When you accept a job offer, one of the key benefits you may receive is an employer contribution to a 401(k) plan. See the Topic: Understanding How a 401(k) Plan Works. Companies typically match a given percentage of your own contribution to your 401(k) plan then the company will also put 4% into your plan. Basically your employer is adding to your salary.
Investing in Your 401k or Making Student Loan Payments
The challenge that many young graduates face is this: Is it better to allocate money to my 401(k) or use this money to pay off my student loan? Before we answer this question, let’s review some general financial principles.
1. Money you invest early in your career will have the greatest financial return for you in the future. Deferring payments into a 401(k) plan will have a dramatic impact on your future wealth. Learn more about our tips for maximizing your earnings and savings.
2. You need to make the required student loan repayments. If you get behind on your student loans or go into default on them you are ruining your credit. This will have a serious impact on buying a car or home. Learn more about what your repayment options are when you graduate.
Evaluating Your Financial Options
With these principles in mind, how do you decide on 401(k) allocation and student loan repayments? Here’s how:
1. Develop the mindset that you are going to continue to live as a student. You simply can’t go on a spending spree when you start getting paid a salary.
2. Max out the employer’s contribution to your 401(k) plan. Your employer is adding to your compensation and you need to take advantage of this.
3. Make the required repayment of your student loan and use strategies covered on the topic: Tips for Repaying Student Loans to limit the interest you pay. Consider refinancing your loans if you have a high enough income and credit score.
4. Decide how much additional money you have available after maxing out the 401(k) contribution and making the required loan repayment. Evaluate the financial impact of the 401(k)/student loan interest impact. You can see how much your monthly payment will be and your total interest amount in our student loan repayment calculator. You may want to test different scenarios.
5. Make the allocation decision that you think works best for you. Whatever you decide, do this prior to January 1 so you can make the necessary adjustments in your benefits/repayment schedule.
Our Advice on Making the Right Financial Decision
The key thing to all of this is that you have to be serious and thoughtful about how you think about your financial future. 401(k) allocations and student loan repayments are critical decisions, and they have to be made early in your career.
At the very least, you should pay your required monthly payment on your student loans and contribute enough to take advantage of your full employer match for your 401(k). If you have extra cash, you should put more money toward your student debt if you have a high interest rate (e.g. 5% or higher). If you have a low interest rate, it may be best to put more money into your 401(k) to take advantage of the years of compound interest growth. Leave your comments below on how you handled this situation.