Case Study: Student Loans vs. Investing

[lielec11]

I'm sure similar questions like this have been posed in different forms before but it is always nice to add your own personal touch. First some things about myself to give you a background. I am a 28 year old engineer living in Long Island, NY currently making $105,000 base salary per year. Currently 8% of that is going towards my 401k (with NO employer match). I rent a small 1BR apt for $1100 per month with my fiance and dog.

I am trying to decide between these two options:

a) Pay down all of my student loans to $0.0 and CEASE ALL INVESTING including 401k contributions.
b) Continue my paying cycle as is and continue investing in my work 401k as well as my independent Roth IRA and individual investment accounts
c) Combination of the a & b

So here are the gory details:

Loans

$94,108.56 @ 3.28% (multiple loans 2.75%-4.75% averaged)
$1,299.00 @ 6%
$8,459.26 @ 5.11% (two loans at 4.8% and two loans at 0.33%)

Investments

$44,942 in 401k (Rate of Return is ~9%, ~12% and 28% last 3 years, NO EMPLOYER MATCH)
$6,231 in Roth IRA/Individual Taxable Account (Rate of return ~6%)

There you have it This does not include any checking/savings amount cash. I will be the first to admit I am blessed with a generous salary due to my hard work ethic and where I live. However, I am constantly going back and forth between what is better for me and my family in the long run, paying down all my student loans immediately, or continue investing and paying them down slowly. Things that keep poping up are my good rate of returns, low student loan interest rates, and tax benefits of 401k contributions.

I just recently started tracking my expenses in September so I do not have accurate trending info on this yet but I am really just looking for info on this one topic, not necessarily early retirement.

I am new to the Mustachian way for thinking/living, so any input/comments would be greatly appreciated.

Thanks in advance,
RyanV, P.E.

[surfhb]

Yes I would keep your contribution the way they are and put as much as possible to the loans.   There's no right answer at your age and income level regardless of all the numbers and calculations people will throw at you ;)

If you really want, you'd have them paid off in 3 years or so

[lielec11]

surfhb thanks for your reply.

You're saying keep my contributions where they are and put as much as possible to the loans. Isn't that contradictory or am I missing something? I can either maintain my current contributions (8% to 401k plus another 500-100 to Roth and other account), or take that money and pummel my loans. Slightly lost :-/

[jamal utah]

Do you get a 401k match from your employer?  That should be a consideration in all of this.

I would suggest a snowball approach for your loans.  First, with whatever money you designate for paying loans make the minimum payment to the two lower interest loans and put the remainder to the 6% loan.  You want to get that paid off asap.  Once the 6% loan is paid off, do the same thing with the 5% loan.   

[Catbert]

If you have a 401k match, I would contribute enough to get the full match.  After that (or I no match) I would turn the focus on the 5-6% SLs.  Once those are gone, turn back to 401k and/or IRA.  I wouldn't consider paying extra on 3% loans until I had maxed out all 401k and IRA options.

[jamal utah]

If you have a 401k match, I would contribute enough to get the full match.  After that (or I no match) I would turn the focus on the 5-6% SLs.  Once those are gone, turn back to 401k and/or IRA.  I wouldn't consider paying extra on 3% loans until I had maxed out all 401k and IRA options.

+1

[lielec11]

Do you get a 401k match from your employer?  That should be a consideration in all of this.

I would suggest a snowball approach for your loans.  First, with whatever money you designate for paying loans make the minimum payment to the two lower interest loans and put the remainder to the 6% loan.  You want to get that paid off asap.  Once the 6% loan is paid off, do the same thing with the 5% loan.

jamal, I am currently doing that now and it has worked wonders. I've knocked down the 6% significantly over the last 12 months doing this.

If you have a 401k match, I would contribute enough to get the full match.  After that (or I no match) I would turn the focus on the 5-6% SLs.  Once those are gone, turn back to 401k and/or IRA.  I wouldn't consider paying extra on 3% loans until I had maxed out all 401k and IRA options.

My currently employer does not match unfortunately so there is no benefit there (I will clarify this in my OP). I've received this recommendation from people in the past when I've considered stopping my investments. However, $90k plus is A LOT to stare down :(.

[GoldenStache]

What % does your company match (if any)?  update

IMHO - lower 401k to get max match (say 5%) - Max out your roth IRA You have until April for 2014(If you are making $105k now, you could be on the verge of making too much to qualify for a Roth in the future) Tough times.. Congrats

Pour everything else you have into:
$1,299.00 @ 6%
$8,459.26 @ 5.11%

Once those are gone, a few months, increase your 401k and max that out and max out your 2015 IRA.  Depending on a ton of other things, you might be able to lower your tax base enough to actually get a deduction for your student loan payments.

Remember - Prior rate of return for holdings means absolutely nothing in determining future returns. 

[Catbert]

My currently employer does not match unfortunately so there is no benefit there (I will clarify this in my OP). I've received this recommendation from people in the past when I've considered stopping my investments. However, $90k plus is A LOT to stare down :(.
[/quote]

I wouldn't pay-off the $90K that's at ~3%, just the 5%+.

[jamal utah]

I agree with Mary.  I have a student loan at 3.5% w/ ~ $45,000 left.  Although I currently pay well more than the minimum I am waiting until I can max out my 401k before kicking it up any more.

[lielec11]

What % does your company match (if any)? 

IMHO - lower 401k to get max match (say 5%) - Max out IRA (If you are making $105k now, you could be on the verge of making too much to qualify for a Roth in the future) Tough times.. Congrats

Pour everything else you have into:
$1,299.00 @ 6%
$8,459.26 @ 5.11%

Once those a gone, a few months, increase your 401k and max that out.  Depending on a ton of other things, you might be able to lower your tax base enough to actually get a deduction for your student loan payments.

Remember - Prior rate of return for holdings means absolutely nothing in determining future returns.

GoldenStache thanks for the info. I updated my post to mention no employee matching so no benefits there. Was unaware of the Roth income limit, I thought it was only the $5,500 per year? I better look into that. Thanks! As far as reducing my taxable income to get a write-off for my student loans, that is out of the questions. I believe last tax season my accountant told me it was somewhere around 60k-70k. I don't have those type of deductions.

[lielec11]

My currently employer does not match unfortunately so there is no benefit there (I will clarify this in my OP). I've received this recommendation from people in the past when I've considered stopping my investments. However, $90k plus is A LOT to stare down :(.

I wouldn't pay-off the $90K that's at ~3%, just the 5%+.
[/quote]

Mary/jamal thanks for your input again. I think starting January I will change my contributions to max out my 401k, cut back on  my individual and Roth until I can pay down the higher interest rate loans down and then add to my Roth while I can.

[jamal utah]

Increasing your 401k contributions has the added benefit of reducing your taxable income meaning that it allows you to stay below the income limit for IRAs for longer.

[index]

You need to max out your 401k before you do anything with your Roth.

You are in the 28% tax bracket and pay 6.5% in state taxes. By only putting away 10% in your 401k you are missing out on a $6700 of contributions worth $2311 in tax deductions.

To put it another way, you are giving up your government match.

Also you should look into a HDHP in order to take advantage of an HAS. In your tax bracket the $3350 you can put in an HSA reduces your tax burden by $1400 in 2015 (42%).

Maxing out the 3350 in an HSA and 6700 in your 401K ($10, 050) would cost you $6330 after tax or 830 more than maxing out your Roth.

After maxing out your 401k and HSA, pay off the 10k at 5-6% then work on that 4.75% loan. I’d start contribution to a Roth once you get rid of the 5-6% loans and just put whatever the minimum payment was on those loans onto the 4.75% loan. If you get married and/or buy a house, your combined MAGI may be under 155k in which you would be able to write off the remaining student loan interest taking that 3.3% student loan and making the effective after tax loan rate 2.1%.   

[surfhb]

If you're only putting 8% into your 401k and spending only $1100 a month for rent, where is the rest of your income going?   

Most of it should be going to the loans :)

[webguy]

I'd pay off those 2 smaller loans now and then do a 50/50 contribution going forward to the loan and investments. That way you're basically treating the 3-5% loan repayment as the conservative aspect of your portfolio while also continuing to invest in stocks. Best of both worlds!

[lielec11]

You need to max out your 401k before you do anything with your Roth.

You are in the 28% tax bracket and pay 6.5% in state taxes. By only putting away 10% in your 401k you are missing out on a $6700 of contributions worth $2311 in tax deductions.

To put it another way, you are giving up your government match.

Also you should look into a HDHP in order to take advantage of an HAS. In your tax bracket the $3350 you can put in an HSA reduces your tax burden by $1400 in 2015 (42%).

Maxing out the 3350 in an HSA and 6700 in your 401K ($10, 050) would cost you $6330 after tax or 830 more than maxing out your Roth.

After maxing out your 401k and HSA, pay off the 10k at 5-6% then work on that 4.75% loan. I’d start contribution to a Roth once you get rid of the 5-6% loans and just put whatever the minimum payment was on those loans onto the 4.75% loan. If you get married and/or buy a house, your combined MAGI may be under 155k in which you would be able to write off the remaining student loan interest taking that 3.3% student loan and making the effective after tax loan rate 2.1%.   

I am not aware of the details behind HSA plans so I'm not sure what I'd be putting my money towards. I understand it's a Health Savings Account, but that is all. Also, I contribute 8%, not 10%, so my cost is actually higher.

I will be getting married next September. Is that 155k taxable income or gross? If taxable we should be good.

If you're only putting 8% into your 401k and spending only $1100 a month for rent, where is the rest of your income going?   

Most of it should be going to the loans :)

In another post (or if I update this one) I will add full disclosure expenses, savings rate, income, etc. But that is for another day ;-) You are right though, since finding this blog I have been really cracking down on myself.

[index]

You need to max out your 401k before you do anything with your Roth.

You are in the 28% tax bracket and pay 6.5% in state taxes. By only putting away 10% in your 401k you are missing out on a $6700 of contributions worth $2311 in tax deductions.

To put it another way, you are giving up your government match.

Also you should look into a HDHP in order to take advantage of an HAS. In your tax bracket the $3350 you can put in an HSA reduces your tax burden by $1400 in 2015 (42%).

Maxing out the 3350 in an HSA and 6700 in your 401K ($10, 050) would cost you $6330 after tax or 830 more than maxing out your Roth.

After maxing out your 401k and HSA, pay off the 10k at 5-6% then work on that 4.75% loan. I’d start contribution to a Roth once you get rid of the 5-6% loans and just put whatever the minimum payment was on those loans onto the 4.75% loan. If you get married and/or buy a house, your combined MAGI may be under 155k in which you would be able to write off the remaining student loan interest taking that 3.3% student loan and making the effective after tax loan rate 2.1%.   

I am not aware of the details behind HSA plans so I'm not sure what I'd be putting my money towards. I understand it's a Health Savings Account, but that is all. Also, I contribute 8%, not 10%, so my cost is actually higher.

I will be getting married next September. Is that 155k taxable income or gross? If taxable we should be good.

Oops sorry I missed the 8% vs 10%.

In order to write off student loan interest your MAGI (Modified Adjusted Gross Income) must be <75k if single or <155k if you are married filing jointly. MAGI is your Gross income - traditional 401K contributions - Health Insurance Premiums and HSA contributions. You would probably need a house or business for it to make sense for you all to itemize. Ie have more deductions than a couple's standard deduction.

An HSA saves you 42% on $3250 (single) and $6650 (married) or $1400 - $2800 per year in taxes so it is probably worth checking out.

[gatorNic]

Some already hit some of the points I would make but if I had to list it:

1. Pay just enough into 401K + any other tax deductions or HSA -->  to bring down your taxable income so that you are in the 25% bracket.  Otherwise you are just giving $3K to the government. You are actually not that far off since the bracket is at about 89K for single.  Married you don't have to do as much at 150K annual since the married bracket for 25% is about $148,850.

2. Pay anything that is left to $1,299.00 @ 6% loan then the $8,459.26 @ 5.11%  (the interest payment on these is lower than the 3K you would get back from step #1)

3. After #2 is paid off I would probably then just max out Roth first then the 401k and if there is anything left pay the other loan since its only at 3% and with the right allocation you should be able to beat that. 

[lielec11]

I actually think your $105k salary is pretty low for 28 years old, especially if that doesn't also include equity. I am four years younger than you and being paid significantly more money as an engineer. You might want to shop around for a new job.

Cathy...  Engineer is a vague term that many (including myself in this thread) mistakenly throw around very casually. As a license engineer I should have been more clear. I am an electrical engineer with a focus in electric power. I work in the MEP consulting industry. If you are the same type of engineer as me, I commend you for being so aggressive in your salary negotiations. However, my gut is you are a different type of engineer (possibly software?), where salaries are much higher. For someone my age, with my experience, in this industry, I am ahead of the curve due to my work ethic and negotiations. If I wanted to make more money, I'd have to commute to NYC and slave away for 60 hours a week. No thank you.