Am I being too aggressive?

[riccardo426]

Hello all

I owe about $170k in student loans on a $130k salary. I am newly graduated, in my mid-20s and have been working about six months. My goal this year is to pay down $54,000 in student loans, which is $4,500 a month. That leaves about $2,500 for everything else out of my paycheck. So far I am on target, but its only been two months this year, obviously. Am I being too aggressive? Or going good so far?

Here is my budget and expenses:

Budget
Rent 1000
Utilities 200
Phone 50
Food and going out 800 (yeah I know. I eat out a lot but I'm getting better.)
Car and gas 0 (don't own one) (why I don't feel so bad about above)
Other 100


Student loans amounts are roughly as follows:
$12k 8%
$45k 7.5%
$70k 6.5%
$30k 5%
$5k 2%

Believe it or not, those loans weren't full tuition either; I had a scholarship.

I am not contributing to my 401(k) this year because of the high interest rate loans out there and no employer match. I am phased out of the IRA. I have decided to be aggressive because I am accruing interest at around 900 per month. Minimum in my loans is 900 on the 25 year repayment, which I did so I can focus on high interest rate debt. I am expecting the 8% loans to be done by June. Planning on focusing more on savings and 401(k) in a year or two, so scaling payments down to $3500 a month at that point.

Emergency fund is about 7k which was funded by my tax refund this year. Don't have any savings except for a 1k checking account buffer. Looking to get engaged in next 18-24 months to long-term SO. Would like to buy a property in 4-5 years.

What do you think?

[dczech09]

Since you are in your mid-twenties, it would be a good idea so start saving for retirement, if only to establish a good habit. You make too much for the Roth IRA. Your 401k has no match, so that leaves you going into the 401k or Traditional IRA, both of which offer virtually the same benefit of tax-deferred growth.

Based on your information-
A Traditional IRA would allow you more control over your investing, but a lower contribution limit and no tax deduction.
A 401k would allow you less control over your investing, but you get a tax deduction and a higher contribution limit.

So, I would recommend the 401k at the end of the day. The tax deduction will benefit you.

While you are paying down the student loans, you should put a small amount into your 401k (like 5% or so- up to you).

Be aggressive with paying down your loans. Live on nothing. Keep the emergency fund. And once you knock out the debt, invest aggressively.

Ultimately, do not let debt stand in your way of saving for the future. Especially with your income.

[jpg7n16]

Technically, if you max your 401k, you would qualify for nearly a full Roth contribution.

Amount of Roth IRA Contributions That You Can Make For 2013

130,000-17,500=112,500

Which is only 500 into the phaseout. By the formula on the IRS site, you would reduce your Roth by 500/15000 * 5500 = 183.33 --- meaning you could do $5316.67 to a Roth this year.


Also, since you have no existing IRAs, you could always make a non-deductible IRA contribution of $5,500, then convert it to a Roth tax-free.


-------------------------

Why do I bring this up? If you're able to pay down $54k/year, then in a few years (3.15 years to be exact), you'll be hurting for a way to save more in tax advantaged accounts.

54,000 - 17,500 - 5,500 = 31,000 more that you'll have to put in taxable accounts at that time

As maxing your retirement plans today would not significantly impair your ability to get out of debt relatively quickly (at current contribution limits it would take 5.48 years vs 3.15 years), I'd probably get a head start.

I'd do the following:
1) Build up 3 months EF (maybe around $8-10k cash)
2) Max 401k
3a) Make full non-deductible IRA contribution
3b) Immediately convert it to a Roth
4) Pay extra on debts starting from highest interest rate to lowest

Following this strategy today will allow you to still get out of debt, and also get about $70-75k more of your assets into tax advantaged accounts over the next 5 1/2 years.

Depending on your location, this may only delay getting into a home from your 4-5 year target, to 6-7 years. So not a significant change to your goal there, but a very significant change to your retirement future. If your SO turns out to be as frugal as you, then collectively you may still be able to hit your 4-5 year target with her savings.


Does this plan necessarily make the most sense when looking at the next year? No.
Does it make sense when looking at the next 10 years? I think so.

[MonkeyMama]

I agree with the others, though there is plenty of room for some middle ground.

Though I often feel that student debt is particularly nasty (you'd can't sell any asset you have received with the debt to be rid of it; you are stuck with if employment prospects are grim. IT's just easy to get very *stuck*). As such, I think it's often wise to throw everything at student loan debt and to just be done with it. & at your age with a 3-year time horizon, it's not like it really makes much difference for the *long* haul. If you are used to throwing that kind of money at student loans, you should be able to make up the savings/retirement side pretty quickly.

That said, I think you make too much income to "completely ignore" retirement. Also, there is room for more efficiency with the taxes. It depends which state you are in. But living in a high tax state myself, you could max out your 401k ($17,500 per year) while saving about HALF of that in taxes. That means, coughing up a mere $9,000 cash flow to fund $17,500 into a 401k. For Federal alone, you are likely well into the 28% tax bracket. So every dollar you put into a 401k is at least a 28 cent tax savings.

I personally think maxing out the 401k and IRA, both, would be a bit much. You don't need to be throwing 18% of your income to retirement out the gate, with all this debt. If you set aside 10% into retirement, would be an excellent start for your age. Is probably what I would do in your shoes.

The others bring up good points though, about losing tax shelter for every year you skip them, so should be considered in the big picture. If you pay off loans in 5 years versus 3, I also see that probably makes little difference in the scheme of things.

[kork13]

Technically, if you max your 401k, you would qualify for nearly a full Roth contribution.

I'd do the following:
1) Build up 3 months EF (maybe around $8-10k cash)
2) Max 401k
3a) Make full non-deductible IRA contribution
3b) Immediately convert it to a Roth
4) Pay extra on debts starting from highest interest rate to lowest

I pretty much agree wholeheartedly with JPG. MonkeyMama makes a good point that you don't NEED to be saving 18% of your income for retirement right now, but it sure wouldn't hurt. Perhaps just consider balancing your retirement savings with your taxable savings, like for saving toward a home downpayment.

Bottom line, you earn a great income, and have low expenses. Those two keys give you the greatest flexibility imaginable. Definitely work to pay off your debts ASAP, but you can do alot of good for yourself by slowing down a bit and directing some of your cashflow toward savings.

[snafu]

I think you have a good plan but it's important to re-evaluate circumstances at the end of the year. What tax rebate results from student loan interest rates? What end of year bonus could be added to pay-back schedule? The gov't talks about student loan forgiveness from time-to-time which might affect your numbers. What is your intended's view of money management and frugal living?

[asmom]

Hello all

I owe about $170k in student loans on a $130k salary. I am newly graduated, in my mid-20s and have been working about six months. My goal this year is to pay down $54,000 in student loans, which is $4,500 a month. That leaves about $2,500 for everything else out of my paycheck. So far I am on target, but its only been two months this year, obviously. Am I being too aggressive? Or going good so far?

Here is my budget and expenses:

Budget
Rent 1000
Utilities 200
Phone 50
Food and going out 800 (yeah I know. I eat out a lot but I'm getting better.)
Car and gas 0 (don't own one) (why I don't feel so bad about above)
Other 100


Student loans amounts are roughly as follows:
$12k 8%
$45k 7.5%
$70k 6.5%
$30k 5%
$5k 2%

Believe it or not, those loans weren't full tuition either; I had a scholarship.

I am not contributing to my 401(k) this year because of the high interest rate loans out there and no employer match. I am phased out of the IRA. I have decided to be aggressive because I am accruing interest at around 900 per month. Minimum in my loans is 900 on the 25 year repayment, which I did so I can focus on high interest rate debt. I am expecting the 8% loans to be done by June. Planning on focusing more on savings and 401(k) in a year or two, so scaling payments down to $3500 a month at that point.

Emergency fund is about 7k which was funded by my tax refund this year. Don't have any savings except for a 1k checking account buffer. Looking to get engaged in next 18-24 months to long-term SO. Would like to buy a property in 4-5 years.

What do you think?

I agree with MM. At $900 interest accrual monthly it is in your best interest to reduce your student loan debt ASAP. You're in your mid-twenties, so waiting a couple or three years to get aggressive with your retirement savings is okay especially for someone with your income potential. You could spend this year on debt reduction alone if it will make you feel better about the amount of debt you carry and next year, activate your 401K (max out). At your income level, it's important you look for every opportunity to reduce your taxes. Are you still able to deduct your student loan interest, I know there's an income phaseout. Oh and make sure you carry some sort of disability insurance. Otherwise you're on the right track.

[jpg7n16]

I personally think maxing out the 401k and IRA, both, would be a bit much. You don't need to be throwing 18% of your income to retirement out the gate, with all this debt. If you set aside 10% into retirement, would be an excellent start for your age. Is probably what I would do in your shoes.

MonkeyMama makes a good point that you don't NEED to be saving 18% of your income for retirement right now, but it sure wouldn't hurt.

Really, my whole thinking was that in 15-20 years, this guy's gonna have more money around than he knows what to do with. I mean, say he goes "light" on the taxable savings at maybe $20k-25k/year. That's realistically somewhere $250-400k in taxable accounts (not even considering investment growth). And at that point, he'll probably be thinking, "Man, I really wish there was a way to get more of this into my Roth or my 401k"

So I viewed it as, "here's someone able to save 54k/130k = 41% of his income each year. Why not make some of that tax advantaged? Would that hinder his goals at all? Meh, not really."

Does OP need 18% for retirement? Probably not. But as he's "saving" 41% anyways, may as well make as much of it tax advantaged as possible. Cause 15-20 years from now he'll want to, but won't be able to.

Oh well. That's my thinking anyways


(I view making voluntary additional payments to debt as savings)

[riccardo426]

Thank you all for the swift and thoughtful responses!

I think this reassures me that there is no single right answer. You see plenty of debt v. retirement threads. At the end of the day, I think if you are building net worth in some way -- either via asset creation or liability reduction, that's a good thing and it comes down to details. Don't let perfect be the enemy of good.

I think I am going to stick through 2013 with this aggressive plan, and maybe scale down to $4,000 a month for debt, $500 a month for 401(k) in 2014. By next year, I will be focusing on lower interest debt, and my loans should be accruing *only* $650 or so in interest per month. If I get a salary bump next year I will put that into retirement savings. In the meantime, I will celebrate upcoming milestones -- loans down to $150k (Julyish), loans equal to my salary (December), no more 7%+ loans (mid-2014) etc.

Some additional info that people were curious about.

-- I deducted the maximum student loan interest for 2012, but will be phased out for 2013.

-- I may be eligible for the IRA if I do the full 401(k) deduction, but given the sliding scale phaseout and that I'd have to do the full 401(k) contribution, I probably won't go down that route for now. Plus if I get a bonus I might be fully phased out. But that's something I will keep in mind as the contributions and phaseouts change. Thanks.

-- This year I will probably itemize deductions -- I have a 6.2% state and local tax rate which will take me over the standard deduction. No mortgage interest or anything else. I should have some charitable contributions to deduct that I would make anyway, maybe $300 this year.

-- For the future: expecting salary to jump to $150k in three years where people in my job with more experience are at. Job security is okay but subject to the overall economy. I am expecting SO to make comparable salary in a few years (same industry, predictable salaries).

-- SO has historically been more frugal/money conscious. SO hates debt especially. In the last year or so I have been doing the rounds with personal finance books, blogs, and forums. Millionaire Next Door was an eye opener.

-- Didn't mention this earlier. No CC debt, pay balances off every month, scores in low-mid 700's.

Thanks, again!

[dunnrobert700]

I think you're 100% right and putting money into a 401K instead would be a bad idea, at least until you pay down off the $127K of debt at over 6.5%. Right now that high interest debt averages out to around 7%.

Even considering 401K tax benefits you can't really expect to earn that much in any reasonable investment portfolio. Basically if you put $1 into your 401K and earn 6% from a mix of stocks, bonds, REIT etc. that's 6 cents that year. But you've spent 7 cents or more servicing the debt you didn't pay off to do that so you lost a cent per dollar that year (1%) on the basis of that decision.


You can always pay a little extra into your 401K later after the higher interest debt is eliminated to get back on track with your retirement goal. You have a retirement goal right?

[riccardo426]

Wanted to provide an update. Would love to hear any thoughts.

My student loans are down to $156k or so. I recently crossed the $25k mark for loans paid. But even as I have been paying $4,500 per month, the real dent in the loans is only about $3,600. Ugh. At least at the end of this month my loans above 8% will be gone.

Found out a few weeks ago that I missed the deadline to enter into my company's 401(k) for the year. I can enroll next March and begin payments next April. Currently thinking to put about 1,000 per month into the 401(k) next year, which would lower money available for loans and savings from $4,500 to $3,750 per month at a 25% tax rate.

The good news is that I have applied for a consolidation loan with a company focusing on loans to those from "highly-ranked" schools. If I'm approved it will shave 200 bps from my loans.

Overall, I'm glad I am in a position to be aggressive with payments, but it can be hard to remain patient. Even as I feel like I am living far below my means, my loans will take several years to pay down.

[snafu]

riccardo, Thank you for the update. The high interest rate on student loans really smacks graduates in the wallet for a very long time. I recommend caution, reading the fine print and very aware of the fees, extra charges from any consolidator as well as how it affects any tax deduction. I remember how frustrated it was to live a lower cost lifestyle while paying of student debt. I kept telling myself I'd spent the money before I earned it.

Sorry you missed the 2013 deadline for employer's retirement plan. It's suggested to capture any free money contributed by your employer so it's worth learning every detail. jpg7 's suggestion[ last February] for IRA contribution with anticipated transfer to ROTH would have tax benefit for 2012 income and might be re-examined for tax benefit 2013 income.

[coffee]

I would say what you are doing is fantastic. However, one must enjoy life. Cut down the payments 500 a month and put 200 a month in some type of retirement vehicle and enjoy yourself a little bit more. If you get a nice tax return, throw that to the debt. (If only our govt thought like that)

[siggy_freud]

I'd be paying down the loans as aggressively as you are. Paying off something with 8% yearly interest is as good as earning 8% interest on the same investment. Unless you have an account that you know is going to make as much or more, you're better off ridding yourself of the high(ish) interest debt.

My opinion anyways.

[riccardo426]

Happy to report my consolidation request went through - no origination fee, no prepayment penalty, 5.5% interest rate. Since its required to be a 5 year term, I decided not to consolidate all of my high interest debt because the minimum payment would be too high. According to the website they are tax deductible, but I am phased out anyway. My minimum payment will go up from about $1,000 per month to around $2,000, but the weighted average on my loans will drop from 6.7% to 5.6%. That should save over $1,000 per year.

My debt load will now be roughly:

1.5k 8% (payoff payment after payday next week, figured not to consolidate this one)
50k 6.5%
68k 5.5%
30k 5%
5k 2%

Now just have to be slow and steady and watch those numbers fall...