Author Topic: Case Study: what to do when loans are gone  (Read 1351 times)

sportsportsports

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Case Study: what to do when loans are gone
« on: September 19, 2017, 08:20:43 AM »
I wasnít sure which place to post this in so if it should be moved let me know. This is my first time posting!

Life situation: Single, I rent a house with 3 roommates in Saint Paul, MN and work in downtown Minneapolis as a data analyst, no dependents, and Iím 25

Gross salary/wages: $52,000 a year

Paycheck deductions:
Transit: $30.35 (I commute ~8 miles to work either on public transit or my bike)
Federal Income Tax: $228.52
Social Security: $122.12
Medicare: $28.56
MN Income Tax: $94.06
Roth 401k: $100.00 (this is 5%, the minimum required to get the company 4% match)

Net bi-weekly take-home (after deductions): $1396.39

Total: $2792.78/month

Other income:
I also get another $1000 a year for coaching a menís water polo team for 6 weeks in the Fall. I donít really factor that into the equation much, but Iíll just leave it here anyways. As a side note, because of this 6 week job, I get access to a gym all year long!

Current monthly expenses:
To get the below breakdown, I averaged my spending in each area over the past 8 months

Rent: $375
Utilities (internet, heat, water, electricity, trash removal): $55
Car/renters insurance: $55
Gas: $30
Cash withdrawal: $70
Grocery: $70
Eating/drinking out: $140         (Feel free to roast me for this one but trust me, I know)
Shopping: $40 
Activities: $200
Miscellaneous: $62

Total spending: $1,097

Iíll explain my spending here a bit.
Cash withdrawal: usually much, much lower because I pay for everything on a cash back credit card, but I withdrew $500 while on vacation in Greece this summer
Shopping: includes house supplies, things for bike maintenance, etc. Basically, any shopping that is not food or drinks
Activities: includes non-recurring events like pro sports games, concerts, membership to the science museum, going to the movies, etc. but mostly recurring expenses like soccer and water polo league fees. Unfortunately you canít really play organized sports without a league fee and I definitely donít want to stop playing.
Miscellaneous: includes one-off spending, like oil changes, co-pays for dentist/doctors visits, 2 haircuts a year, etc.

Iím recognize that I am very lucky in that being under 26 means I am still on my parentsí health and dental plans. They also currently still pay my cell phone bill on their family plan, even though Iíve offered to start paying my portion numerous time over the last year. Once they agree to start letting me pay, itíll be $30-$40/month. Also, once I turn 26 this time next year, I will be using my company's pre-tax insurance plans, but I donít have all the details on that at the moment.

Assets:
Cash: $7,600
1999 Ford Escort: bought for $1200 a year ago
Road bike: worth $800 (bought for $100, thanks to boyfriend owning a used sporting goods store)
Vanguard personal Roth IRA: $1000

Liabilities:
Student loans: $1,260.08, interest rate @ 3.150%
I will be paying off my last student loan this week (!!!!) which means I will be completely out of debt!

Comments:
I traveled around the world for a year after I graduated from college in May of 2015, and since coming back and starting work full time in September of 2016, Iíve focused pretty much all my extra money on my student loans. I know there is some debate about loan interest rate % vs. possible investment % gain (my loan %s were not above 4.4%) however, I also know myself and I didnít want debt hanging over my head so thatís why my main focus has been my loans. Basically, because these are paid off, Iím going to have a fairly decent amount of money every month that Iím not sure what to do with and Iím very interested in the whole idea of FIRE.

I know I didnít break down my spending in super detail, and I know there are some places I can decrease spending, especially eating/drinking out. I'm working on it, and now that I recently moved it will be easier. I don't even want to explain what my living situation was up until a month ago. But, if Iím being honest, Iím not super concerned since I save a very solid chuck of my income each month already.

My main question is:
What would you do with the extra 50-65% of income each month if you were in my situation with no debt?

Related questions:
-Which is more important, maxing out my IRA or contributing a higher percentage to my 401k? My thought had been to keep contributing the minimum on my 401k until Iíve maxed out my IRA each year.
-I know that I should/want to start a general investing account. I would do this through Vanguard as well. In relation to the above question, is this account more or less important than my retirement accounts?
-I also want to start saving for a future house downpayment (hopefully buying in the next few years once the Twin Cities market takes a turnaround), but donít want the money just sitting there in a bank savings account not gaining any interest either. Iíve never had to save up that much before, so Iím not sure where to start. What is a good plan for this kind of saving?

Any help or advice is much appreciated, thanks in advance!

RidetheRain

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Re: Case Study: what to do when loans are gone
« Reply #1 on: September 19, 2017, 10:20:07 AM »
Congratulations on becoming debt free! You seem to be in a really good position and while you seem to see a few spots for improvement, I don't see any punch-worthy problems considering your overall income to spending ratio. It's always good to tighten up, but you don't have an emergency.

Your questions:
Quote
What would you do with the extra 50-65% of income each month if you were in my situation with no debt?
Save for retirement!

Quote
-Which is more important, maxing out my IRA or contributing a higher percentage to my 401k? My thought had been to keep contributing the minimum on my 401k until Iíve maxed out my IRA each year.
This depends on what you think you'll be pulling from your retirement account. Since you plan to purchase a house, you may find that you are expecting to spend MORE money later than you do now, so consider this carefully. Follow investment advice here if you are confused:
https://forum.mrmoneymustache.com/investor-alley/investment-order/


Quote
-I know that I should/want to start a general investing account. I would do this through Vanguard as well. In relation to the above question, is this account more or less important than my retirement accounts?
Retirement accounts first! See the same link as above. You definitely want to take advantage of all tax-sheltered accounts first. This is really the last thing you should be investing in - when all your better options are exhausted.

Quote
-I also want to start saving for a future house downpayment (hopefully buying in the next few years once the Twin Cities market takes a turnaround), but donít want the money just sitting there in a bank savings account not gaining any interest either. Iíve never had to save up that much before, so Iím not sure where to start. What is a good plan for this kind of saving?

If you plan to purchase in the next three or fewer years, keep this in the same type of account you would an emergency fund. That timeline means that you can't bend with the stock market or handle volatility. Keep it safe in a savings account.

If you are more flexible and can wait for six years or longer, then you might be able to get away with investing in safer investments. This doesn't sound like you though.
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boarder42

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Re: Case Study: what to do when loans are gone
« Reply #2 on: September 19, 2017, 10:37:20 AM »
On saving for a house a few things
1. Make sure you want a house and are aware of all the costs and it makes financial sense to own vs rent
2. make sure youre getting a good deal on the house
3. If you find the right house for the right price with the right life timing, the money you have saved up to buy doesnt have to be 20%.
4. You can find lenders who will buy out PMI for a slight increase in rate or a bit more closing costs these are almost always better than paying PMI - but its a math equation
5. You can always refiance to a lower interest rate but you cant go back in time and buy a house a lower interest rate.
6. assuming you bought your house with a good deal you may be able to refinance PMI away after 6 months.  just be aware this is an option
7. there is never a time you absolutely must buy a house
8. Knowing number 7 and the fact that 20% down isnt required, i would take my money and invest it in a taxable Vanguard total stock market account.  when the right house comes up sell off what you need for a down payment and buy it.  If the market has gone down maybe you wait, but the housing market could be depreciated too and you could have a good time to buy.

Overly conservative people here will tell you that you have to have 20% down.  i've got friends who have no PMI who only own 3% of their house and have a 3.5% interest rate on a 30 year loan.  HOW? bc rates were once at an all time low and no matter what you do you cant go back in time and get those rates again.

This makes me of the opinion its never to early to buy the Right house for the Right price but it can be too late. 
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sportsportsports

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Re: Case Study: what to do when loans are gone
« Reply #3 on: September 19, 2017, 11:26:20 AM »
Thank you so much for your responses! I really appreciate it.

boarder42, you've given me a bunch to think about as far as saving for a house, thanks! My boyfriend didn't have 20% down for his condo either, so I know that's an option. I know I'd like to have as much as possible, but I definitely see your point on #8 and have been leaning in that direction.

RidetheRain, I will read up on the investing order link you gave me, thanks! A follow-up question:

You definitely want to take advantage of all tax-sheltered accounts first.

Currently, my 401k and IRA are both Roth because I will probably be in a higher tax bracket when I retire and can afford to pay the tax right now. Would you suggest I change my thought process here and start saving a % of my income in a pre-tax account? And if so, what would your argument be for that in my case? Everything I've been hearing from everyone I've been talking to is to go solely with Roth until I move up in tax brackets (if/when that happens)

Novik

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Re: Case Study: what to do when loans are gone
« Reply #4 on: September 19, 2017, 11:30:47 AM »
You definitely want to take advantage of all tax-sheltered accounts first.

Currently, my 401k and IRA are both Roth because I will probably be in a higher tax bracket when I retire and can afford to pay the tax right now. Would you suggest I change my thought process here and start saving a % of my income in a pre-tax account? And if so, what would your argument be for that in my case? Everything I've been hearing from everyone I've been talking to is to go solely with Roth until I move up in tax brackets (if/when that happens)


Roth accounts are also tax-sheltered because withdrawals (and presumably growth? someone in the US should confirm that) are tax free. Just different timing of the shelter.
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boarder42

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Re: Case Study: what to do when loans are gone
« Reply #5 on: September 19, 2017, 11:36:37 AM »
You definitely want to take advantage of all tax-sheltered accounts first.

Currently, my 401k and IRA are both Roth because I will probably be in a higher tax bracket when I retire and can afford to pay the tax right now. Would you suggest I change my thought process here and start saving a % of my income in a pre-tax account? And if so, what would your argument be for that in my case? Everything I've been hearing from everyone I've been talking to is to go solely with Roth until I move up in tax brackets (if/when that happens)


Roth accounts are also tax-sheltered because withdrawals (and presumably growth? someone in the US should confirm that) are tax free. Just different timing of the shelter.

i used to think and use the same logic but in reality most people especically those here end up in lower tax brackets when we retire.  Here is a mad fientist article on why.   

http://www.madfientist.com/traditional-ira-vs-roth-ira/

and another really good one
http://www.madfientist.com/retire-even-earlier/

i was all roth all the time before coming here with a similar mindset.  now i'm only Roth in my IRA b/c our incomes make a Trad IRA not tax deductible.  but my 401k is now traditional.  for reference we're in the 25% bracket now and expect to be in the 15% at FIRE. If you're in the 15% now roth is better.  and if you ever fill up your 15% bucket then roth becomes better.

filling up your 15% bucket would be the top of the 15% bracket plus any exemptions and deductions x25 making it over 2MM in tax deferred accounts for a couple before you hit this number
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RidetheRain

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Re: Case Study: what to do when loans are gone
« Reply #6 on: September 19, 2017, 12:29:55 PM »
When you get your money you are taxed on that income. If you put that money in a Roth IRA then the earnings you make on that money are not taxed when you take it out. If you put that money in a regular account then you ARE taxed on the earnings when you take it out. Contributions (the actual $$ you invest) is not taxed because it already was (income tax).

If you are currently saving 50-65% of your income right now, then logically you would pull less money from your accounts in retirement and have a lower tax bracket - regardless of your current bracket. However, you are talking about lifestyle changes (e.g. house) which can drastically change your spending. That means that it may not be as cut and dry. When in doubt go with traditional 401k. There are no absolutes with this of course - the tax code could randomly change and brackets could shift wildly. For example, if universal healthcare is instituted in the US, tax brackets could increase drastically to pay for it as they have in other countries. This could mean that your tax rate will go up a LOT in retirement - potentially reducing the benefit of traditional 401k.

However, if you are planning on spending the equivalent of 20-30k a year then the government might misclassify you as "poor" and give you a low bracket despite the uptick in brackets overall. It's a gamble! The best you can do is base your expectations on what is occurring now and plan for that.
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Laura33

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Re: Case Study: what to do when loans are gone
« Reply #7 on: September 19, 2017, 12:31:30 PM »
You definitely want to take advantage of all tax-sheltered accounts first.

Currently, my 401k and IRA are both Roth because I will probably be in a higher tax bracket when I retire and can afford to pay the tax right now. Would you suggest I change my thought process here and start saving a % of my income in a pre-tax account? And if so, what would your argument be for that in my case? Everything I've been hearing from everyone I've been talking to is to go solely with Roth until I move up in tax brackets (if/when that happens)


Roth accounts are also tax-sheltered because withdrawals (and presumably growth? someone in the US should confirm that) are tax free. Just different timing of the shelter.

i used to think and use the same logic but in reality most people especically those here end up in lower tax brackets when we retire.  Here is a mad fientist article on why.   

http://www.madfientist.com/traditional-ira-vs-roth-ira/

and another really good one
http://www.madfientist.com/retire-even-earlier/

i was all roth all the time before coming here with a similar mindset.  now i'm only Roth in my IRA b/c our incomes make a Trad IRA not tax deductible.  but my 401k is now traditional.  for reference we're in the 25% bracket now and expect to be in the 15% at FIRE. If you're in the 15% now roth is better.  and if you ever fill up your 15% bucket then roth becomes better.

filling up your 15% bucket would be the top of the 15% bracket plus any exemptions and deductions x25 making it over 2MM in tax deferred accounts for a couple before you hit this number

First, to clarify the earlier question:  Roth contributions are made with post-tax $, but they grow tax-free and can be taken out without any taxes owed.  Traditional IRAs are made with pre-tax $ (that $ doesn't count as part of your taxable income), and they grow tax-free, but you pay taxes when you take any distributions at whatever your then-applicable income tax rate is.  So the general thinking -- tax-bracket arbitrage -- is correct.

One thing to consider:  at $52K, your taxable income will likely put you in the 25% tax bracket for federal tax purposes (starts at $37,951 for 2017, goes to $91,900 -- no idea what your state taxes/brackets are).  Assuming one exemption ($4050) and the standard deduction ($6350), you are looking at a taxable income of around $41,600.  So you will pay a 25% tax rate on about $3500 of income ($41,600-$37,951) -- or about $875 of that $3500. 

This is likely worth it if you expect to be in an even higher tax bracket at retirement -- i.e., if you expect your taxable retirement income to be more than whatever the future version of @$92K is, or if you expect tax rates to go up in general.  But you could also contribute a few grand to a traditional 401(k) or IRA to get your total taxable income below the @$38K cutoff for the 15% bracket*, and then just keep putting the rest of your savings in the Roth version.

*You're not going to get into the 10% bracket, because that starts around $9K of taxable income.
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MDM

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Re: Case Study: what to do when loans are gone
« Reply #8 on: September 19, 2017, 01:16:13 PM »
...you could also contribute a few grand to a traditional 401(k) or IRA to get your total taxable income below the @$38K cutoff for the 15% bracket*, and then just keep putting the rest of your savings in the Roth version.
Great advice.

merula

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Re: Case Study: what to do when loans are gone
« Reply #9 on: September 19, 2017, 02:09:04 PM »
Welcome fellow St. Paul resident!

If you want to live in Minneapolis or St. Paul (as opposed to a suburb), just be aware that the housing vacancy rate here is ridiculously low, which impacts the rent vs. own analysis. I found that owning a single-family home was more cost effective than renting, while owning a condo was not.

My recommendation to you would be:
-Contribute enough to your 401(k) to get any match available
-Max out a traditional IRA with Vanguard or another low-expense company
-Max out 401(k)

On house down payments, I got a 2.75% rate because I had 20% to put down. Had I had only 5%, it would've been 3.5%. 0.75 pts doesn't sound like much, but it would've been a difference of $30,000 over the life of my loan. You can go either way (and find a lot of support on this board either way), but make sure that the rent versus buy comparison you're using takes that into account.

Traditional IRAs allow for penalty-free withdrawals for first-time homebuyers. So, if your choice is between maxing the IRA or saving for a house,    buy a fund like Vanguard Target Retirement 2020 within your IRA. If you use it, it's not really different from saving in a taxable account (except for shifting when you incur the income), but if you don't, you get the benefit of that year's IRA contribution. You can shift funds around within your IRA later, but you can't get a prior year's contribution back.

sportsportsports

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Re: Case Study: what to do when loans are gone
« Reply #10 on: September 21, 2017, 10:01:50 AM »
Thanks everyone! I've done some thinking and I thought I'd give you an update on what I plan to do, at least for the next 6 months:

Once I pay off my loan, I'm going to follow Laura33's advice and put 10% into a pre-tax 401k while maintaining the 5% I already put into the Roth 401k. Since after looking into it, I'm making a guess that I'll most likely be in the 25% tax bracket when I retire (honestly, I might also be in the 15% bracket but I'm trying to account for potential lifestyle changes that I can or can't anticipate happening in the next 10+ years). Then I'll allocate any additional money that had been going into my loans into my Roth IRA until I max out my contribution for the year.

After that, I'll up my Roth 401k contribution and put a little bit away into my savings account for travel/potential house payment while keeping in mind what merula and boarder42 have said about funding down payments. If that account gets higher then I'd like, I'll look into other investing options. I haven't done a ton of research on the housing side, and I've signed a lease til this time next year so I have a little bit of time. I'll probably start researching more intensely in the new year.

merula, yay Saint Paul! And I definitely don't want to be in a suburb! So I appreciate the intel :) I plan on being able to put 20% down but like I said, I'll research all of that more intensely later.

Thanks again! And if there'd anything else I should consider, I'd love to hear it.

jamccain

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Re: Case Study: what to do when loans are gone
« Reply #11 on: September 21, 2017, 10:16:27 AM »
Old guy here...

Here is an easy four step process for you:
1.  Max out the company match on the 401K, stop investing there. 
2.  Save and then hold all your cash tight. 
3.  Wait for the impending market cash and then deploy your load of cash into low cost index funds which mirror the S&P, DOW, whatever.  Don't worry about finding the bottom of the market, just deploy your funds when most of the people you know are sufficiently depressed and the media is saying to never invest in stocks again. 
4.  Ignore all the people who will probably attack this post while parroting investing advice they don't understand. Ignore your peer group because they haven't lived through enough market ups and downs to know left from right.  There is a difference between living it and reading about it in a book. 

Investing in stocks and bonds in this environment (historically high market P/E ratios) is a recipe for losing half your money in the next couple years.  The counter argument will be "but you're not interested in taking money in the next couple years, over time it will pay off, dollar cost averaging, etc etc.  Don't lose half your money, don't feel bad about having cash on hand, don't follow the sheep to the slaughter. 

MDM

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Re: Case Study: what to do when loans are gone
« Reply #12 on: September 21, 2017, 11:07:10 AM »
4.  Ignore all the people who will probably attack this post while parroting investing advice they don't understand.

Investing in stocks and bonds in this environment (historically high market P/E ratios) is a recipe for losing half your money in the next couple years.

One might see Inside the S&P 500: Dividends Reinvested, in particular the chart below, and ask oneself, "is 2017 like 1997 or 2007?"  And ask further, "and how would one know?"

You pays your money and you takes your chances.



farfromfire

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Re: Case Study: what to do when loans are gone
« Reply #13 on: September 22, 2017, 12:55:18 AM »
Investing in stocks and bonds in this environment (historically high market P/E ratios) is a recipe for losing half your money in the next couple years.  The counter argument will be "but you're not interested in taking money in the next couple years, over time it will pay off, dollar cost averaging, etc etc.  Don't lose half your money, don't feel bad about having cash on hand, don't follow the sheep to the slaughter.
This is really bad advice. Whether or not you think you're special, you do not know better than the countless people, posts, and analyses on this forum that refute this argument. On the other hand, your opinion would be most welcome in the "Top is in" thread

czr

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Re: Case Study: what to do when loans are gone
« Reply #14 on: September 22, 2017, 06:48:02 AM »
2.  Save and then hold all your cash tight.
3.  Wait for the impending market cash and then deploy your load of cash... 

Did you follow this advice during the last 'top' in 2006-07 and when did you get back in. Also, when in this current bull market did you think the top is in?

More importantly, besides having to time the market twice, I don't think the OP has has enough ammo (maybe $5-10k investable assets) using this strategy to make an serious impact on changing behavior. The other posters recommendations of keeping lifestyle low and constantly increasing savings contributions (401k, ROTH, savings) is a better long term strategy.

Acastus

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Re: Case Study: what to do when loans are gone
« Reply #15 on: September 22, 2017, 11:14:26 AM »
My priority for investing is;
1. 401k to the match
2. HSA
3. Roth IRA
4. Taxable savings towards a goal - newer car in a 2 years, higher education, house, for example
5. Max 401k

You have 6 months expenses in savings and soon to be debt free, so you are ahead of the curve. I could not say that until I was 30. Not sure if you have an HSA option in your health insurance. If you do, grab it. Young healthy people can save a bundle with this.

CU Tiger

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Re: Case Study: what to do when loans are gone
« Reply #16 on: September 22, 2017, 11:56:53 AM »
2.  Save and then hold all your cash tight.
3.  Wait for the impending market cash and then deploy your load of cash... 

Did you follow this advice during the last 'top' in 2006-07 and when did you get back in. Also, when in this current bull market did you think the top is in?

More importantly, besides having to time the market twice, I don't think the OP has has enough ammo (maybe $5-10k investable assets) using this strategy to make an serious impact on changing behavior. The other posters recommendations of keeping lifestyle low and constantly increasing savings contributions (401k, ROTH, savings) is a better long term strategy.

Market timing sounds like such a great idea, and would be, if you had ESP and the gift of precognition.

I have boringly put money into the stock market, through mutual funds, every month since about 1993. There have been good times and bad, but overall, my money has grown. The percentage I invested back when I was young was smaller because I was dumb and didn't appreciate the value of compound investing. We save a higher percentage now. We'll retire early.

So I agree that keeping your lifestyle low/investing money NOW is probably a better bet.
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