Paying off Student Loans - Help us strategize?

[boofta]

My wife and I graduated with $140,000 in combined student loan debt in 2011. This amount ballooned up to $155,000 via interest when we began paying it down in January, 2014. We now owe $66,000. We have $38,500 in the bank and are expecting to net $22,000 within the next 45 days from our business. We grossed $148,000 last year. We're projecting to gross $185,000 this year, but there's no telling if that'll happen for certain (we're both Realtors in our late twenties). Our business expenses are minimal, and our monthly household overhead hovers around $3,000. Our business costs around $500/mo on average to run (license renewal months are steep, so this is averaged out over the year). Other than our modest mortgage of $1,200, we have no other debts whatsoever--and intend to keep it that way.

We are trying to figure out how aggressive we want to be with getting rid of them this year. I filed a tax extension for us since our student loans are at 6.8% interest which is significantly higher than the interest that accrues on unpaid income tax, at least to my knowledge. We owe $19,000 by October for 2014 and are coming into our busy real estate season right now.

My question is--with our income being where it is at and with deals in the pipeline, should we be ultra aggressive on our student loans and leave only $25k in the bank to cover our financial obligations (roughly 6 months' worth of business and personal expenses), or should we play it conservatively considering we have a large unpaid tax bill and keep it closer to $40k or higher? We have no other assets of considerable value (our cars are old and paid-for, and our home equity is not worth touching).

I personally want them gone and will feel liberated once they are. I just don't want to put us in jeopardy by spending down our Go-to-HE\\ fund and then experiencing a financial crisis. What would YOU do? How much would YOU keep on-hand to feel safe?

[AnotherReader]

You need to understand the penalties for not paying the tax by April 15th. It's not just interest that is accruing. There is a failure to pay penalty that you should look at. If you use a CPA to prepare your returns, that person can explain the financial consequences of not paying your taxes on time. From the IRS website:

Paying tax late. You will have to pay a failure-to-pay penalty of ½ of 1% (.50%) of your unpaid taxes for each month, or part of a month, after the due date that the tax is not paid. This penalty does not apply during the automatic 6-month extension of time to file period, if you paid at least 90% of your actual tax liability on or before the due date of your return and pay the balance when you file the return.

In your shoes, I would pay the IRS immediately, including your best estimate of interest and penalties.

[boofta]

You need to understand the penalties for not paying the tax by April 15th. It's not just interest that is accruing. There is a failure to pay penalty that you should look at. If you use a CPA to prepare your returns, that person can explain the financial consequences of not paying your taxes on time. From the IRS website:

Paying tax late. You will have to pay a failure-to-pay penalty of ½ of 1% (.50%) of your unpaid taxes for each month, or part of a month, after the due date that the tax is not paid. This penalty does not apply during the automatic 6-month extension of time to file period, if you paid at least 90% of your actual tax liability on or before the due date of your return and pay the balance when you file the return.

In your shoes, I would pay the IRS immediately, including your best estimate of interest and penalties.

Thanks for the response. I understand there is a penalty on the unpaid balance, however 6.8% of our remaining student loan balance of $66,000 is $2,244 in interest if we were to hold this debt for another six months instead. In IRS penalties, we'd be paying ,570 assuming a flat 1/2% per month penalty if we didn't pay the remainder until October 15. IRS charges 3% on top of federal short term rate (0.47% for June, 2015), which would put our total penalty to $329.64 + $570 = 899.64 for paying 6 months late. Please correct me if my understanding is not accurate or incomplete, but it looks to me that paying off the student loans first would save us thousands in interest over paying the IRS first, even after including their interest rate and penalties. Am I missing something? Is it worth playing the numbers like this to redirect the capital toward high interest debt?

**EDIT** Wow, I did my math horribly wrong on the 66k owed. The actual interest accumulation is $2,244, not $4,488 over 6 months. This does change things a bit.

[TBH]

I would personally pay off the IRS first because the stress of owing money to the IRS would outweigh a small difference in interest cost. Also, student loan interest is tax deductible, which reduces the cost of carrying it.

If I were you, I'd do this:

1. Pay the IRS off now from your savings, while continuing to pay minimum on student loans.
2. Build savings back up to 6 months' expenses for personal and business.
3. Then attack student loans aggressively, keeping that 6-month efund in cash.
4. When student loans are gone, turn your attention to retirement savings. You didn't mention retirement, so I'm assuming you haven't been focusing on that while you're paying off debt. I think that's a decent choice, especially since as business owners you may not have an employer matching your contributions so you're not losing out on those. You're losing out on potential investment gains, but you've done an impressive job keeping your expenses low and paying off those debts fast. But when they're gone your next priority has to be retirement. Once you've caught up on retirement I'd allow a little lifestyle creep, within reason.

[boofta]

I would personally pay off the IRS first because the stress of owing money to the IRS would outweigh a small difference in interest cost. Also, student loan interest is tax deductible, which reduces the cost of carrying it.

If I were you, I'd do this:

1. Pay the IRS off now from your savings, while continuing to pay minimum on student loans.
2. Build savings back up to 6 months' expenses for personal and business.
3. Then attack student loans aggressively, keeping that 6-month efund in cash.
4. When student loans are gone, turn your attention to retirement savings. You didn't mention retirement, so I'm assuming you haven't been focusing on that while you're paying off debt. I think that's a decent choice, especially since as business owners you may not have an employer matching your contributions so you're not losing out on those. You're losing out on potential investment gains, but you've done an impressive job keeping your expenses low and paying off those debts fast. But when they're gone your next priority has to be retirement. Once you've caught up on retirement I'd allow a little lifestyle creep, within reason.

Thanks, I appreciate all of these responses. I think I'm trying to do too much at once. The student loan debt load has weighed on us for years--psychologically and financially--so I think we're just super anxious to wipe them out as it's a precursor for investing, travel, and starting a family. But even if the loan debt were fast-tracked, Uncle Sam isn't going to forget about what's owed to him.

I think I'll play it semi-cautious, wait for these three deals to close within the next 7-10 days ($15,375 net to us), and pay the tax bill in full at that time. Then I'll keep $25k-$30k in the bank as our 6 month business and personal safety net, and throw the rest at student loans after setting some aside for next year's taxes (to avoid making this same mistake twice). Once they're gone, we'll shift our focus to a combination of mortgage debt reduction and retirement investing.

[AnotherReader]

The IRS is a tax collector, not a lender. From the IRS' perspective, you are raising red flags about your interest in compliance and in your money management skills. You are in a business that is often targeted for audit anyway. A nasty audit might be headed your way, and that will cost you far more than any interest savings. In your shoes, I would pay this off, apologize profusely, and pay on time in the future.

You accrue penalty at 0.5 percent per month, so you are correct about the $570 in penalty, pennies more if it's compounded. You are approximately correct on the interest. IIRC, you are not liable for the much higher failure to file penalty until after the extension expires.

The potential consequences are not worth the relatively small savings here.

[richard johnson]

The smart way to pay back student loans faster is to obviously save more and spend less. Spend less on entertainment. There are lots of fun ways to do this — hosting a movie night or potluck with your friends instead of going out, going to bars during happy hour instead of late at night, and borrowing books and movies from the library instead of buying them are just a few options.