Author Topic: Case Study - Put money into 401k or be aggressive on debt  (Read 4830 times)

Awitte58

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Case Study - Put money into 401k or be aggressive on debt
« on: July 29, 2015, 10:03:14 AM »
Greetings everyone!
Junior Mustachian here.

I just graduated and began my career as a mechanical engineer. I am now able to put money into a MassMutual401k plan. My company will put in 15% of whatever I put in(for every $100 I put in they will put in $15).
My plan was to put the max into the 401k pre-tax for 10 years to prep my 'grandpa' fund(MMM article reference).

The attached excel file has some estimated percentages put into 401k and how much money it would leave me with after paying the minimum for my bills.

My question for you all is: Do you think it would be wiser to not put anything into 401k and use any excess cash towards paying off the mortgage/student loans?
My concerns: 1) I am missing out on the free money the company matches.
2) Without putting anything into 401k pre-tax I am in a higher tax bracket.

Currently I am debating on putting in 20% pre-tax so that leaves me with a handsome sum for spending cash after monthly expenses. This will still accumulate roughly $10k into my 401k before my company puts any in. If I wind up if leftover money I would put it into my vanguard index/mutual funds most likely.

I appreciate any and all opinions/input you all have to offer!!!! I am very eager to begin growing my own 'stache'
Alex

Slam

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #1 on: July 29, 2015, 10:19:59 AM »
No, that would not be wiser.  Your concerns are accurate.  Max out 401k contributions and get that extra 15% (free money).  Using math, after that you should go Vanguard, but personally I would use any extra money to pay off student loans, starting with the highest interest rate.

supomglol

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #2 on: July 29, 2015, 10:28:46 AM »
That is an absurd 401K match.  Does it not have a maximum benefit? 
Regardless; I'd been shoveling money in that thing so fast they'd rethink the program.  If you contributed the max of 18500/year thats an extra 2775 in your pocket before interest. 
MAX IT!

Cheddar Stacker

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #3 on: July 29, 2015, 10:40:20 AM »
Refi the student loans with SoFi. There are plenty of referral links around here, even an entire thread devoted to it. That will get that 6.8% interest rate down a ton and save you interest long term.

Without the 401K contributions you will be in the 25% tax bracket. With the 401K contributions you will save 25% tax, plus earn a 15% match. That's a 40% return before considering the ROR on the actual investment. Don't even think about pre-paying those loans unless you have extra funds after maxing out the 401K, at least while you have that match.

MDM

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #4 on: July 29, 2015, 10:56:51 AM »
One nuance: does your employer offer a Roth version of the 401k?

If so, consider contributing enough to traditional plans (IRA and/or 401k) to get out of the 25% federal bracket, then putting the rest into Roths while you are in the 15% bracket.

The employer match will go into a traditional 401k account regardless of whether you use the traditional or Roth for your contributions, but that's ok.


seattlecyclone

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #5 on: July 29, 2015, 11:09:20 AM »
You should do something about your 6.8% student loans. That's a pretty high interest rate. Look into refinancing. With your engineering career I would hope you could find a lower rate on SoFi. If that works out, max out the 401(k) without question.

Awitte58

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #6 on: July 29, 2015, 11:35:48 AM »
Thank you all for the quick replies! I did look into SoFi for the student loans, but the issue is I do not know yet what the term (10 yr 20 yr etc) is for those? They are through the gov obviously...is that 10 usually?
When I plugged in 34600 at 6.8% avg rate for 10 years.. the options SoFi gave me were like .2% lower and the 'lifetime savings' wasn't much.
If the term of the loans is 20 years then the SoFi interest rates made me save like 10k!!!!

I don't have to start paying on them for another 2 months so once the housing stuff is situated then I'll look into the refinancing

One nuance: does your employer offer a Roth version of the 401k?

If so, consider contributing enough to traditional plans (IRA and/or 401k) to get out of the 25% federal bracket, then putting the rest into Roths while you are in the 15% bracket.

The employer match will go into a traditional 401k account regardless of whether you use the traditional or Roth for your contributions, but that's ok.
Could you elaborate on that? My company does offer a Roth setup...

So if I put X into the 401k pre-tax in order to get myself to a lower tax bracket... You suggest I put the remainder into the Roth account.
A few questions:
Is the Roth account post-tax?
Do they match the funds that are put into the Roth?
If they do match those funds does it go into 401k or the Roth?

Again, thank you all for the replies! Keep em comin! :D

MDM

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #7 on: July 29, 2015, 11:46:03 AM »
Could you elaborate on that? My company does offer a Roth setup...

So if I put X into the 401k pre-tax in order to get myself to a lower tax bracket... You suggest I put the remainder into the Roth account.
A few questions:
Is the Roth account post-tax?   Yes
Do they match the funds that are put into the Roth?  Check your employer's specifics, but usually yes.
If they do match those funds does it go into 401k or the Roth?  The employer match will go into a traditional 401k account regardless of whether you use the traditional or Roth for your contributions, but that's ok.

See above with replies highlighted.  To decide Roth vs. traditional, you need to compare marginal rate now vs. marginal rate when you withdraw that contribution and its returns.  The rule of thumb is that for current rates of 25% and above use traditional, and for current rates of 15% and below use Roth - but as with all rules of thumb, YMMV.

Awitte58

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #8 on: July 29, 2015, 12:25:38 PM »
Awesome! Thanks for your input!

Is there a tool somewhere 'out there' that takes the tax rates into account so you can determine how much needs to go into 401k to drop to the 15% bracket.
That would allow me to figure out a % of gross to put into the 401k and how much $$ should go into Roth each month.

 

tvan

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #9 on: July 29, 2015, 12:33:20 PM »
Don't just look at SoFi (people here seem obsessed with them).  There are many others.  Just yesterday I compared rates for myself at SoFi and several others.  Meet Earnest gave me the best, and SoFi was nearly 1% higher (same length, variable, etc.).

MDM

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #10 on: July 29, 2015, 12:38:30 PM »
Is there a tool somewhere 'out there' that takes the tax rates into account so you can determine how much needs to go into 401k to drop to the 15% bracket.
You could try here or there.

Awitte58

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #11 on: July 30, 2015, 08:24:50 AM »
Thanks for that MDM.

One more question: What is better the Roth IRA or traditional IRA?

My understanding is you put pre-tax money into traditional and the tax is deferred until you withdraw. The Roth IRA is money you put in after tax and is tax-free when withdrawing?

After I put in the correct amount into 401k to drop me to the 15% bracket then the remaining I should put in after tax into a Roth IRA.  That is my understanding.

dandarc

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #12 on: July 30, 2015, 08:32:18 AM »
It is not a better or worse thing.  Your description of the accounts is correct.  You can only know for sure whether traditional or Roth was better for you after the fact.

Using 15% as the cutoff is reasonable, but if you keep expenses low enough even in retirement, you could find going traditional works out better even in the 10% bracket.  Basically, the higher your marginal tax rate is today, the more you should lean traditional.  Roth is a slam-dunk if you are paying 0 federal income tax, and pretty compelling in the lower tax brackets, but as you are paying higher taxes, taking the savings now looks better.

And don't forget state taxes - particularly if you're making your living in a state with high income taxes and the plan is to move to a state with lower or no income taxes when you retire, traditional looks pretty good.

dandarc

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #13 on: July 30, 2015, 08:40:33 AM »
Another reason you might go traditional even in the lower brackets is if it will help get you the Saver's credit, or a larger credit.  If you're single with just the standard deduction, and your AGI is say 19K after 401K contributions, you could put 1K into a traditional IRA, and your saver's credit will jump up from $400 to ~$800 (it would be $1,000, but it is non-refundable, so it would be limited to the tax you otherwise would have paid).

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Retirement-Savings-Contributions-Credit-(Saver%E2%80%99s-Credit)

seattlecyclone

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #14 on: July 30, 2015, 08:52:24 AM »
If you're in a low tax bracket now, but are on a career path where your income is likely to get high enough that you're ineligible to make pre-tax IRA contributions, you might want to go with traditional now and Roth later when that's your only option (unless you already owe zero tax, in which case Roth is a no-brainer). Every dollar you put in a Roth IRA instead of a traditional IRA acts to lower your expected taxable income during retirement, which in turn makes it less likely that choosing to go with Roth for that dollar will prove to have been a good idea!

Bob W

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Re: Case Study - Put money into 401k or be aggressive on debt
« Reply #15 on: July 30, 2015, 09:03:08 AM »
I concur with the invest first crowd.   I would fully fund all IRAs,  401ks and HSAs prior to considering the debt.

A couple of points

1. Student loans can be forgiven in the event of death or disability --- You would be surprised to know the percentage of people that end up disabled.
2. Student loans can be deferred in the event of loss of income or lower income.
3. You can't go back in time and fund retirement vehicles
4. If at some point for some reason you decide to lump sum pay your loans you can.

So even at a 7% SL rate I would invest first and make minimums on the loans.   I would do it auto pay so you don't have the psychological drag paying it each month.  It is really a networth question and not cash flow.  So it will help you to track net worth as your primary yard stick.

With rates as low as they are for mortgages I wouldn't ever consider prepaying them over investing.

If you have extra money after all your investments and minimums are paid (which I think you should) I would still put that money in S and P Vanguards vs. paying down the debts. 

Very bright future for you.   Invest every penny and don't spend money on frivolous shit and you will be retired in way less than 10 years.