The idea:
For some of those paying down debts, it would be better to reduce their payments and put more into their pre-tax
retirement accounts beyond the employer match.
When it should be done:
Start with the maximum interest rate on a loan that you would not pay down. Lets say the rate is 3%.
Take your take marginal tax rate and subtract your predicted future marginal tax rate. Lets say 37% (Fed 25% + State 5% + Social 7%) and 20% (Fed 10% + State 5% + 5% future hike). So you gain 17% using a pretax account.
If you have a 6% loan you are paying off then you shouldn't payoff the loan faster than five years (17/(6-3)) until you are maxing out your pretax account or no longer paying a 25% marginal federal tax rate.
I was wondering:
- Do you agree with the basic idea?
- What would your numbers be?
P.S. Before you ask, the maximum interest rate you select should take care of the expected future returns and discounting for future value. And I could have saved a couple thousand dollars if I'd thought of it a couple years earlier.