Reader Case Study - Student Loan/Retirement Allocations

[ejchis]

Removed.

[Slow&Steady]

This is mostly just to bump your post up but like everyone I have an opinion.

With you already maxing HSA, I believe the only other tax advantaged option you have is an IRA (traditional or Roth, whichever you qualify for).  The max you can contribute to an IRA is $5500/year so I would max that out yearly.

$319,000 in student loan debt is really hard for me to wrap my mind around but your income is almost double mine at that same age so maybe it will be worth it in the long run.  If you send the $5500/year to an IRA that leaves you will an extra $58,000/year add that to the $48,000/year minimum you will be paying on the student loans and try to get those paid off before you hit 35.  It might be too far of a stretch (especially once you add interest) but would be a fun personal competition to see if you can do it.  Hopefully by then you will have employment that will allow you to contribute to a 401k or similar, with higher contribution limits that just an IRA.  Either way I would try to continue your current living expenses after the debt is paid off and divert that $100,000/year into some form of investing for retirement.  You will technically be starting your retirement late (especially for a higher income) but if you keep your living expenses low you could probably catch up pretty quick.

[Trip]

My personal opinion is that at 5.99% it is that it is probably close to a toss-up. Personally, I would attack those loans since the rate is over 4% higher than the current yield on a 10Y treasury note. If you want to be more aggressive, then historically you'd do a little better in the market if you go with a low cost fund. However, a guaranteed 5.99% return for paying off loans would be more attractive to me than hoping that history repeats itself and stocks perform an average of 7% over the coming decades.

If you are able to get those rates down below 5% then I would shift more towards pumping up the retirement funds.

[therethere]

At 6% I think its a wash as to whether investments would outpace the loans. However, with your big salary you're paying a lot of taxes. You definitely need to minimize this as much as possible. Is there a 401k at your work? If so, definitely max it out  first if available before doing anything else (except having an emergency fund).

[therethere]

A typical match is only like 4% of contributions which is really not that muchl. You're in the 25% Tax bracket (if not higher) and Illinois is 3.65%. By contributing you are immediately saving almost 30% on 18k every year if you contribute. So what if the fees end up being 1-2% higher than the best plan? Personally, I'm all about lowering your tax liability as much as possible in the 25% or higher bracket. I only wish there was more space to avoid taxes!

You should easily be able to contribute to an IRA, 401k, and HSA then use the leftover to snowball your loans or invest. Whichever you feel most comfortable with.

[TXScout2]

If the employer has an HSA I assume they also have a 401k.  I agree, I would max out your employer 401k to $18k, you can optionally put an additional $5500 per year into IRA and convert it into Roth (this will be non-deductible though).  After that I would throw everything into the loan.  401k fees suck but they've sucked for long enough that a lot of them are beginning to offer options with lower fees.   

[NoStacheOhio]

A typical match is only like 4% of contributions which is really not that muchl. You're in the 25% Tax bracket (if not higher) and Illinois is 3.65%. By contributing you are immediately saving almost 30% on 18k every year if you contribute. So what if the fees end up being 1-2% higher than the best plan? Personally, I'm all about lowering your tax liability as much as possible in the 25% or higher bracket. I only wish there was more space to avoid taxes!

You should easily be able to contribute to an IRA, 401k, and HSA then use the leftover to snowball your loans or invest. Whichever you feel most comfortable with.

As an added bonus, you may be able to do a normal Roth contribution because the 401k contribution will reduce your AGI

[randymarsh]

It would be odd for a white collar job paying 125K not to have a 401k. Definitely possible they don't match, but the plan should be there.

If you could contribute the full 18K, you'd end up paying about $5,000 less in taxes. Any higher fees are outweighed by the tax savings.

[renata ricotta]

Your emergency fund seems on the high side to me (about your age, similar income, similar cost of living city). I try to aim for $5k or so, which is about 2.5 months of expenses, but my job is pretty stable and I have safety nets (employable spouse, home equity, lots of credit, family who would give me the shirt off their backs). It's a personal comfort thing, so you do you.

Here's how I would approach it in my brain, if it were me.

Current Situation:

Monthly gross (and taxable income): ~10400
Taxes/other paycheck reducers: ~3600 (about a 34% tax rate)
Monthly net: 6800
Fixed expenses: 1500
Minimum Loan Payment: 3500

Total left over: $1800

Now, if you max out a 401(k), you would end up with this scenario:

Monthly gross: 10400
401(k): 1500
Taxable income: 8900
Taxes (assuming same high rate, which might not be accurate): 3026
Monthly net: 5874
Fixed expenses: 1500
Minimum Payment: 3500

Total left over: $874

You can then take that $874 and either 1) throw it at your student loans, or 2) fully fund a Roth IRA, which you are now eligible for because you've reduced your adjusted gross income to be under $116k. You only need $458 and change per month to fully fund a Roth IRA. So, you still have $416 to throw at your student loans. Plug this into an online calculator to figure out how much this will save you in interest. I've plugged your numbers (assuming some dates, check your details) into the bankrate one, and estimated that you'd save a total of $15k in interest and shaved about 1.5 years off of your student loan.

At the end of this scenario, you have:
1. A fully funded 401(k), beginning the magic of compounding interest working in your favor while you're younger
2. A fully funded Roth IRA, which but for #1 you would not be eligible for, also with compounding interest
3. A savings of $15,000 in student loan interest
4. A reduction in your tax liability to the tune of $574/mo, or $6888 per year.

By October 2024, you will have:

1. $162,000 in contributions to your 401(k), plus all of the growth your fund has experienced in that time (details may vary based on fees on funds your employer offers, market, etc.).
2. $49500 in a Roth IRA, plus 2% reinvested dividends (if you use VTSAX), plus all of the growth
3. A paid-off student loan
4. Savings of 15,000 in student loan interest
5. Savings of $61,992 in taxes

Now, compare the scenario of paying down your student loans instead.

1. Shaves about 4 years off of your student loans, meaning you'd be ready to start saving for retirement in 2022, at age 38. That might stress me out.
2. Saves about $55,000 in student loan interest

By February 2022, you will have

1. A paid off student loan
2. A savings of $55,000 in student loan interest
3. Higher tax liability than you would have otherwise, and
4. No retirement savings, when you're nearing 40.


Please check my math, your pay stubs, and your student loan amortization schedule. There are certainly a lot of variables in play I didn't account for - raises, changes in employment or employment benefits, changes in your COL, changes in your tax filing status, changes in the tax code, etc. etc. But, given the information you know now, if it were me, I'd pick Scenario #1.

Steps:
1. Build emergency fund
2. Max out 401(k)
3. Max out Roth IRA
4. Throw everything left over in student loans

[renata ricotta]

Ha, right after I hit post, I thought of a better way to frame the comparison of the two scenarios. Instead of looking at two different dates, look at them on the same date (I'll use the sooner one, Feb. 2022, because I'm sure the allure of "getting my loan paid off sooner" is strong), and compare your net worth.

In February 2022, you would have:

Scenario 1:

1. $108,000 in a 401(k) (6 years at $18k, not counting any returns)
2. $33,000 in a Roth IRA
4. An outstanding loan balance of ~$114,800

Net worth: $26,200 Note that this assumes that an index fund will yield zero returns in the next 6 years. What's the likelihood of that, you say? Very low, in my opinion. This is a very conservative estimate.

Scenario 2:

1. No retirement savings
2. A paid-off student loan

Net worth: $0

 

[MDM]

See below for some generic recommendations and some links you could explore for more details.
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA    
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic).  See also
   https://www.bogleheads.org/forum/viewtopic.php?f=2&t=182081,
   http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845
   and other posts in that thread about exceptions to the rule.
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial   
   
The emergency fund is your "no risk" money.  You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001   
      
If your 401k options are poor (i.e., high fund fees) you can check   
   http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/
for some thoughts on "how high is too high?"