Pay off student loan vs. retirement savings

Discussion in 'Off The Beaten Track' started by Gazpacho, Jul 8, 2011.

  1. Gazpacho

    Gazpacho Well-Known Member

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    In order to pay for my undergraduate and graduate education, I took out almost $100,000 in student loans. All the loans were federal Stafford loans, about 60% unsubsidized (interest accrues during school) and 40% subsidized (interest does not accrue during school).

    The interest rate is fixed at 6.8%, and the standard repayment period is 10 years.

    My salary covers my regular expenses as well as the standard student loan repayment. Assuming I don't lose my job and my regular expenses stay steady, I have a little money left over.

    Is it better to use this money to pay off the student loan debt, or should I put it in a retirement account? My employer will only match up to $1500 per year for retirement, and only if you've worked there five years, so that's not a deciding factor.

    My financial situation is otherwise healthy. This is the only debt I have, no credit card debt. During school, I contributed to a Roth IRA using money from the student loans in order to take advantage of my low tax bracket as a student. That account now has about $20,000, so I have an emergency stash.
     
  2. Debbie S

    Debbie S Well-Known Member

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    I guess the economic consideration is the rate of return your retirement fund would get over the rest of the period you would pay back your loan. If you'll earn less than 6.8%, then it makes sense to pay down your debt. If you'll earn more, then choose the retirement fund option. But long-term rate of return is hard to predict (how many years left do you have on repaying your loans?) and remember that your assets, assuming a steady rate of return, do accumulate over time. The earlier you start saving and the more you put in, theoretically, you'll have much more at retirement than someone who didn't.

    You might be better stashing the extra money in some short-term investment that you could easily get to in an emergency (job loss, medical event). You don't want to tap into your Roth IRA except as a last resort.
     
  3. MacMadame

    MacMadame Cat Lady-in-Training

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    Personally I think you have a legal and moral obligation to pay off your student loans.
     
  4. bek

    bek Guest

    The person is still making student loan payments. She/he is just wondering if they should pay extra on their student loans, or save some of it.

    I actually think maybe half/half???
     
  5. MacMadame

    MacMadame Cat Lady-in-Training

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    Oh, nevermind then. I read the message a couple of times and didn't catch that so clearly I have stupid head today. :lol:
     
  6. Aceon6

    Aceon6 Get off my lawn

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    My brother is an investment advisor/broker. Saving even a little will have big dividends at retirement. Even at today's volatile rates of return, you can expect to increase your retirement account by at least a third in 20 years. So, if you can afford $1,000 a year for the next 20 years ($20,000 in), you'll have $30,000 at the end. In short, yes it's worth it if you can afford it.

    As for the emergency stash, you can use the Roth without penalty only in certain situations. To protect against the unexpected, try to have 3-6 months of living expenses, including student loan repayment amounts, in a regular account. Personally, I'd fund that first. Once that stash is built up, I'd do retirement savings with any extra money, or split between retirement and additional loan repayments.
     
  7. FunnyBut

    FunnyBut Well-Known Member

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    I think you should put in at least as much into retirement to get the $1500 company match (if you aren't doing so already). Whatever the match % is, I'm sure you'll be doing much better than 6.8% on that money.

    Beyond that, I would consider putting some additional into student loan repayment. 6.8% seems a somewhat high rate to me, not something I think you have a can guarentee you'll outperform with other investments. Also , student loans can't be discharged under most any circumstances, so I think it'd be good to get that debt smaller sooner.

    Congrats to you for graduating, having solid savings, being to cover yourself and loans, and still have money left over. I understand that's not easy for most recent grads to do nowadays.
     
  8. HisWeirness

    HisWeirness Happy Russian Hunger Games!

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    I agree with Aceon6 to put some of the extra money into your Roth IRA and some into an emergency fund. How you do the split is up to you.

    I believe you can withdraw the funds you put into a Roth IRA without penalty, just not any appreciated value.

    I'd normally say to first do your 401k match at work, but if you think you will not work there long enough to be fully vested, you can just stick to the Roth IRA.
     
  9. manhn

    manhn Well-Known Member

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    Is the interest on your student loans tax deductible? If so, save for retirement.
     
  10. peibeck

    peibeck Letting Poje be on top

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    It is deductible up to $2500.
     
  11. Cheylana

    Cheylana Well-Known Member

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    Are you looking to buy a house in the near future? Worth thinking about whether you want to have some cash on hand for a downpayment and how current mortgage interest rates compare to your student loan interest rate.

    The "smart money" thing to do is probably to save for retirement, but I paid off my low-interest student loans a few years ago anyway. It was largely for psychological reasons. They were enormous ($185,000 at one point) and I was anxious to be debt-free. It's not like a mortgage where you have an asset (house) on the opposite side of the balance sheet, and I was afraid that if I were to lose my job I would be stuck with all this debt and no way to pay it.
     
  12. PDilemma

    PDilemma Well-Known Member

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    Are you getting more interest on retirement than you're paying on student loans? That's an issue to consider.

    I'm using retirement funds to pay for grad school right now as the interest the IRA gains is way less than what I would pay on student loans. My intention is to pay my IRA back when I am employed full time again in the same way I would pay back a loan.

    My husband is also investing through a company plan which we will be able to put more in when I am fully employed again.
     
  13. Cheylana

    Cheylana Well-Known Member

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    Deductibility of student loan interest depends in part on your annual gross income -- there's a cutoff somewhere around $80,000, I think, though I haven't looked at that in a while. I wasn't able to deduct a penny once I started work as a NY attorney.
     
  14. Gazpacho

    Gazpacho Well-Known Member

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    Thanks for all your answers!

    6.8% is the fixed rate on federal student loans, which is lower than private student loans. Interest rates are really low these days, so it's higher than a mortgage rate, but if interest rises, then it's a good deal.

    Federal student loans are also discharged upon death or permanent disability, unlike private loans. So if I die before the payment is up, my survivors aren't held liable. I don't know how much that fact should play into my decision though.

    That's my understanding too.

    Yes, it's tax deductible up to $2500 if you're under a certain income. On the other hand, retirement funds are also not taxed other than the Roth IRA which is taxed now but not when you withdraw from it.

    I don't know if/when I'll buy a house. The Roth lets you withdraw money for a house down payment, but then I'd be dipping into what's supposed to be an emergency stash.

    That's a good point that I hadn't considered. I do worry about affording my student loan payments, but I think federal student loans let you defer payment if you lose your job. It lessens the temporary load, but you'll pay more in the long run, of course.

    That's what's making the decision tough. Now the interest greater on the student loans, but what if the stock market does well, and the retirement fund earns greater return than the student loans in the long run? It's all uncertain.
     
  15. Aceon6

    Aceon6 Get off my lawn

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    Gaz, sounds like there are pros and cons either way and it might make sense to put 1/2 of the extra into the loans and the other 1/2 into your savings. You can always change the allocation if your circumstances change.

    One other thing that my brother recommends is putting any "found money" into the retirement account. Gifts, bonuses, etc. It's a way to keep adding without seeing an impact on your monthly budget.
     
  16. PDilemma

    PDilemma Well-Known Member

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    We are prepared to reevaluate our decision if that occurs in the next year before I'm done. But I just don't see it happening.
     
  17. bardtoob

    bardtoob Well-Known Member

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    Legally and morally, if she is within the terms of the loan then there is nothing to judge. How a person wants to operate within the terms of the loan is a personal choice.

    To me, not saving for retirement is immoral if saving would lead to less indebitedness at the end of one's life. It is bad stewardship in my book.
     
  18. Anita18

    Anita18 Well-Known Member

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    I agree with half into retirement and half to pay off the loan. You really don't know what things are going to be like in the future, so you might as well try to hit everything equally if things are so uncertain.
     
  19. reckless

    reckless Well-Known Member

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    I went through the same debate when I graduated law school. I had about the same amount of debt at graduation (and that was more than 15 years ago). I also graduated several years before law firm salaries skyrocketed, when government student loan rates were much higher (my consolidated rate was 9%), when student loan interest was not deductible, and when student loan companies did not offer incentives like reductions in interest rates to people who made timely payments. So that may provide some context for my decision.

    Basically, I contributed a little to my IRA (the limit for most of the years was only $1,500 so it wasn't a huge amount) and put whatever extra money I had to repaying my student loans. Over eight years, I managed to pay down the balance from just over $100,000 to about $55,000. Just being able to pay a little extra principle down at a time really makes a huge difference.

    At that point, I bought my first home and got a second mortgage/equity line that was at a lower rate than my student loans (and was deductible), so I used the equity line to pay off my loans. My timing was pretty good with the housing boom, and a year later, I refinanced and paid off the second mortgage. (I should add that my refi was very conservative so, even with the housing crash, I still have plenty of equity in the house.)

    Obviously, nobody can predict what will happen with the housing market and loans are not being written as freely as they were in the early 2000s, but you may want to think about whether your decision has to be invest in the market versus pay off loans.

    I will add that the day I paid off my student loans was one of the happiest of my life.
     
  20. Louis

    Louis Tinami 2012

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    Gazpacho, congratulations on making very intelligent financial decisions so far. You sound like you have an excellent financial head on your shoulders, and I'm sure whatever you decide will be reasonable.

    In addition to the dollars and cents here, I'd consider the psychology of the situation, too. Are you OK with taking 10 years to pay off your student loans? If so, I'd save for retirement, a house, etc. and treat your student loans as a fixed monthly expense.

    Would you feel a lot better if you could pay off your loans in 7 years? 5 years? If so, use an amortization scale to calculate the payment you'd need to get that accomplished, and then put what's left over into retirement and/or a separate emergency fund from your Roth. (I agree with others that it would be wise to build up a true savings account with 8 months of expenses.) Just make sure you don't make yourself completely miserable in the present saving for the future. Some sacrifice and living slightly below your means are good; misery and obsessive focus on debt that was incurred for good reason are not. :lol:

    If your employer doesn't match until you've been there for five years and you haven't yet been there five years (that's how I'm reading your post), forget the 401(k) until you hit the five-year mark. You have less control over the investments, and depending on your employer, the fees may be higher than in an account you can control. Roth IRA is the way to go, or if you're over the income limit, traditional IRA that you can then convert to Roth.

    Good luck, and again, congrats! Sounds like you are doing great.
     
  21. Gazpacho

    Gazpacho Well-Known Member

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    Thanks! I've been very fortunate to get this job, fingers crossed it'll last. I've spent the past few years listening to classmates who haven't found jobs, so I made sure to put the maximum contribution in a Roth as an emergency fund. I'm also fortunate that I don't have extra expenses. The classmates who can't find jobs and have kids to support are really sad cases. One of them had a special needs child, and it's heartbreaking.

    I don't know what feels psychologically comfortable. Obviously paying interest never feels psychologically comfortable. Nor does not having an emergency fund. Back in my head, there's a nagging sense that I may die before the student loans are paid off. Life is unpredictable, as is death. If my student loans aren't paid off, my survivors aren't held liable for them. Should that factor into my decision? What about the fact that I can extend the payment period past 10 years if I run into financial hardship?

    What is an amortization scale?

    Is it hard to withdraw money from a Roth? I was planning to use that as an emergency fund rather than having a separate emergency savings account.

    Yes, my employer doesn't match until you've been there five years. At that point, the match becomes retroactive. So if I put in $1500 now and leave before five years, it doesn't get matched. But when I hit my sixth year, the $1500 becomes retroactively matched. If I put in $800 now, in five years $800 gets matched, etc. So should I still put $1500 in now? I don't see myself lasting five years at this place, but lots of people have said that and ended up spending their whole working lives there.

    I'm also allowed to put in more than $1500, up to $16,500 I think. Anything above $1500 doesn't get matched at any time.

    So if I allocate money toward retirement, I then have to decide which retirement fund. What are the advantages/disadvantages of putting it in a regular IRA, Roth IRA, and 401(k)?

    Finally, how will this affect my credit score and ability to get a loan, especially a mortgage? If I pay off the student loan, that raises my credit score, but I'll also have less to put toward a down payment, which means higher mortgage rates and more to borrow.
     
    Last edited: Jul 10, 2011
  22. AxelAnnie

    AxelAnnie Well-Known Member

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    You are kidding, right? Pay back the loans. That money was given to you in trust and good faith. You used it for you education. Now fuflill your obligation and pay it.back.
     
  23. BittyBug

    BittyBug Kiteless

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    This would be a highly unusual plan provision. Are you sure the plan doesn't instead match as you go along but with the company match and any related investment gains / losses not vesting (becoming yours) until you've reached 5 years of service? So the company match money would be in your account all along, but if you left prior to 5 years you wouldn't be able to take it with you because it would not yet be yours?

    And what is the match? Is it dollar for dollar, so you put in $1,500 and they put in another $1,500? Or is something less? Either way, it's free money so unless your plan has really lousy and high cost investment options, think about whether you'd be better off putting any retirement money into the 401(k) rather than an IRA because worst case you don't stick around for 5 years and you'd end up in the same place (no match), but if you manage to stay long enough to vest, you'd get that company match boost from the 401(k) plan that you wouldn't from an IRA.

    As for Roth vs. pre-tax, it depends.
     
  24. milanessa

    milanessa engaged to dupa

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  25. Anita18

    Anita18 Well-Known Member

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    I think that may have been in response to Gazpacho's last post asking whether the fact that student loans aren't held liable on next of kin if she dies before paying them all back should factor into her choice between loan-paying vs retirement funding. Some can interpret that statement as intending not to pay them back at all. :eek:

    But the original post was asking whether it was better to pay off the student loans early vs putting more into a retirement fund.

    IMO it depends on what's more comfortable for you. My sister paid off all her loans early because she hates having debt, while I'm fine with paying them off slowly at the standard rate. (We both had about the same amount, less than $10,000.) I did some rudimentary calculations and estimated I'd save about $300 in interest, which wasn't worth my nervousness of not having a bigger emergency fund. :lol:

    To be fair, $10,000 is nowhere near $100,000, so you'd be saving a lot more in interest if you paid them off early. Then again, you could also find yourself in a tough spot if you lost your job and didn't have a big-enough fund to tap into. I'm neurotic about this though, I have separate accounts and treat my Roth IRA as something I DO NOT TOUCH EVER. Aside to put the max amount in every year. :lol: Heck, I even treat my mutual funds as something I don't take out of ever, and I have a savings account on top of THAT. So yeah, YMMV. I don't think most people are as neurotic about their financial cushion as I am.
     
    Last edited: Jul 10, 2011
  26. Louis

    Louis Tinami 2012

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    Echoing what BittyBug said, find out more about your 401(k). Is it a five-year cliff vesting with 0% vesting on employer contributions until year five, when they become 100% vested? Or is it a plan where 20% gets vested each year for five years? Either way, it might be a good idea to take advantage of it, but the second option would be a no-brainer.

    Life is certainly unpredictable, but I wouldn't let death factor into the equation here unless you have some kind of diagnosis that makes you think you may die within the time period of your student loans. Probability says you'll live long enough to pay them off, so go with that. Bankrate.com has amortization schedules where you can "solve" for what payment will help you get your loan paid off in X number of years.

    Withdrawing from a Roth is a subpar option because you want to leave that money in there to grow tax-free for as long as you can, and you're limited by how much you can contribute to a Roth. So if you withdraw $1,000 from a Roth versus a savings account, you lose the compound tax-free growth for the next however many years. E.g., say you're 25 and plan to start withdrawing for retirement at age 70. Assuming 6% rate of return over time, the $1,000 you have in your Roth will compound to about $13k by age 70. The $1,000 in your taxable account will compound to only about $7k, assuming 33% federal, state, and local taxes. The tax advantage of a Roth is really wonderful, which is why you're so limited as to how much you can contribute. IMO, it's OK to use the Roth as a "life-and-death emergency" (e.g., you get cancer) fund, but not a regular emergency fund (e.g., your car breaks down). Have a separate savings account for that.

    Re: your credit score, as long as you make payments on your student loans, I don't think it will matter either way. Sometimes paying off your student loan may actually lower your credit score, as you have one less type of debt. E.g., paying off the mortgage on my former house actually lowered my credit score. And re: mortgage, these days you pretty much need 20% down unless you qualify for a special program like FHA. If qualifying for a mortgage is your goal, the cash on hand for a down payment will probably trump whatever extra monthly payment you have on the student loans.
     
  27. Gazpacho

    Gazpacho Well-Known Member

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    :huh:

    Uh, no. I wouldn't commit suicide just to not pay back loans!

    Federal student loans are discharged upon death. If you die before 10 years, your survivors are not held liable for any amount that remains. This possibility is built in to the rates of the loan.

    Hmm, I interpreted it as not matching until you hit your sixth year and then retroactively matching, but I'll ask again.

    You said 6%--is that the average rate I can expect? If the student loans are 6.8% and the average rate of return is 6%, then it makes sense to pay off the student loans, right?

    Should I try to max out the Roth contributions before contributing to a 401(k) and/or regular IRA?

    I'm confused. So if I want a mortgage, is it better to have extra money for a down payment, or less debt showing on my credit report?
     
  28. PrincessLeppard

    PrincessLeppard Pink Bitch

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    If you can put 20% down, your interest rate on your mortgage will be lower. I was only able to put down 10%, but my interest rate is still significantly lower than my friends who put down 0-5%.
     
  29. Garden Kitty

    Garden Kitty Tranquillo

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    I'd put a little money into more immediate "emergency" savings, but maybe not a full 8 months (since the roth is there in a worst case scenario). I'd put enough into the IRA to get the match (and try to stay the time to get the match unless an aternative offer made up for it financially). Then I'd go for the IRA Roth. While a Roth can be an emergency fund, I'd really try to think of that money as "off limits".

    As someone mentioned, the choices depend a lot on what makes you feel secure. If you don't have a defined benefit pension, starting early and letting the money build is the best way to build up your balance for retirement.

    I'd worry about using all the extra money to pay down loans without having addressed emergency and other funds as well.

    You're paying the loan back and living up to all your obligations under the loan. You have no obligation to pay it back early, although if that is what makes you feel most secure, then there is some advantage in doing that. But there is no one way to do this, and any of the uses you describe are good. Kudos to you for saving the extra.
     
  30. Twilight1

    Twilight1 Well-Known Member

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    I am just on the tale end of my student loan... down to my last $6000 from $30000 which is pretty good!! :)

    I say if you are already making your payments, retirement savings is a good way to go esp. if you can go openended. That is to say, my husband contributes $100 a month to his RRSP but can also make random deposits into it as well. That way, you are saving, but if some expense comes up, you have your $20000 nest egg, but also have the means to deal with random things that pop up in life. The odd payment on your student loan is cool.

    I am a huge believer in retirement savings. I put in $200 a month in mine through work, but they also match that. Once my student loan is done, that $350 is being put in an RRSP. I am already used to not using that money, but that means, each month I will be contributing $750 (give or take) a month to my retirement.

    Which in the grand scheme of things means, I could retire earlier and go on trips everywhere. :D