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  1. #1

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    Pay off student loan vs. retirement savings

    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. #2

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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. #3
    Internet Beyotch
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    Personally I think you have a legal and moral obligation to pay off your student loans.
    Actual bumper sticker series: Jesus is my co-pilot. Satan is my financial advisor. Budha is my therapist. L. Ron Hubbard owes me $50.

  4. #4

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    Quote Originally Posted by MacMadame View Post
    Personally I think you have a legal and moral obligation to pay off your student loans.
    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. #5
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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.
    Actual bumper sticker series: Jesus is my co-pilot. Satan is my financial advisor. Budha is my therapist. L. Ron Hubbard owes me $50.

  6. #6

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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.
    AceOn6, the golf loving skating fan

  7. #7

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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. #8
    The wiener takes it all
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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. #9

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

  10. #10
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    Quote Originally Posted by manhn View Post
    Is the interest on your student loans tax deductible? If so, save for retirement.
    It is deductible up to $2500.
    I meant to take the high road.... but I missed the exit.

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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.
    "Marge, if you're going to get mad at me every time I do something stupid, then I guess I'm just going to have to stop doing stupid things!" - Homer Simpson in the Mr. Plow episode

  12. #12
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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. #13

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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.
    "Marge, if you're going to get mad at me every time I do something stupid, then I guess I'm just going to have to stop doing stupid things!" - Homer Simpson in the Mr. Plow episode

  14. #14

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    Thanks for all your answers!

    Quote Originally Posted by FunnyBut View Post
    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.
    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.

    Quote Originally Posted by HisWeirness View Post
    I believe you can withdraw the funds you put into a Roth IRA without penalty, just not any appreciated value.
    That's my understanding too.

    Quote Originally Posted by manhn View Post
    Is the interest on your student loans tax deductible? If so, save for retirement.
    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.

    Quote Originally Posted by Cheylana View Post
    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.
    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.

    Quote Originally Posted by Cheylana View Post
    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.
    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.

    Quote Originally Posted by PDilemma View Post
    Are you getting more interest on retirement than you're paying on student loans? That's an issue to consider.
    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. #15

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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.
    AceOn6, the golf loving skating fan

  16. #16
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    Quote Originally Posted by Gazpacho View Post

    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.
    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. #17

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    Quote Originally Posted by MacMadame View Post
    Personally I think you have a legal and moral obligation to pay off your student loans.
    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. #18
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    Quote Originally Posted by Aceon6 View Post
    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.
    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. #19

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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. #20
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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.

    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.

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