How to invest first windfall/savings

[Ynari]

I'm graduating school in December.  At that point, my (subsidized) student loans will start being due, my grandparents are giving me $16k as a graduation gift (approximately the amount of my student loans), and I will begin work at a job where I can save about $4000 a month given projected living expenses.

Student loans are $13,500 at 3.5% and $2,800 at 5%.

I've considered putting the money towards a downpayment on a house sometime mid- to late 2015 (I plan on moving in the fall, so this makes some sense) and then paying off the loans after securing the house. Or, I could pay off the loans right away and put off the house for a few extra months, but then I'm paying rent for that time and moving a lot instead of investing in the house.  Or I could put it in stocks, but that only seems logical if I plan on renting for the foreseeable future.

My question: How would you employ the $16k windfall and future line of savings, given a blank slate? House, debt, stocks, combo?

UPDATE:

I've been thinking about this and the $5500 into a Roth IRA sounds great.  But I just had another question - I originally opted out of the 401k plan at my internship favoring liquidity, but I'm thinking of putting off the house until 2016 which would mean I don't require such liquidity.  My company's plan says I can contribute to a Roth 401k or "traditional after tax contributions" (not quite sure the difference).  Would this be a smart way to invest the $5000 from my internship that I was otherwise going to put in a personal vanguard account?

[slugline]

Congrats on your pending graduation. Based on what I see above, I would favor saving for the house down payment -- assuming that you're pretty sure you're not going to move in the next few years.

Are you in the USA? Will your job come with a 401K? If so, then that's where you probably want to start building your stash in stock funds using tax-deferred contributions.

[RetireAbroadAt35]

Your next step depends entirely on your long-term goals.

Are you planning for financial independence?

[gimp]

4k/month savings is sweet. If you're thinking of being able to put a downpayment on a house within the year, I assume you're moving somewhere that houses aren't terribly expensive. Mind sharing what sort of loan you're looking to get for a house?

[Ynari]

My job has a 401k with a 50% match up to 6%.  I plan on always meeting at least that match, but maxing out doesn't seem very important at this juncture.

I am aiming for FI in the sense that I think it will give me leverage for more flexible working hours, etc.  I enjoy my job, I'm just not horribly enthused at the standard 50 hour work week in my field.  If I can work for 5 years and have a comfortable 'stache (not quite FI but halfway there), it will give me a little more flexibility.  FI in the next 15 years is a loose goal I'd be happy with.

[Prairie Stash]

I'd pay off the $2800 loan at 5% instantly.  It's a higher rate and a nuisance loan. 

the next step is difficult, it depends on what job you have and the likelihood you won't move.  As you point out there's too many variables.

[JCfire]

I'm graduating school in December.  At that point, my (subsidized) student loans will start being due, my grandparents are giving me $16k as a graduation gift (approximately the amount of my student loans), and I will begin work at a job where I can save about $4000 a month given projected living expenses.

Student loans are $13,500 at 3.5% and $2,800 at 5%.

I've considered putting the money towards a downpayment on a house sometime mid- to late 2015 (I plan on moving in the fall, so this makes some sense) and then paying off the loans after securing the house. Or, I could pay off the loans right away and put off the house for a few extra months, but then I'm paying rent for that time and moving a lot instead of investing in the house.  Or I could put it in stocks, but that only seems logical if I plan on renting for the foreseeable future.

My question: How would you employ the $16k windfall and future line of savings, given a blank slate? House, debt, stocks, combo?

If the $16k windfall really only represents 4 months of savings in your new job, and you are getting it in December, I think it's very likely that you should use it to make 2014 contributions to tax-advantaged savings before you lose the opportunity for that tax year permanently.  You can do at least $5500 in a Roth IRA (assuming you had very low income this year), saving yourself any future taxes on earnings from that invested money.  Whether you want to make any contributions to an HSA or even a 401k (if your job starts this year) depends a lot on your marginal tax rate for 2014. 

From there, I would likely pay off the $2800 loan at 5% and save the remainder for a downpayment.  If you do the Roth IRA and $2800 loan, and you're saving $4000/mo (kudos to you by the way), you've only delayed your home buying date by 2 months, which is not a big deal.

[GGNoob]

If the $16k windfall really only represents 4 months of savings in your new job, and you are getting it in December, I think it's very likely that you should use it to make 2014 contributions to tax-advantaged savings before you lose the opportunity for that tax year permanently.  You can do at least $5500 in a Roth IRA (assuming you had very low income this year), saving yourself any future taxes on earnings from that invested money.  Whether you want to make any contributions to an HSA or even a 401k (if your job starts this year) depends a lot on your marginal tax rate for 2014. 

From there, I would likely pay off the $2800 loan at 5% and save the remainder for a downpayment.  If you do the Roth IRA and $2800 loan, and you're saving $4000/mo (kudos to you by the way), you've only delayed your home buying date by 2 months, which is not a big deal.

+1 I agree to all of this. Then take whats left and save for your downpayment on a house in at least a "high" interest online savings account.

[Ynari]

If the $16k windfall really only represents 4 months of savings in your new job, and you are getting it in December, I think it's very likely that you should use it to make 2014 contributions to tax-advantaged savings before you lose the opportunity for that tax year permanently.  You can do at least $5500 in a Roth IRA (assuming you had very low income this year), saving yourself any future taxes on earnings from that invested money.  Whether you want to make any contributions to an HSA or even a 401k (if your job starts this year) depends a lot on your marginal tax rate for 2014. 

From there, I would likely pay off the $2800 loan at 5% and save the remainder for a downpayment.  If you do the Roth IRA and $2800 loan, and you're saving $4000/mo (kudos to you by the way), you've only delayed your home buying date by 2 months, which is not a big deal.

Your plan seems sound.  I hadn't considered the Roth IRA, as the gift itself is tax free to me, but it's smart to avoid future tax.  I'll have to speak with my grandparents about the timing of the gift, though even if it's later I might even be able to max it out with the savings from my internship...  we'll see, but great advice!

4k/month savings is sweet. If you're thinking of being able to put a downpayment on a house within the year, I assume you're moving somewhere that houses aren't terribly expensive. Mind sharing what sort of loan you're looking to get for a house?

The SO and I aren't terribly "big" people - I've been scouting 500-600 sq ft (and up, in the same price range) homes in the northwest Denver, CO, area and have found quite a few currently on the market for under $150k.  My company has a location in Denver and my SO is applying to UC Boulder for grad school.  I'm going to have to research mortgages a bit more, but with USAA a 15 year fixed rate at 3% puts us at roughly what we're paying per month in rent now (in Chicago).

[gimp]

Awesome.

If I were you...

Wipe out 5% debt first, throw some into an IRA, save the rest; add your job income savings to get that downpayment. Once you have the downpayment, get a decent emergency buffer (whether it's cash or easy credit or however you want to roll), get the house. From then on, every year max out 401k, ira, hsa if applicable, and any other tax-deferred plan; pump the rest into your smaller 3.5% loan and then the house at 3%.

[AlanStache]

Talk to your grandparents about using the money for other purposes, yes its yours, but a five minute talk could smooth things out if you decide to use it for a down payment.  Show them the numbers get them on board, make sure everyone else in the family knows you are using graduation money for a down payment and GG are not giving you a house. 

Yes kill the 2.8k loan.  Before you buy make sure you want to live there for a number of years.  Also I will just drop here that I bought less home than I wish I had, I would kill for a garage.  And congratulations on graduation.

[rocksinmyhead]

I think Prairie Practicality and JCfire have excellent advice! pay off the 5% loan right away, no reason not to.

the big benefit to maxing out your 401K is in tax savings. I didn't really see/get this until people here explained it to me. based on your planned monthly savings it sounds like you're gonna be in a pretty high tax bracket. it's worth running the numbers on this! I would check out these posts:
http://forum.mrmoneymustache.com/ask-a-mustachian/u-s-tax-withholding-questions/
http://forum.mrmoneymustache.com/ask-a-mustachian/student-loans-vs-401k-for-taxes/

also, whether the "buying a house saves me money on rent" argument is legitimate depends TOTALLY on costs of renting vs. owning in your area (and how long you planned to be there but it sounds like this is pretty established). I get the feeling that a lot of people rush into buying a house and try to justify it as being the better financial choice. it's okay if you actually just want a house, but don't fool yourself into thinking it's better financially if it actually isn't. lots of stuff on the boards about this, and the NYT has a good calculator for comparing the two.

final question: just curious, how do you know you "like your job" if you don't start til after you graduate in December? are you interning there now or something?

[Ynari]

Yeah, rocksinmyhead, I'm currently an intern.  Job offer will come after the internship, though the company is growing and I'm a diligent and capable worker with good reviews so it's something I feel safe betting on. 

Your thread about tax is really eye opening, particularly because "having an income high enough to warrant strategizing about taxes is SO new to me" resonates with me as well.  My family growing up was single-income and employed by the government so there wasn't really anything complicated about taxes, so even though I knew about most of it I wasn't really exposed to things like "tax strategies".  In a way it feels almost unethical to "game the system" like this...

[desrever]

Yeah, rocksinmyhead, I'm currently an intern.  Job offer will come after the internship, though the company is growing and I'm a diligent and capable worker with good reviews so it's something I feel safe betting on. 

Your thread about tax is really eye opening, particularly because "having an income high enough to warrant strategizing about taxes is SO new to me" resonates with me as well.  My family growing up was single-income and employed by the government so there wasn't really anything complicated about taxes, so even though I knew about most of it I wasn't really exposed to things like "tax strategies".  In a way it feels almost unethical to "game the system" like this...

The #1 advice I wish I'd received during my college work study / intern / great expectations years would have been to put some cash away in a Roth IRA during those low-AGI years. The #2 advice would have been to set things up so that any dividends are automatically reinvested commission free; otherwise you have little eddies of cash stacking up that are hard to put to work efficiently -- the smaller the account balance, the truer this is.

It's not gaming the system; the tax code incentivizes some behaviors and penalizes others. It's much more the case that the system is controlling you, than you it.

Roth makes sense for you now for a few reasons: the big one is that the money will grow capital gains tax free. You can withdraw the principal amount at any time, and after five years you can take a distribution of up to 10k in gains to purchase a house -- in practice you will want to do none of these things, because that money in the Roth is undergoing a sweet little tax advantaged chain reaction, you want that fire to keep burning bright as the sun, with all the fuel you got. BUT just knowing you've got access to that money if you ever need to turn a tight corner can be a powerful thing on its own, even if you never need to dip into it. In any case, there's very little downside for you here.

You can keep contributing to a Roth normally until your AGI is 112K. Then you have to do a more complicated backdoor approach (others here can tell you all about that, not sure about the details). You can fund a Roth and also fund a 401k. Iirc you also can't contribute more than your AGI -- so if you hadn't worked this year, you couldn't fund it with gift money.

[GGNoob]

Your plan seems sound.  I hadn't considered the Roth IRA, as the gift itself is tax free to me, but it's smart to avoid future tax.  I'll have to speak with my grandparents about the timing of the gift, though even if it's later I might even be able to max it out with the savings from my internship...  we'll see, but great advice!

You have until April 15, 2015 to max out your 2014 IRA contributions. So even if you get the gift in January, you can still make a 2014 IRA contribution to max it out.

[Ynari]

Updated first post:

I've been thinking about this and the $5500 into a Roth IRA sounds great.  But I just had another question - I originally opted out of the 401k plan at my internship favoring liquidity, but I'm thinking of putting off the house until 2016 which would mean I don't require such liquidity.  My company's plan says I can contribute to a Roth 401k or "traditional after tax contributions" (not quite sure the difference).  Would this be a smart way to invest the $5000 from my internship that I was otherwise going to put in a personal vanguard account?

[rocksinmyhead]

Yeah, rocksinmyhead, I'm currently an intern.  Job offer will come after the internship, though the company is growing and I'm a diligent and capable worker with good reviews so it's something I feel safe betting on. 

Your thread about tax is really eye opening, particularly because "having an income high enough to warrant strategizing about taxes is SO new to me" resonates with me as well.  My family growing up was single-income and employed by the government so there wasn't really anything complicated about taxes, so even though I knew about most of it I wasn't really exposed to things like "tax strategies".  In a way it feels almost unethical to "game the system" like this...

I'm so glad it helped!! I know it totally blew my mind as well. and I really don't think of it as "gaming the system"... and I'm definitely reasonably liberal, not anti-tax by any means, but you know what... you're just following the rules and not accidentally giving the gov't more money than you need to/are supposed to. nothing to feel bad about there (IMO).

re. your more recent question, I can't see a reason not to contribute to a tax-favored instead of a taxable account. I'm not sure what "traditional after tax contributions" means since to my mind, a Roth 401k is after-tax and a traditional 401k is pre-tax, but whichever is better probably depends on your future plans. I am in an industry now that I don't plan to stay in, and when I get out I'll probably take a 50% pay cut (not a joke, and this is one of the main reasons I'm into MMM), so I always go traditional (pre-tax) assuming I'll be in a lower tax bracket in the future. if you don't plan to ER and don't plan on a career change that results in a low tax bracket, Roth 401k isn't a bad idea. just my $0.02 (and I am far from the most knowledgeable person here).

[Ynari]

The tricky part of my situation is that right now I'm paying very low taxes being a dependent with a low gross income (for this year only).  My current income tax is lower than what it will be in ER.

So from what I see: If I put $5000 in the Roth 401k, it's like upping the max I can put in the Roth IRA because I can roll it over in the future at no penalty.  The Roth IRA is a good choice for me because I pay low taxes now, and I won't pay taxes or penalties on the earnings if I 1. wait until I'm 59.5 or 2. wait 5 years and use it for qualified expenses.

So, best case scenario I get tax-free money when I'm 60.  Otherwise, I can draw from the principle whenever I need and possibly get earnings tax-free for certain expenses before then.