Suppose you have $20,000 in student loans earning an interest rate of 6.8% per y

Question

Suppose you have $20,000 in student loans earning an interest rate of 6.8% per year. Upon graduation, you get a job that offers a 100% match on employee retirement contributions up to 3% of salary. If, for example, you make $50,000 and contribute $1, 500 (3% of your salary) then your employer will contribute an additional $1, 500 (3%). However if you contribute $1, 000 then your employer will only give you an additional $1, 000; and if you contribute more than 3% (say, $2, 000) your employer will still only give you $1, 500 (3%). Assume that you will earn a guaranteed 4% return on your retirement savings. What percentage of your income should you contribute to your retirement account? A. 0% B. 3% C. 6% D. None of the above

Explanation / Answer

Here the cost of student loan is 6.8% and return on retirement contribution is 4%. Since the return on retirement contribution is lower than cost of loan, it is advisable not to invest any amount greater than the maximum amount matched by the employer. Since the employer pays maximum 3% of monthly income, The employee should contribute only 3% of his income into retirement account to get the full benefit of matching by employer and use rest of the money to pre-pay the loan.

correct answer is option B. 3%.

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