401k or student loans

[drsmith41]

Is it better to contribute more to the 401k and take advantage of the compound interest while young or is it better to pay off your student loans quicker and just contribute the minimum of what the company will match for your 401k?

I am 25 years old with a lot of student loan debt and my wife and I are having a little disagreement about how to allocate funds. She wants to contribute 3% and I want to contribute about 7%. My company will give me 25 cents on the dollar for the first 3% I contribute.

Generally speaking, will the long term advantages of saving for retirement early offset the cost of the student loan interest?

[disneysteve]

I would definitely contribute enough to get the full match. Beyond that point, it is a risk and judgment call. Paying off the loans provides a guaranteed return. What is the interest rate on the loans?

[drsmith41]

Interest on the student loans is about 5%. That might change soon though as I plan to consolidate them so I can get my debt to income ratio looking better on paper. The longer term on the loan doesn't bother me because I will still make the pre-consolidation payment amounts.

[disneysteve]

Originally Posted by drsmith41

Interest on the student loans is about 5%. That might change soon though as I plan to consolidate them so I can get my debt to income ratio looking better on paper.

If consolidating lowers your interest rate, it is worth doing (if it doesn't cost you anything) but don't do it just to lower your payment and extend your term.

[jpg7n16]

Originally Posted by drsmith41

I am 25 years old with a lot of student loan debt and my wife and I are having a little disagreement about how to allocate funds. She wants to contribute 3% and I want to contribute about 7%. My company will give me 25 cents on the dollar for the first 3% I contribute.

As long as you're making less than $120k combined, I would agree with her- but for a different reason.

Only contribute 3% with the match - and put the other 4% (total 7%) into Roth retirement accounts.


If your income is combined at less than $120k you get to deduct the interest so 5%, becomes a tax adjusted 3.75%. And since Roth investments are tax free on withdrawal - you only have to beat 3.75% to come out ahead. Stocks are expected (not guaranteed) to average 7-11%. Might be higher, might be lower.

So I would like to see you take the match only, pay the minimum on the school loans in order to save as much as possible in the Roths.


You should also be striving to get retirement savings up to 15-20%.

[buildmybudget]

To me, the answer to your question is all about the interest rate. If it's higher than 6%, I would allocate enough to get the maximum match from my 401k and put the rest towards my loan--especially with the recent volatility in the market. If the loan is less(my student loan is at 1.8%), I'm going to pay the minimum on the loan for as long as possible and max out my 401k and Roth IRA. Whatever interest I pay on the loan is tax deductible anyway.

[Hadwin]

It always is a better decision to pay off all the debts before start savings .
I suggest you to pay your debt and after paying you can go for saving or even investing the money you have .

[jpg7n16]

Originally Posted by Hadwin

It always is a better decision to pay off all the debts before start savings .
I suggest you to pay your debt and after paying you can go for saving or even investing the money you have .

Is it? What do you mean by 'better'?

Which is better: to pay extra on a 0% loan? or to invest in a 3% US Treasury note?

[buildmybudget]

Originally Posted by Hadwin

It always is a better decision to pay off all the debts before start savings .
I suggest you to pay your debt and after paying you can go for saving or even investing the money you have .

Again, if you can invest roughly risk free(say, at 5-6% in bond funds in your 401k) and your student loans are at 1.8%, why would you pay the loans off early? Especially on a long term loan like my SL, I would really be dinged after losing out on the compound interest.

[Robert742]

I agree with contributing to the 401k to get the company match (assuming you will work there long enough to become fully vested in the company match), with the rest used to start a ROTH IRA (assuming your income qualifies for one).

Compound interest is a powerful thing over a lifetime and trumps the simple interest you pay on a loan. Just make sure any money you commit to an IRA or your 401K is money YOU WILL NOT TOUCH until you retire. You should regularly fund an emergency fund as well.

I'm not a fan of debt, but having a student loan with the effective interest rate the same as long=term inflation is a great deal. I would not be in a hurry to pay that debt off.

[LivingAlmostLarge]

We did not pay off our student loans we rolled it into a 0% CC. I've been paying it off here and there and will roll again this month. We max out our 401k and IRAs and ESA. We also max out the ESPP at work. We're getting out of debt "slowly" but I figure by end of this year student loans done. Then car loan, then finally mortgage. Last year also we paid down the mortgage a bit so we could refinance it.

[drsmith41]

Originally Posted by jpg7n16

If your income is combined at less than $120k you get to deduct the interest so 5%, becomes a tax adjusted 3.75%.

I have a couple questions. Notice I am a "saving kindergartner."

What interest do I get to deduct? Student loan interest at tax time? Is that how it adjusts to 3.75%?

Also, the poster above this post mentioned rolling student loans into a 0% CC. Is that a credit card? How do you get a 0% credit card??? Or, what does the CC stand for?

Thanks!

[jpg7n16]

Originally Posted by drsmith41

I have a couple questions. Notice I am a "saving kindergartner."

What interest do I get to deduct? Student loan interest at tax time? Is that how it adjusts to 3.75%?

haha stick around and you'll get there soon!

There are different types of interest as far as your income taxes are concerned.

Student Loan interest - always deductible (if you meet the income requirements)
Mortgage interest - part of your itemized deductions
Credit Card/car loan/other interest - never deductible

And the end of each year, you should get a notice from your student loan company that lets you know how much you paid in interest on your loans this year. Let's say that number is $1,000 (easy math)

As long as your income isn't too high, you get to take that number and deduct it against your income - regardless of whether you itemize your other deductions, or just take the standard deduction. (See line 33 on form 1040: http://www.irs.gov/pub/irs-pdf/f1040.pdf )

This deduction directly lowers your taxable income for the year. Assuming a 25% tax bracket, each additional $1000 of income costs $250 in taxes. So your $1000 interest deduction, saves you $250 in taxes for the year.

So for example purposes, let's say you owed $20,000 across your student loans. This is what your math looks like:

$1000 interest - 250 reduction of taxes = $750 net interest cost

1000 / 20,000 = 5%
750 / 20,000 = 3.75%

Also, the poster above this post mentioned rolling student loans into a 0% CC. Is that a credit card? How do you get a 0% credit card??? Or, what does the CC stand for?

Thanks!

Yes, CC= credit card. There are usually offers flying around about 0% on balance transfers, or 0% for the first x months.

There is no such thing as a CC that offers a perpetual 0%.... except one that you pay off every month You can't get charged interest if you don't have a balance!

[LivingAlmostLarge]

Nope us bank humane credit card 0% interest and no BT fee. Special offer. I landed it awhile ago. I pay off in full our charges but this is a balance transfer to not pay the 6.8% flat rate on my DHs student loans.

I hate interest. If we weren't moving we'd pay off the credit cards this month. But my DH isn't keen on spending our cash.

[drsmith41]

Ok thanks guys!

[Robert742]

@ Livingalmostlarge: a 0% interest rate that is not a teaser rate, with no balance transfer charges is VERY humane, so the US Bank card is well-named. Hopefully, the credit card reform laws will keep US Bank from arbitrarily raising your rate, should they decide to be less humane.

With the changes in credit card law, I can't imagine they still offer that card, but by golly, I'm going to look into it. Thanks for the information!