should have pushed her this way. Forget Ramsey on this one.


I believe that Dave Ramsey usually quantifies that you are only stoping your retirement investing for less than 2 years.

If it's going to be longer than that he advises to keep up with the retirement investing and matching.

Also I think that most matching is up to a certain percent. Usually less than 10% of your income. I would say this person could afford to keep the match up to 10% then take another 40% and put on the debt while living off of 50% of her income. I don't know about you, but how many single, living at home people need more than $40,000 to live on per year?


Good grief! I'm pretty debt-phobic myself, and Dave has some good ideas, but he's certainly not all-knowing. In this case, his aversion to debt seems to be so strong that it has resulted in a knee-jerk "get rid of it at all costs!" Not contributing to a matched 401k so you can pay off debt a little quicker shorts you badly in the long run, and smacks of debt-phobic panicking. It's not like the lady in question is a 40+ year old displaced, obsoleted factory worker woth credit card debt, in dire danger of losing her house. It's not even like she'll just blow that 6%, either: 401k money is automatically taken out before you see it! It's on frikkin' autopilot!

Mike, your math is dead on. Let's assume 6% interest rate for the student loan. Assuming the 401k match ceiling is half of the first 6% she contributes, and that she's in a 25% tax bracket with no state taxes, she'll put $4,800/yr into her 401k but only "miss" $3,600 from her after-tax paycheck (a difference of about $300/month). A $100K, 10yr, 6% student loan costs about $33,500 in interest over ten years. Plugging $300 extra in would reduce that interest by about $9,500 and shave four years off the loan. By contrast, put just that $300 "missed money" into the matched 401K for those 6 years = $300 + $150 match = $450/month, or $5,400 per year. And that's without any tax-deferred interest; imagine what this could turn into with the magic of compounding interest 30+ years from now.

Dave's math skills were definitely off that day....

Anonymous Dragonlady
, at 1:24 PM, January 22, 2008  

Her interest rate is probably even lower than 8%. Dave is not a math nerd. If he were, he wouldn't make this mistake and so many others. He is so one tracked that he refuses to ever say that a low interest rate debt could ever make sense. I wrote about maximizing employer match in my blog. Dave makes the same bad argument about paying off your house first or investing. If you have a low interest load on your house (<9%) it really always make for sense, mathematically, to invest that money. He likes to ask people "would you take a loan out on your house to invest in the stock market?" to make a point. But there is a big difference to taking a HELOC on your house to invest, and using left over money after paying your mortgage payment to invest. I know he is really trying to keep his advice simple and geared for the lowest common denominator, but sometimes I can't stand it.


The only argument I have is with the 15%. The annual cap for contributions to a 401(k) for 2008 is $15,500, which is nearly 20%.

Otherwise... I'm nearly unhinged by the thought of debt, and will do just about anything to pay it off quickly. But I signed up for my employer's retirement savings plan as soon as I was eligible, and even when money was tight, I always contributed something.

So yeah. Bad advice, Dave. Part of staying out of debt is thinking ahead to future needs and planning for them. Retirement savings is a huge part of that.


I am not a DR fan. He's rude, obnoxious, and other than "get out of debt" seldom gives good advice. To many times I've heard him give bad advice to people because he simply didn't take the time to do the math.
I too have an employer who matches 50%. You simply cannot go anywhere else and beat that 50% return. I hope the caller's daughter realizes DR's mistake and takes advantage of this wonderful benefit.


I believe there is more to this than just the math. What we also need to factor in is human behavior. If the daughter modifies her behavior such that she gets out of debt quickly and never falls off the wagon then the loss on the match will likely be made up in a short time.

I haven't drank the kool aid but you have to understand and appreciate that Dave is trying to help people change behavior more than teach math.

Anonymous Anonymous
, at 1:00 PM, January 27, 2008  

If my employer offered this benefit, I would snatch it up in a heartbeat. It's silly not to.

** Comments Closed on this Post **

Thoughts on my personal finances, goals, experiences, motivations, and accomplishments (or lack thereof).

My financial life began turning around when I took responsibility for it.
— Dave Ramsey


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