Author Topic: Incur large taxes to pay off student loan?  (Read 4179 times)

chicknelump

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Incur large taxes to pay off student loan?
« on: July 18, 2014, 05:49:46 PM »
Hi everyone,

I'm new to the site. Have been following the articles for the last week and found it refreshing to see people who are trying to escape the hollow priorities of the modern life. I don't know if my aim is to retire early (I find my job very fulfilling), but hope I can learn to stay grounded.

Okay, so here's my problem I was hoping for some opinions on.

I don't really have a lot of consumer debt except the mortgage and a car at 0.9%, and saving well into my retirement savings.

My major problem is $90K on student loans which is consolidated into a professional student line of credit. (consolidated government student loans for undergrad and professional school and bank loans. Interest is at prime rate ~3%) It used to be around $130K but I think I've been pretty good to slowly cut it down during my training to what it is currently.

Now I'm finished training and earn a good living. I've also incorporated and all my earnings go into my business account, and I pay myself a salary (I'm the only employee) for tax purposes and to support my older parents without incurring lots of taxes.

I have lots saved up in my corporation, more than enough to pay off my student debt in one fell sweep. But my financial advisor is telling me I would pay WAY more in taxes to take money out of the corporation (as that would put me up into the highest tax bracket of 46%) than what I pay for interest at 3% for my loan. At my current rate of repayment, I would pay it down in about 3.5 years.

Clearly the numbers don't lie... but I still feel really uneasy about the situation. I've lived through my parents bankruptcy when I was younger when their business folded during the recession, and remember living at one point in fear of eviction. Clearly I am very debt adverse from this history... although I guess that's not necessarily a bad thing.

Would this be considered a 'good' debt? Or at least a 'not-so-bad debt'? Should I just tell my inner voices to shut up and do what makes the most financial sense?

seattlecyclone

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Re: Incur large taxes to pay off student loan?
« Reply #1 on: July 18, 2014, 06:03:23 PM »
Seems like if having your corporation pay you an extra $90k would put you in the highest tax bracket (which starts at just over $400k for a single person), you must have an income at least in the $300k range already, right? Couldn't you find some room in that income to pay off these loans over the next year or two without increasing your income further?

chicknelump

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Re: Incur large taxes to pay off student loan?
« Reply #2 on: July 18, 2014, 06:16:49 PM »
Seems like if having your corporation pay you an extra $90k would put you in the highest tax bracket (which starts at just over $400k for a single person), you must have an income at least in the $300k range already, right? Couldn't you find some room in that income to pay off these loans over the next year or two without increasing your income further?

Oh sorry forgot to mention i'm Canadian. 46% bracket is for somewhere around $130k income and 43% for around 90K

chicknelump

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Re: Incur large taxes to pay off student loan?
« Reply #3 on: July 18, 2014, 06:29:00 PM »
Jeebus, 300K salary? I wish!! LOL

ljp555

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Re: Incur large taxes to pay off student loan?
« Reply #4 on: July 18, 2014, 08:56:02 PM »
What tax bracket are you in now?

Emg03063

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Re: Incur large taxes to pay off student loan?
« Reply #5 on: July 18, 2014, 10:32:15 PM »
Should I just tell my inner voices to shut up and do what makes the most financial sense?

Yes.  If your company is holding the cash you would otherwise be paying yourself, and you're the owner and sole employee of the company, who's going to take it.  The only scenario where I could see you coming out ahead by paying off the loan early is if your company is bankrupted by a judgment against your company that is not able to pierce the corporate veil to go after your personal assets.  I'm not familiar with Canadian business law, but in the US, I think that's a pretty rare scenario.  As long as you carry malpractice insurance in excess of your total assets (personal and corporate), I think that's a non-issue.  Any debt that allows you to become wealthier by having it than you would be paying it off is good debt.  This qualifies.

Cheddar Stacker

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Re: Incur large taxes to pay off student loan?
« Reply #6 on: July 18, 2014, 10:43:37 PM »
I don't know canadian taxes but in the US once the corporation has paid taxes it can pay dividends/distributions and they are either taxed at lower rates or not taxed at all. I would talk to a tax accountant about this, not a financial advisor.

chicknelump

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Re: Incur large taxes to pay off student loan?
« Reply #7 on: July 19, 2014, 05:56:19 AM »
Here in Canada, dividends are taxed less only within the corporation. Once given as dividends, it's taxed at personal tax rate with some additional exception - like you can't use it for retirement fund deductions. It's still the best way for me, as I can support my parents through dividends pre-tax income, and I can income split, if my spouse ever decides to stop working full time.

My accountant was the one that initially told me the plan to pay down my student debt by taking a lump sum from the company... but in hind sight he may have been just telling me what I wanted to hear when I told him about my debt aversion. When I discussed it with my advisor, he looked at me as if I was insane.

aj_yooper

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Re: Incur large taxes to pay off student loan?
« Reply #8 on: July 19, 2014, 08:17:38 AM »
I would not worry about the debt as you have it mostly saved already in your corporation, assuming the SL is a fixed rate obligation.  You can continue chipping away at it as you have been doing.  I don't like debt either, but I would be good about this one. 

Do you have a good plan for the money in the corporation?  That is where I would spend my thinking time.

Wile E. Coyote

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Re: Incur large taxes to pay off student loan?
« Reply #9 on: July 19, 2014, 10:33:12 AM »
I would not worry about the debt as you have it mostly saved already in your corporation, assuming the SL is a fixed rate obligation.  You can continue chipping away at it as you have been doing.  I don't like debt either, but I would be good about this one. 

Do you have a good plan for the money in the corporation?  That is where I would spend my thinking time.

I second this. 3% is cheap money.  Reinvest the money to grow the business.  You should be able to beat a 3% return without much difficulty.

rmendpara

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Re: Incur large taxes to pay off student loan?
« Reply #10 on: July 19, 2014, 12:11:33 PM »
Can the business extend you a loan/line of credit?

I'm not a tax expert, especially not for Canada, but you would end up "paying" your company interest instead of paying to the student loan lender.

Anyway, that's my only creative idea.

In reality, 3.5 years is a very good payoff period... especially because your rate is low at 3%. I understand your psychological need to be debt free (or minimal debt), but it's just that... psychological. The math suggests you should do the following in descending order:

- pay it off as slow as possible (assuming it's fixed rate 3%)
- pay it off quickly through earnings at your current income level
- pay yourself a big bonus and pay it off soon

It's ultimately up to you. Even option #3 isn't bad... it's just sub-optimal.

chicknelump

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Re: Incur large taxes to pay off student loan?
« Reply #11 on: July 19, 2014, 05:24:30 PM »
I haven't looked into it too much, but our tax laws is such that it's pretty difficult to do it. A lot of paper and legal trail is required to make sure that it is a loan, and not a dividend, and even then it's not guarnateed they won't tax me on the loan. Plus I'd pay taxes on the interest I pay to my own company.

I think talking to more people (you guys included) I feel more comfortable with the idea of slowly paying down the debt. It would be nice psychologically to move it to another bank or something, because I always see it and there is also the urge to use the LOC every time I log into my bank account.

Can the business extend you a loan/line of credit?

I'm not a tax expert, especially not for Canada, but you would end up "paying" your company interest instead of paying to the student loan lender.

Anyway, that's my only creative idea.

In reality, 3.5 years is a very good payoff period... especially because your rate is low at 3%. I understand your psychological need to be debt free (or minimal debt), but it's just that... psychological. The math suggests you should do the following in descending order:

- pay it off as slow as possible (assuming it's fixed rate 3%)
- pay it off quickly through earnings at your current income level
- pay yourself a big bonus and pay it off soon

It's ultimately up to you. Even option #3 isn't bad... it's just sub-optimal.