The Money Mustache Community

Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: RuntoFIRE on December 01, 2014, 06:08:17 PM

Title: Get rid of debt first, or invest?
Post by: RuntoFIRE on December 01, 2014, 06:08:17 PM
Hi all,

New Mustachian here, trying to figure it all out. I have a question that I've been grappling with as I arrange my finances.

I have $35,000 of student debt (two loans of $25K and $10K each). Both are at 2.5% variable interest rate, the rate hasn't changed in a long time and I don't expect it to. I am paying the minimum on the bigger loan ($237 a month), and more than the minimum on the smaller one ($500 a month). I also invest in my company's 401K (6% of income), Stock Purchase Plan (5% of income), make contributions into my Vanguard accounts (~$720 a month), and put ~$720 a month into a general savings account, where I keep about 10K. I make about $125K a year.

Should I concentrate on paying off my loans first and foremost, and then invest? Or should I continue putting money into investments and savings, while continuing to pay my loans as I have been? I expect to get some sort of bonus come Feb/March (probably about $10-$15K), and I plan to put that money fully to pay down debt.

I know that normally paying down debt comes first. But this debt is at only 2.5%. I get a better rate of investment than that.

Please help!
Title: Re: Get rid of debt first, or invest?
Post by: neo von retorch on December 01, 2014, 06:23:59 PM
What is the interest rate of your student loans connected to? A federal rate?

Do you get any federal tax deduction on the student loan interest you pay?

How much tax will you pay on investment gains?

If you have some way of knowing that the rate will stay low, then it does make sense, mathematically, even after tax implications, to invest rather than pay off the debts, assuming you won't need to pull investments out unexpectedly (when they could be worth less than the average gain you expect over the long term.)
Title: Re: Get rid of debt first, or invest?
Post by: TerriM on December 01, 2014, 06:28:43 PM
And what is the return rate on your investments?
Title: Re: Get rid of debt first, or invest?
Post by: Exflyboy on December 01, 2014, 07:05:29 PM
Instead of just saving taxed money in your Vanguards, Asssuming you won't need the money for a long time (like say 7+ years) you should be maxing out your 401k ($17,500 <age 50) and then a Roth IRA ($5500)

This is because your paying a big chunk in taxes.. the 401k is saved tax free and reduces your W2 income.. in other words you get paid to save your income at your top tax rate.

Frank
Title: Re: Get rid of debt first, or invest?
Post by: lielec11 on December 01, 2014, 07:18:41 PM
Quote from: Exflyboy on December 01, 2014, 07:05:29 PM
Instead of just saving taxed money in your Vanguards, Asssuming you won't need the money for a long time (like say 7+ years) you should be maxing out your 401k ($17,500 <age 50) and then a Roth IRA ($5500)

This is because your paying a big chunk in taxes.. the 401k is saved tax free and reduces your W2 income.. in other words you get paid to save your income at your top tax rate.

Frank

I second flyboy's sentiments. Seems like you're doing fairly well saving your money in general so why not reap some tax benefits by maxing your 401k?
Title: Re: Get rid of debt first, or invest?
Post by: MDM on December 01, 2014, 07:41:54 PM
Agata, welcome to the forums.

Here is a quick look at your cash flow, based on what is in your OP and a wild guess at your expenses, if you do as Exflyboy and RyanV recommend (and I'll add a +1 as well).

See http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-'case-study'-topic/msg274228/#msg274228 if you want to download the spreadsheet and enter better details.

Good luck!


CategoryMonthly amt.CommentsAnnual
Salary/Wages$10,417$125,000
FICA base salary/wages$10,417$125,000
Traditional IRA$458At maximum$5,500
401(k) / 403(b) / 457(b) / TSP /etc.$1,458At maximum$17,500
Income subject to IRS tax$8,500$102,000
ESPP/After-tax 401k$521$6,250
Paycheck income before tax$7,979$95,750
Federal Adj. Gross Inc.$8,500$102,000
Federal tax$1,5742014 rates, stand. ded., 1 exemption$18,894
State/City tax$467Guess, using 5.50% * Fed. AGI$5,610
Soc. Sec.$605Assumes 1 earner paying$7,254
Medicare$151$1,812
Total income taxes$2,798$33,576
Income before other expenses  $5,181$62,174
Monthly Expenses:
Miscellaneous$3,000$36,000
Non-mortgage total$3,000$36,000
Loans:
Student Loan$236$2,828
Student Loan$94$1,131
Total Expense$3,330$39,959
Total to invest$1,851$22,215
Available for taxable investment:$1,851$22,215
Summary:
"Gross" income$10,417$125,000
Income taxes$2,798$33,576
After-tax income$7,619$91,424
IRA+401k+ESPP+529/other$2,438$29,250
Living expenses$3,000$36,000
Non-mortgage loans$330$3,959
After-tax investable$1,851$22,215
Time to FIRE?:
Time to FIRE18years
Safe Withdrawal Rate4.00%percent
Real return on tax-deferred investments5.00%percent
Real, after tax, return on taxable investments3.75%percent
Expected retirement total tax rate25.00%
Current Savings
Projected Savings at Retirement
Taxable$556,806
Tax-deferred (e.g. trad. IRA/401k)$647,045
Total projected stash$1,203,851
Projected Expenses in Retirement
Non-loan, non-work expenses$36,000
Income taxes$12,000
Total$48,000
Stash for retirement expenses @4.0% SWR$1,200,000needed
Have $3,851 extra.