Roth IRA or Student Loan Debt

[PharmD2012]

I am looking for advice about whether to start investing towards retirement now or wait until loan debt is paid off. I am a new grad and my husband will graduate in May 2013. We have a large amount of student debt from pharmacy school, but we will have nice incomes.

Student Loans remaining:
Me: $62,000 at 6.55% (currently paying $750/mth, about $30 more than the minimum)
Husband: $66,000 at 6.8% (not in repayment yet - planning to start paying in September)

Car Loans remaining:
Me: $25,000 at 2.9% (paying minimum $409/mth)
Husband: $14,000 at 5.9% (recently starting throwing extra money at this - paying $1620/mth, minimum is $370)

My take home pay has been $6300/mth since I started my job in August. My husband is working some while he is still in school, making $500/mth. He has received a job offer to start in August that will provide approximately the same pay as I am receiving now.

Our plan is to pay off the higher interest car in about 9 months, then when my husband starts working we should be able to put $7000 total/mth towards student loans (paying them off in about 2.5 years), then finish off what's left on the lower interest car at the end. After all this, we are planning to start looking to buy a house. We realize now that getting new cars was foolish so it'll be a while before we change vehicles.

Should we start Roth IRAs now for $3000/year and pay $500/mth less than we were planning towards our loans (assuming we can't scrape up this money from lowering other expenses or extra income)? Or wait 1 year or wait until all our student loans are paid off? I am 24 and my husband is 25. My employer does not match 401K contributions, so I haven't started that either. Right now we have $3000 in savings as our limited EF until we get loans paid off.

[dczech09]

Congrats on the awesome incomes! Over 100% of your loan amounts!

What I would do is this:

Pay off the 5.9% car loan as quickly as possible.
Pay off the 2.9% car loan.
Invest $5,000 per year (each) into Roth IRAs (you both qualify as long as your combined income is under $173,000 per year under current law).
Then work on paying off the student loans while saving for retirement.

I would do that in that order if I were you. You could also look at investing a little in 401k as well as the Roth IRA. I know you do not get an employer match, but it still is a good tax shelter.

The most you should save for retirement is 15% while you are paying down debt. That would be 15% of your household income.

I know Dave Ramsey fans would suggest paying off ALL debt first. However, I am of the belief that you should invest for retirement at least a little while paying down the student loans.

Do you have a mortgage?

[PharmD2012]

Thanks for your input. I think we might not qualify to invest in Roth IRA after 2013, but I'll have to check on that to determine exactly how much our AGI will be. Paying less than we had planned toward student loans makes me nervous because we have so much, but it probably is good to think more long term. We do not have a mortgage, just renting a cheap apartment. And we don't use credit cards, but I am debating whether we should get one and pay it off every month to improve our credit.

[dczech09]

According to the IRS, the 2013 income limit is $178,000 for married couples filing jointly. If you make in between $178,000 and $188,000, then you get a reduced contribution limit.

From the information you have given, it sounds like you and your husband might be just under the limit. It is based on AGI, so you will need to look into that.

Renting a cheap apartment is smart and I would recommend you do that while paying off any debt. You don't want to have any other debt when you take on a mortgage.

As far as the credit card goes- you could certainly do that. I know a lot of people do in order to build credit. The only problem is that you have to make sure it is paid off each month so you don't get hit with interest.

[jpg7n16]

I am looking for advice about whether to start investing towards retirement now or wait until loan debt is paid off...

Student Loans remaining:
Me: $62,000 at 6.55% (currently paying $750/mth, about $30 more than the minimum)
Husband: $66,000 at 6.8% (not in repayment yet - planning to start paying in September)

Car Loans remaining:
Me: $25,000 at 2.9% (paying minimum $409/mth)
Husband: $14,000 at 5.9% (recently starting throwing extra money at this - paying $1620/mth, minimum is $370)

As the SL interest is deductible, that reduces your costs to around 5%. Making his car the most expensive debt you have at the moment at roughly 6%. That's not super high, or super low. So in this case I tend towards advising a 50/50 approach. (Half of excess cash to retirement, half to debt reduction)

Now given that you guys are about to significantly increase your income (and tax rates are likely to rise), I would make the Roth contributions for 2012. (You have until April 2013 for it to count).

Although I'm trying not to make it too complicated, this is what I'd do if I were you:

1. Stop paying extra only until April 2013, and devote 100% of excess cash each month towards Roths.
2. After April, switch to a 50/50 split of excess cash each month. {Say you have $2,000 extra above your required EF at the end of the month. Well, $1,000 would go to the Roths, and $1,000 to debt elimination.}
3. Pay down debts in this order: 5.9% car, 6.8% SL, 6.55% SL
4. Pay off the 2.9% debt as slowly as possible. Do not use the 50/50 strategy for this debt. Simply make your minimum payment, and use the excess funds for other goals.

The benefit here is that you not only pay down your debts quicker, but you also start building up retirement savings.


After you've paid off the 3 higher rate loans, I would use the 50/50 strategy to build up to a 3-6 month EF. Then start saving 10-15% for retirement while building up cash for a downpayment. Once you're in your new home, I would do 15-20% for retirement.

Right now we have $3000 in savings as our limited EF until we get loans paid off.

How long would you be able to last on that in a financial emergency? IMO since you cannot reborrow any of this debt you're paying off, you should probably have 1-2 months expenses in cash while paying it off.

What I would do is this:

Pay off the 5.9% car loan as quickly as possible.
Pay off the 2.9% car loan.
Invest $5,000 per year (each) into Roth IRAs (you both qualify as long as your combined income is under $173,000 per year under current law).
Then work on paying off the student loans while saving for retirement.

Why would you have them keep the higher interest rate debt around the longest?

If they begin making sizable incomes soon, they will not qualify for the student loan interest deduction. Publication 17 (2011), Your Federal Income Tax

And if they do not make enough to lose the deduction, then they are only in the 25-28% bracket. Making their effective loan rate on the debt at least: 6.55% * .72 = 4.71% and 6.8% * .72 = 4.90% -- both of which are higher (aka more expensive) than the 2.9% car.

[PharmD2012]

I believe our income before taxes will be about $205,000 ($95K/yr + $110K/yr), although for 2013 it will probably be around $140K since the second job won't kick in until August. I haven't been able to figure out what deductions we will qualify for. I have a feeling I had too much withheld from my paycheck for 2012 because I put my allowances as "0" and requested for an additional $232/mth to be withheld.

We probably need to increase our EF to $5000 based on the 1 - 2 month suggestion. Right now we would need about $4000/mth.

[dczech09]

Why would you have them keep the higher interest rate debt around the longest?

If they begin making sizable incomes soon, they will not qualify for the student loan interest deduction. Publication 17 (2011), Your Federal Income Tax

And if they do not make enough to lose the deduction, then they are only in the 25-28% bracket. Making their effective loan rate on the debt at least: 6.55% * .72 = 4.71% and 6.8% * .72 = 4.90% -- both of which are higher (aka more expensive) than the 2.9% car.

I was looking at it from the stand-point that you want to get rid of a debt with collateral before a higher rated. But yes, your method is good too. The OP could go with one of three orders:
1. Collateral debts first
2. Lowest balance first
3. Higher interest rates first

I believe our income before taxes will be about $205,000 ($95K/yr + $110K/yr), although for 2013 it will probably be around $140K since the second job won't kick in until August. I haven't been able to figure out what deductions we will qualify for. I have a feeling I had too much withheld from my paycheck for 2012 because I put my allowances as "0" and requested for an additional $232/mth to be withheld.

We probably need to increase our EF to $5000 based on the 1 - 2 month suggestion. Right now we would need about $4000/mth.

Good point on the emergency fund; that momentarily escaped my mind.

If I were you, I would do the Roth IRA while I still could (based on income). Then after that, you should go for the 401k.

[jpg7n16]

you want to get rid of a debt with collateral before a higher rated.

Why??

[jpg7n16]

I believe our income before taxes will be about $205,000 ($95K/yr + $110K/yr), although for 2013 it will probably be around $140K since the second job won't kick in until August. I haven't been able to figure out what deductions we will qualify for./

If that's the case, then once he begins working, I would switch to paying off the student loans before the car, if it's not paid off by then. With a great income like that, it should be easy to knock the SLs out relatively quick. And it will be pretty unlikely that you'll qualify for the SL interest deduction at that time.

According to the IRS (Publication 17 (2011), Your Federal Income Tax ) the current limit on income is $150k for married filing joint on the SL deduction. This is an above the line deduction, meaning you get to take it whether you itemize or not. There is a possibility that you come in under that if he starts later in the year, but I highly doubt you'll make it once he's there a full year.

I would also consider switching from Roth IRA to additional 401k contributions at that time.

We probably need to increase our EF to $5000 based on the 1 - 2 month suggestion. Right now we would need about $4000/mth.

Fortunately, you're pretty close already I like that $5k amount in the EF. Seems good for your situation.

[dczech09]

Why??

Personally (and this may just be me), I would prefer knocking out a loan where the creditor could potentially come after me if I default, over a loan with no collateral.

Obviously the goal is to not default, so that SHOULD not be a concern.

However, let's say I had a student loan and an auto loan. And let's say I pay off the auto loan first (despite the interest rate). Then if I for some reason lost my job, I would not have to worry about a repo if I default on the auto. Since the auto loan is paid off, I would not be at risk of this.

On the flip side, if I paid off the student loan and then lost my job, then I could be at risk of losing my car while unemployed.

Now, obviously I should have an emergency fund in place to make this a moot point. However, looking on an emergency planning standpoint, I see it as advantageous to clear up the auto loan before going after the student loan. After all, the student loan has no collateral attached.

This is my preference. You may agree or disagree. But I think it does serve some purpose.

[dczech09]

Also, we could look at from the standpoint that since the auto loan has collateral attached, we should assign a risk premium to that to account for the additional risk. And based on what risk premium we assign to the auto loan, it could be higher risk than the student loans.

Albeit, this is a subjective methodology

[jpg7n16]

Personally (and this may just be me), I would prefer knocking out a loan where the creditor could potentially come after me if I default, over a loan with no collateral.

So you would argue to pay off the mortgage (backed by your home as collateral) before paying off your credit cards (no collateral backing)?

I agree more with what you said about the EF being there for a reason.

[dczech09]

So you would argue to pay off the mortgage (backed by your home as collateral) before paying off your credit cards (no collateral backing)?

No, not all. I view home loans differently since they back an asset that is hopefully going up in value. The car on the other hand is going down in value, so we could argue that the car is effectively costing the 2.9% APR plus depreciation.

There are several reasons why I see the car loan as riskier than the student loans. Collateral is one reason. Depreciation is another.

I look at things through a hierarchy like this:
1. Bad debts- IRS, payday loans, trash lenders
2. Credit cards
3. Auto, boat, RV, motorcycle loans
4. Student loans
5. Home loans

To me, this order makes sense when you consider the risk levels. Would you recommend someone pay off a mortgage before student loans since they SOMETIMES have a higher interest rate? Most people would not advise that because student loans are perceptually more risky than mortgages.

Like I said before, the OP could certainly go after higher rate first. Mathematically, that does make the most sense as it reduces the overall interest paid. However there is more than one "strategy" to paying off debt. Dave Ramsey for instance likes to advise the low balance first. I'm simply offering another option.

The OP could pick either method and still succeed at accomplishing the goal. It is just the matter of which road to take.

[Goldy]

Normally I would tell you to focus on your debt but with great incomes in the next few months I am very tempted to tell you to hit the Roth hard. Thanks to compounding interest the difference between leaving a sum of money in a Roth for 44 years vs 43 years can be larger than one might expect. I don't think you can go wrong either way.

[bjl584]

Unless someone's debt is overwhelming, then I advise that they both pay down debt and save for retirement. In your case, you should be able to fully fund retirement and pay down your debts ahead of schedule, especially once your husband starts working full time.