SLs or retirement?

[riverwed070707]

Currently contribute 12% of my income to 401k with 6% company match, plus $1,200/year to DHs Roth IRA. We are 26 and 31, total retirement basket is at about $35k right now.

I have $9,400 in SLs to pay off with interest rates between 2.2% and 6.8%.

I'm going to be freeing up some dollars in the budget. I've identified 3 potential options and wanted to get SAs advice on which would be best.

1) Max DHs Roth (additional $316/mo), accelarate SL payments ~$75/month (payoff in 51 months vs 85).

2) Put additional funds toward SLs to pay off ASAP (about 20 months if no extra money is freed up throughout the year, but likely sooner), then max Roth.

3) Combo. Double SL payments to $280/mo to cut payoff time in half (38 months) and increase Roth contributions to $360/mo.

Other deets: DH is in school, but we are not currently taking on any more school debt -- everything is being paid in cash as we go. I currently contribute $750/mo to savings (28% of our take home) but a portion (~2/3) of this is used to pay for DH & DDs school. I plan on increasing savings to $1k at the same time as making the change to SLs and retirement.

Any thoughts appreciated!

[KTP]

pay minimum on at least the 2% student loans.

max out Roth for both you and spouse by putting your EF money in the Roth. You only get one shot at this valuable space each year ($10,000) and it sounds like you are only using up $1200 each year. You can withdraw these Roth contributions at any time to use in an emergency with no penalty, and if there is no emergency, well, then you will thank yourself in your 40s when you have a $200,000 Roth account.

(keep the EF Roth money in short term bonds so it is always there when you need it)

edit: you are probably in the 15% tax bracket? if so, I would cut back the 401K contribution to just enough to get the full company match, and put the rest of the money in the two Roth IRAs (if you can't find other monies for these contributions)

[riverwed070707]

I can't pay a minimum on the 2% loans. I send one check each month to direct loan servicing... to my knowledge there is no way to designate where the extra is going.

Not sure I love the idea of putting our efund in a Roth. I see the earning potential, but to me, retirement is untouchable and efund can be used when we're in a pinch. I would sell my car and get a second job before I'd touch my retirement...efund on the other hand, can always be refunded after a few months of scaling back spending.

[KTP]

Not sure I love the idea of putting our efund in a Roth. I see the earning potential, but to me, retirement is untouchable and efund can be used when we're in a pinch. I would sell my car and get a second job before I'd touch my retirement...efund on the other hand, can always be refunded after a few months of scaling back spending.

I only suggested putting enough of the EF in the Roth to make sure you reach the maximum contribution for this year. If you want, you can call that portion an EFRoth and not feel guilty if you have to pull it back out because it would not have been there in the first place had you not moved some of your EF money. For reduced hassle, I will still keep $2000 or so in checking for EEF (extreme emergency fund) for when you can't wait a few days to get the contribution check mailed back to you.

Alternatively, like I suggested, reduce your 401K contribution to just enough to get the full company match (that is free money). You are in a low tax bracket and the Roth is just too good to pass up.

[jpg7n16]

I can't pay a minimum on the 2% loans. I send one check each month to direct loan servicing... to my knowledge there is no way to designate where the extra is going.

You might wanna check on that. My SLs had a default option to pay and have the payment spread out at their choosing. But I was able to find a way to pay extra on the ones I wanted to pay extra on. (I have Edfinancial Services - Welcome - Edfinancial Services)

I'd call your loan service company and ask. Couldn't hurt to check

Not sure I love the idea of putting our efund in a Roth. I see the earning potential, but to me, retirement is untouchable and efund can be used when we're in a pinch. I would sell my car and get a second job before I'd touch my retirement...efund on the other hand, can always be refunded after a few months of scaling back spending.

I don't like it either. But I do agree with KTP while you're in the 15% bracket, it makes more sense to use a Roth than the 401k (after emp match).

IMO - Keep the EF out of retirement accounts. 401k @ match (no more, no less). Roths for excess.

[KTP]

Couple A contributed $1200 to one Roth (even though they were eligible for two, like all couples with at least one income). They kept $12,000 in a bank savings account for their EF.

Couple B contributed the maximum $10,000 to Roths by using $8800 of their EF. They kept the remaining $3200 of the EF in a bank saving account.

The universe split into two time lines.

In time line one, neither couple has a big emergency. Couple A will always have $8800 less in their Roth account than Couple B. They have robbed themselves of $8800 of Roth space.

In time line two, both couples have a $12,000 emergency. Couple A pays for this out of their bank saving account, keeping the $1200 Roth intact. Couple B withdraws $8800 of their Roth contribution and $3200 from their bank savings account, keeping $1200 of the Roth intact.

The only difference is couple B has the chance at a bigger Roth balance if they never have a catastrophic emergency.

[kork13]

The universe split into two time lines.

WOOOOOAAAAAAAAAH!!!!!!!!!

[jpg7n16]

Since couple B has to keep $8800 of their Roth invested in a money market fund (so as not to expose the emergency fund to market risk), and the MM fund yields very little, there are little to no benefits of the tax sheltering. The EF is taking up valuable Roth space that could have been used for more profitable investing (and thus maximize the tax advantage)


Couple B also has to keep detailed records of the contributed basis of the Roth, to make sure they don't withdraw beyond contributions and into earnings. Also, in catastrophic timeline - couple B has withdrawn funds and cannot replenish the EF, (since Roth has an annual contribution max)

Couple B's EF is just taking up room in the Roth that couple A is using for retirement savings.

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

Giving both couples $30k to start, couple A maxes their roth ($10k), keeps an EF in the bank ($10k @ 1%) and invests the remaining in taxable brokerage ($10k). Roth and taxable invested for retirement goal. Both earn 8% on average for 30 years.

At end of 30 years:
EF: $12,512.72 (1% interest minus 25% tax bracket on interest income/year)
Taxable acct: $87,032.58 (8% growth minus 15% LTCG tax)
Roth: $100,626.57
Net worth: $200,171.87

Couple B instead puts their EF in their Roth ($10k), has no EF outside, and invests the remaining $20k long term (8%)
EF: $0
Taxable: $174,065.17 (8% growth minus 15% LTCG tax)
Roth: $13,478.49 (1% interest tax free)
Net Worth: $187,543.66

So in the best of times, the EF held outside lets the Roth shine for what it's meant to do.

[KTP]

Your arguement is flawed because my argument only dealt with cases where the couple could not contribute the maximum to the Roth because of budget issues.

If the budget is tight and all you have to contribute to Roths is $1200, then how is couple A going to contribute $10,000 to a Roth AND keep their $12000 EF in a bank at 1%? Money fairy?

I suggest to make up the $8800 Roth shortfall by moving some of the EF to the Roth...it doesn't hurt anything, except as you mention the hassle of keeping records.

Also, in later years when their income has increased, they can rebuild the EF outside the Roth and continue contributing $10,000 to the Roths each year, thus the $8800 in the Roth that was acting as their EF can gradually be switched to a higher yield higher risk investment.

I have done all I can to explain this, so I am dropping the subject. We are only talking about maybe a few thousand extra dollars at retirement...not significant.

Ok here is what it might mean. Say after 5 years they have rebuilt their EF outside the Roth and can switch the $8800 money in the Roth that was ear tagged as an EF and invested in money market into a stock index yielding 8%. After 35 more years, this $8800 will grow to $130,000. Since the Roth is tax free, you have to compare this $130,000 with a taxable account of $130,000 which you owe capital gains tax on $122,500. Even at a rate of 20%, if that is still available, that is a tax of $24,500.

So my strategy has potentially provided your retirmeent with an extra $24,500...not a huge amount, but something.

[Slug]

I can't pay a minimum on the 2% loans. I send one check each month to direct loan servicing... to my knowledge there is no way to designate where the extra is going.

I also have different loans with different rates. I called my loan servicer and directed them to put all of my overpayment to my variable rate loans. You should definitely call to check on that option.

[snshijuptr]

If it's the Direct Loan Servicing that you access through myedaccount.com, then you can direct your overpayments by calling them. Note that you have to pay all interest first across all loans before you can direct the principal, but it still works. The solution might be to use Kwikpay for your regular loan payments and then after that one clears to make an additional payment either over the phone or online if you can direct it online. We've found that they are helpful once you wait forever to get them on the phone.

[BMEPhDinCO]

Currently contribute 12% of my income to 401k with 6% company match, plus $1,200/year to DHs Roth IRA. We are 26 and 31, total retirement basket is at about $35k right now.

I have $9,400 in SLs to pay off with interest rates between 2.2% and 6.8%.

I'm going to be freeing up some dollars in the budget. I've identified 3 potential options and wanted to get SAs advice on which would be best.

1) Max DHs Roth (additional $316/mo), accelarate SL payments ~$75/month (payoff in 51 months vs 85).

2) Put additional funds toward SLs to pay off ASAP (about 20 months if no extra money is freed up throughout the year, but likely sooner), then max Roth.

3) Combo. Double SL payments to $280/mo to cut payoff time in half (38 months) and increase Roth contributions to $360/mo.

Other deets: DH is in school, but we are not currently taking on any more school debt -- everything is being paid in cash as we go. I currently contribute $750/mo to savings (28% of our take home) but a portion (~2/3) of this is used to pay for DH & DDs school. I plan on increasing savings to $1k at the same time as making the change to SLs and retirement.

Any thoughts appreciated!

How much is your DH's Roth earning? Why don't you have a Roth? I would drop your 401k down to 6%, then use the rest to open your own Roth (diversify retirement money). Then, I would try and get at least $6000 into the roths ($3k each) for the year. Once that's done, put the rest into the SL IF you can tell them to put it on loans over 4% interest rate only.

Ideal Steps Are:
1. Max 401k
2. EF of 3 months
3. Max Roth
4. Student Loan extra payments to rates > 4%
5. 401k contributions

I know you want to pay the loans off fast - really, I do feel the same way with mine. BUT by doing the above, you'll be in a better position!

[Hector]

My first priority would be to make arrangement so that extra payment would go towards student debt with higher interest rate.
Then I would make priority of paying student debt with higher interest rate. For sure I would put everything into student debt with 6.8% after company match.

About 401k and Roth,
As others mentioned, I would contribute upto company match in my 401k if I am in 15% bracket. Then I would max out Roths before contributing to 401k.