Student Loans OR Down Payment OR Retirement

Archived From: Finance
  • Page :
  • 1
  • Text Only
Voting History
rated:
I am 2 years out of grad school and getting close to paying off student loans. My wife and I are interested in buying a house at some point in the future and we know we are behind saving for retirement, but our original plan was to pay down loans as fast as possible, and reevaluate after making some good progress. Good progress has been made, now I would like to re-evaluate, and get some input on what our next steps and goals should be. Our current finances:
Debts:
13K student loan at 4.8% variable rate.

Retirement/Savings:
14K - 401K
7k - Roth IRA / Emergency Fund
3K - Cash Emergency

Relevant Monthly Budget (I will gladly provide more info if helpful):
Retirement: $230 (5% of income)
Minimum Student Loan Payment: $150
Extra to invest/pay off student loan/etc.: $900


I make ~60k before taxes (wife is home with our 1 year old), and right now we have about $900 a month to be putting towards loans/retirement/down payment etc (in addition to the monthly minimum payment on my student loan). I would like feedback on 3 options

  1. Continue to aggressively pay down student loans (pay off in ~1 year)
  2. Save money towards down payment
  3. "Catch up" on retirement


My wife is leaning towards Option 1, I am favoring Option 2. My thoughts/plan on retirement are to get in to a house and or pay off my student debt, and then shift all of that extra income to retirement. We are very disciplined with our money, so I am not worried about being able to do that when the time comes. Any thoughts or insights are appreciated! Thank you.

Member Summary
Staff Summary
  • Also categorized in:
Thanks for visiting FatWallet.com. Join for free to remove this ad.

4.8% isn't bad considering a 30-year mortgage is just slightly lower.

A monthly $150 debt comes out to about $30,000 difference in what you can qualify for assuming there are no other debts. In some parts of the country that could mean the difference between a 3 and 5 bedroom house. In others, that pays for an extra 50 sq ft.

If you're in the los angeles area, you can forget about buying a home until you have at least 300k down with that salary.

Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

The thing is there's a hard cap on the tax-advantaged retirement contributions you can have each year. You can't "catch up" on an unused portion of that in future years. I think the smart move is to put everything you can into 401k/IRA. Your loan rate isn't horrible, though I expect it will get worse over the next few years. But the balance is small. I think the minimum will still give you progress toward paying it off, but retirement contributions are an opportunity you won't entirely get back.

It's a very long term move, and paying off the loans isn't a bad plan either, but I'd bet on option 3 being financially best.

fwuser12 said:   Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

The 401k contribution counts for the credit as well.  No need to make an IRA contribution unless his 401k plan has bad fees or investment options. 

hairybeast said:   
fwuser12 said:   Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

The 401k contribution counts for the credit as well.  No need to make an IRA contribution unless his 401k plan has bad fees or investment options. 

  You are right, I didnt know that.
In any case, the extra 10-20% credit makes this an easy decision to go with #3. OP can decide 401k vs IRA depending on fees and employer match.

Thanks all.

I know this is another conversation entirely, but what about gains in buying vs renting? According to the NYT rent/buy calculator, buying a home pays off in less than 5 years (ballpark figures) compared to renting for us. My quick and dirty Excel calcs seem to point to roughly even net worth after 10 years between putting equity into a home (1% home price growth rate), and dumping all of that money into retirement (10% return - probably not feasible, but used for sake of argument). Perhaps I am not accounting for enough cost of home ownership - but it seems from the outside at least to be more attractive to be building at least a little equity than paying rent every month?

Am I way off?

fwuser12 said:   Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

  I didn't know about the savers credit (although looking back on last years return I got it apparently). It appears it is only good for up to 4,000 contribution - so a $400 credit?

No employee match unfortunately. 

SlimTim said:   The thing is there's a hard cap on the tax-advantaged retirement contributions you can have each year. You can't "catch up" on an unused portion of that in future years. I think the smart move is to put everything you can into 401k/IRA. Your loan rate isn't horrible, though I expect it will get worse over the next few years. But the balance is small. I think the minimum will still give you progress toward paying it off, but retirement contributions are an opportunity you won't entirely get back.

It's a very long term move, and paying off the loans isn't a bad plan either, but I'd bet on option 3 being financially best.

  I understand the idea of losing the tax-advantages every year that I don't contribute. But I don't quite understand how it works in practice, at least for me. Please let me know if I am missing something, I probably am

The limits for IRAs are 11K (wife and I combined). Limits for 401K 17.5 K. So the most we could contribute is 28.5K per year. But my income would have to go up considerably to be approaching those caps, so I can still "catch up" without going over that 28.5K contribution. In other words, right now I am contributing 5% towards retirement. I would like to be contributing more like 15-20%. If I continue to only put 5% of my income towards retirement for the next 5 years, I could then make up that difference by contributing say 30% of my income for 5 more years (or however long it takes) without ever getting close to 28.5K. (90K * 30% = 27K). I will be doing pretty well to be making 90k in 10 years, if I continue in my field.

Thanks again all, for your thoughts! 

You know better than I do about likelihood of approaching 401k/IRA limits, and it sounds like you're thinking of what I assume is the appropriate time window. Whatever the student loan term is for minimal payoff - I assume about 10 years. But right now with a $60k income, you contribute $2760 and have the option of adding 10,800 to it. So the current max you could do is about $13500. I think if it's a priority, you'd be able to hit $28500 well before your income increased another $30k. Really, I think the issue is when will your contributions get within about 10k of the limits - that's when you start to only partially 'catch up' with the contributions you are thinking of forgoing now.

But paying off the loan is nothing to stress about - if it will give you significantly more satisfaction, go for it. It's not like you're weighing retirement savings vs borrowing to buy a fancy RV.

For buying vs renting, if your location is stable, buying does work out best in most locations most of the time. But that's a big if for some people, especially early in a career or with a growing family. Priorities shift and opportunities come and go. The flexibility you get with renting can be worth a lot, and selling a home with only 5 years ownership or less will usually lose most of the financial gain to transaction costs.

MagicLoogies said:   
fwuser12 said:   Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

  I didn't know about the savers credit (although looking back on last years return I got it apparently). It appears it is only good for up to 4,000 contribution - so a $400 credit?

No employee match unfortunately. 

  With no employer match, there is no reason to invest in the 401k, unless you have access to great investments that are otherwise unavailable (or cost more) outside. This is not common but does happen.

Yes the saver's credit is for a maximum of 4k contribution. Assuming you qualify for only 10% credit, that is still 10% free money. Can you up your IRA contribution and get to the 20% credit threshold? Remember you can contribute 5.5k for each (total of 11k for the couple). You will likely quality for full deduction of the IRA contribution, which will help reduce AGI. Moreover, as a first time homeowner, you can take out up to 10k penalty free from an IRA for your home purchase. So you dont have anything to lose. Simply save inside an IRA, get the saver's credit and if really needed for a downpayment, take out 10k from the IRA.

 

I would not accelerate payments on the student loan debt.  Boost your monthly retirement savings up to 10 to 15% of your income, and put the rest in short term savings for your eventual home purchase, emergency fund, and other purposes.  Don't be in a hurry to buy a house unless you are REALLY stable in your location.  Although a lot of the general guidance talks about 5 to 7 year break even points, houses have a way of killing budgets.

fwuser12 said:   
MagicLoogies said:   
fwuser12 said:   Are you putting enough to get full employer match in 401k?
ETA: At your income level, you will qualify for saver's credit by making an IRA contribution. Perhaps you should put just enough in the 401k to get full match and the rest to an IRA.

  I didn't know about the savers credit (although looking back on last years return I got it apparently). It appears it is only good for up to 4,000 contribution - so a $400 credit?

No employee match unfortunately. 

  With no employer match, there is no reason to invest in the 401k, unless you have access to great investments that are otherwise unavailable (or cost more) outside. This is not common but does happen.

Yes the saver's credit is for a maximum of 4k contribution. Assuming you qualify for only 10% credit, that is still 10% free money. Can you up your IRA contribution and get to the 20% credit threshold? Remember you can contribute 5.5k for each (total of 11k for the couple). You will likely quality for full deduction of the IRA contribution, which will help reduce AGI. Moreover, as a first time homeowner, you can take out up to 10k penalty free from an IRA for your home purchase. So you dont have anything to lose. Simply save inside an IRA, get the saver's credit and if really needed for a downpayment, take out 10k from the IRA.

 

Thanks, that is helpful to confirm how I understood it.

I am near the top end of the 10% threshold, so I don't think I can get down to the 20% bracket (AGI of less than $40K).
  

Thanks all for your input. Option 3 with a small amount of savings set aside will be the way we go!

Minority Report here.

Dear OP, I was in your situation three years ago - just out of school and couldn't decide between debt repayment, retirement, or saving up for a down payment. While saving for retirement might be the best from a pure math point of view, consider some counterpoints:

1) Contributing to retirement accounts sacrifices flexibility that you now need at your stage in life with a young child and an early career.
2) The stock market is at an all time high, with all "normal predictors" pointing to a bear market.

In your shoes, what I would do is either save up for a down payment or wipe out your student loan. You are in a rare situation where your wife is on board with paying off debt. Why don't you lock in a 4.8% return, risk free? You won't find a better deal anywhere else. You get very good return on your money and you gain future cash flow. This is objectively better than contributing to retirement!

Saving for a down payment is also a better option than saving for retirement, since a big pile of cash can be spent to get you into a better situation, whether it be a place to live or moving to a new and better job where you will make more money or have opportunities for advancement. The main liability with a large pile of cash is that you might overbuy a house or use the cash for other consumption. Another element of buying vs. renting is that you will lose all of your discretionary time. Taking care of a house is a lot of work.

I vote for paying off the student loans! Here's the key: if you keep your goals simple, your savings rate will be higher than if you split your focus. The truth is finance is more behavioral than anything else.

Three years ago I was in your situation, renting with student loans and a 1 year old. Today, I am debt free minus my mortgage and about to set retirement savings on automatic for the next 30 years.

While I understand the value of paying off student loan (4.8% return, risk free), because of OP's income, he will qualify for at least 10% in saver's credit (for up to 4k). That is 10% return, risk-free. He should put at least 4k into the IRA/401k to get that.

The saving for downpayment can be done inside an IRA, making use of the penalty free withdrawal for up to 10k (20k along with spouse) for first time home buyer.

OP can contribute to a Roth IRA, where the contribution can be taken out tax and penalty at any time, for any reason.

Contribution to an IRA (Roth or traditional) doesn't necessarily mean one has to invest it in the stock market.

Ok. So it looks like you can contribute to a Roth IRA to get the savers credit, especially if the 20% credit level is really out of reach with deferred IRA contributions, and withdraw those funds after April of the next year and still keep the credit. There are rules about not withdrawing from an IRA for two years prior to receiving the savers credit as well. Look into it.

I would contribute the two $2000s to get the savers credit and invest that money in a bond or treasury fund with the purpose of saving for a down payment - or anything else.

fwuser12 said:   While I understand the value of paying off student loan (4.8% return, risk free), because of OP's income, he will qualify for at least 10% in saver's credit (for up to 4k). That is 10% return, risk-free. He should put at least 4k into the IRA/401k to get that.

The saving for downpayment can be done inside an IRA, making use of the penalty free withdrawal for up to 10k (20k along with spouse) for first time home buyer.

OP can contribute to a Roth IRA, where the contribution can be taken out tax and penalty at any time, for any reason.

Contribution to an IRA (Roth or traditional) doesn't necessarily mean one has to invest it in the stock market.

  My thinking is that my next 20K that is free to be put towards one of these 3 options goes into a Roth IRA - basically a dealers choice downpayment or retirement fund. After that, maybe we move more toward putting some cash away for a down payment, but still continue decently to retirement savings.

(thanks, for some reason I never realized that both my wife and I can pull out the 10k from an IRA)

catanpirate said:   Ok. So it looks like you can contribute to a Roth IRA to get the savers credit, especially if the 20% credit level is really out of reach with deferred IRA contributions, and withdraw those funds after April of the next year and still keep the credit. There are rules about not withdrawing from an IRA for two years prior to receiving the savers credit as well. Look into it.

I would contribute the two $2000s to get the savers credit and invest that money in a bond or treasury fund with the purpose of saving for a down payment - or anything else.

  
Just so I am making sure I am doing the math right:
For 2017 
Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $37,000 AGI not more than $27,750 AGI not more than $18,500
20% of your contribution $37,001 - $40,000 $27,751 - $30,000 $18,501 - $20,000
10% of your contribution $40,001 - $62,000 $30,001 - $46,500 $20,001 - $31,000
0% of your contribution more than $62,000 more than $46,500 more than $31,000
 

So to get to the 20% credit, my AGI has to get down to <$40K. With an expected income around 60k, that means I need to lower my AGI by 20K (primarily by retirement funding) to earn an extra $400 (20% rather than 10%). 



Disclaimer: By providing links to other sites, FatWallet.com does not guarantee, approve or endorse the information or products available at these sites, nor does a link indicate any association with or endorsement by the linked site to FatWallet.com.

Thanks for visiting FatWallet.com. Join for free to remove this ad.

While FatWallet makes every effort to post correct information, offers are subject to change without notice.
Some exclusions may apply based upon merchant policies.
© 1999-2017