So Finally Made the Decision to pay off that 23k School Loan..

**bjl584** · 01-17-2012, 03:18 AM

Congrats on paying off the Student loans. Once your EF is built up you may want to look into starting a Roth IRA (if you don't already have one.) Congrats again

**Savingmonster** · 01-17-2012, 08:27 AM

I am currently contributing like 8 percent thru my companies, 401k... Its increasing a percentage each year...

Is is there a difference with that, and the roth?

Can i also start up a roth in the future? If needed, can i have my company's 401k i am currently contributing and a roth? Or is this over kill...

I plan on just keeping the 401k at 8 percent and max it out in a few years to 15 percent...

Im still super shakey with understanding 401ks, roth, and just all this retirement stuff... Why cant i just be immortal like Hogan????

**bjl584** · 01-17-2012, 08:39 AM

Because Hulk Hogan is way more awesome than mere mortals like us.

But, yes, you can start up a Roth anytime that you like in addition to your 401K. The difference is that a Roth is after tax as opposed to pre tax like a 401K. You can contribute up to 5K a year and draw the money out tax free once you are 59.5.

I would think about starting one ASAP.

**b4freedom** · 01-17-2012, 11:48 AM

Originally posted by Savingmonster View Post

This 23k loan is the ONLY debt I have currently. I don't own a car, a home (I just pay rent), and I don't have CC..

I am 34 yrs old and I make 70k a yr. I just felt like, I have 6 more years before I am 40.. When I am 40 I want to be in an exclusive position and I want to have at least $100,000 in savings..

What's the rate on the student loan debt? If the rate is 8%, pay it off. If the rate is 2.25% then you're better off investing the money towards retirement.

**jpg7n16** · 01-18-2012, 07:43 AM

Originally posted by Savingmonster View Post

Im still super shakey with understanding 401ks, roth, and just all this retirement stuff...

Well you're not doing THAT bad. One of the keys for retirement savings is just putting money away on a regular basis. You're already doing that. Another is to reduce your living expenses - which you're doing by paying off debt, so good job again.

Warning: the rest of this post is long (but hopefully worth it

)

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To better understand the world of retirement savings accounts, first picture a world without them. Imagine there were no 401ks, no pensions, no IRAs and no Roths. Imagine your only option was a taxable brokerage account.

You know you've got money today, but need money down the line when you can't work anymore. Q: How would you save for your future? A: By using a taxable brokerage account. In this account, you would buy up stocks/bonds/mutual funds (according to your risk profile) - and would just pay tax on any gains you made when selling investments. Also you'd be taxed each year on any interest and dividends you earned that year. It's the normal course of the income tax world.

And you'd be taxed on your entire salary each year.

But now, come to reality - where there are more accounts than just taxable brokerage accounts. There are special retirement specific accounts that help out with those tax consequences - called Individual Retirement Arrangements (IRAs). Not everyone qualifies for some of these accounts. The government designed them to help people have incentives to save up for retirement, and limits who they feel needs incentives. (If you make $300k/year, the government doesn't think you need incentives to save, so you wouldn't qualify, etc.) There are income limits for who qualifies, and there are limits to just how much you can put away in these accounts.

There are essentially 3 versions of IRAs:
1) Roth IRA: no tax deduction today, but no tax later
2) Traditional IRA [if Deductible]: yes tax deduction today, but yes tax later
3) Traditional IRA [if Non-deductible]*: no tax deduction today, and still taxed later (but only on earnings)
* quick note: everyone qualifies for #3, regardless of income

The beauty of these accounts is that you don't have to be taxed each year on gains/interest/dividends like you did in the normal world. Not paying taxes each year lets you keep more invested. Taxes only matter if/when you withdraw from the account.

And different from the taxable brokerage account, you may even get a tax deduction, or have tax free gains. A definite bonus!

But in creating these accounts, they needed to make sure you use the money for retirement. That's why they created them. To keep the incentives for retirement savings, they charge a 10% penalty tax for using the funds in a different manner (good or bad). There is a 10% penalty tax applied if you decide to say, use your "retirement" money for that lovely new car you can't afford, or to pay off your CC debt, or to avoid bankruptcy. (There are a couple excpetions, but it's best to treat retirement money as though they don't exist)

Individual Retirement Arrangements (IRAs)

http://www.irs.gov/pub/irs-pdf/p590.pdf

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Then there are employer sponsored plans. These are run through your company and are completely separate from your personal investing (taxable brokerage and IRAs) The most well-known of these plans are 401ks and pensions.

What is a 401k? Essentially, you'll make $70k this year as salary. So you'll be taxed on $70k this year as salary. But what if you were able to go to your employer and say, "look I know I made $70k this year, but can you postpone paying it all to me this year? Only pay me $55k so my taxes will be lower. Pay me the rest in a few years when my income isn't so high! Oh and can you invest that $15k in the meantime? I'd like to choose how it's invested, and I'll take the risk if my choices don't pan out."

That is a 401k (aka - elective deferral plan). You are electing to defer a portion of your income into a future year. Your employer sets this aside in an account for you, and gives you limited investment options for how you'd like to invest it in the meantime. You choose your investments, and you bear the risk. (403b's, 457 plans, SIMPLE IRAs, SEP IRAs, and TSPs all work on the same concept)

What is a pension? A pension is where the company saves for you. Instead of you setting aside your own income, the company builds up savings for you in a company managed account. They choose the investments, and they bear the risk.

401(k) Resource Guide
Tax Topics - Topic 424 401(k) Plans
Publication 525 (2011), Taxable and Nontaxable Income

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Now the world gives you better options than just a taxable brokerage account. Since you need to save up for retirement anyways, why not take advantage of the tax benefits of some of them?

In most cases, you'd like to be able to use a combination of accounts. One that gets the best of both worlds (tax deductions now, and no tax later)

401k (lower taxes today)
+ Roth IRA (no taxes later)
+ taxable brokerage (no penalties for early withdrawal)
= a well rounded retirement tax situation

This is a start, but I hope this gives you a better picture of the world of retirement accounts.

**cypher1** · 01-18-2012, 08:09 AM

Awesome post JPG! I'm actually sending this to my friends for guidance.

**Money Gal** · 01-28-2012, 09:44 AM

I would be fully funding my 401K up to the limits before paying extra towards student loans.

There may be some mental benefit from being out from under student loans, but you get no 'catch up' on the compounding of retirement savings if you are funding at a low rate while you are young.

**kv968** · 01-29-2012, 04:07 AM

Originally posted by jpg7n16 View Post

Then there are employer sponsored plans. These are run through your company and are completely separate from your personal investing (taxable brokerage and IRAs) The most well-known of these plans are 401ks and pensions.

What is a 401k? Essentially, you'll make $70k this year as salary. So you'll be taxed on $70k this year as salary. But what if you were able to go to your employer and say, "look I know I made $70k this year, but can you postpone paying it all to me this year? Only pay me $55k so my taxes will be lower. Pay me the rest in a few years when my income isn't so high! Oh and can you invest that $15k in the meantime? I'd like to choose how it's invested, and I'll take the risk if my choices don't pan out."

That is a 401k (aka - elective deferral plan). You are electing to defer a portion of your income into a future year. Your employer sets this aside in an account for you, and gives you limited investment options for how you'd like to invest it in the meantime. You choose your investments, and you bear the risk. (403b's, 457 plans, SIMPLE IRAs, SEP IRAs, and TSPs all work on the same concept)

One thing I'd like to add to JPG's excellent post is that some employers also MATCH your 401k contribution to a 401k up to a certain percentage.

For example, some will put in $0.50 for every dollar you do up to say 6% of your salary and some may even match you dollar for dollar up to a percentage of your salary. The first thing you should do is ALWAYS at least put in as much as they are matching. They say there's no such thing as "free money" but that's the closest you'll ever get to do it so ALWAYS contribute at least that much.

So Finally Made the Decision to pay off that 23k School Loan..