Author Topic: Max tax advantaged accounts or wipe student debt?  (Read 1328 times)

ThePhilosopher

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Max tax advantaged accounts or wipe student debt?
« on: November 10, 2018, 08:11:42 AM »
My wife and I are trying to decide whether we should eliminate her student debt before maxing out our tax free accounts (401k, 457, Traditional IRA, and HSA).

Current Liquid Assets:
  • Savings: $38,000
  • Stocks (taxable account): $31,000

Student Loan Information:
  • $54,000 @ 5.68%
  • The minimum payment is $660 per month for 112 months

Tax Information: Expected marginal tax rate - wife and I's combined taxable income $114,000. Since we are filing jointly, this places us in the 22% bracket.

Tax-deferred Investment Options:
  • My investment choices: S&P 500 index fund with an expense ratio of .45%. Currently placing 7% of my income in 401k. ($5,460 of the max $18,500 contribution - 29% of possible)
  • Wife's investment choices: S&P 500 index fund with an expense ratio of .03%. Currently placing 6% of her income in 457/401k. ($2,340 of the max $18,500 contribution - 12% of possible)
(There aren't any total stock market indexes available in our 401k/457s, so I've opted for S&P 500 indexes instead. This is recommended by jcollins as the best alternative (https://jlcollinsnh.com).)

Based on case study I posted a week ago, there were several people saying that we should use our savings/stocks to pay off the student debt. I figured I'd simplify that case study and focus it on this specific issue. Afterwards, we could rebuild or savings account to comfortable level.

Step 7 of "Investment Order" article states, "Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield." Our student loan's interest rate is below that value, so it sounds like we should perform steps 1-6 before contributing above the minimum payment. Contributing money to all 6 steps would greatly minimize the amount of money above the minimum payment that we could place on the loan. This would result in the loan sticking around for a long time.

I'd assume that this order is based of solid math and statistics, so I imagine we should stick to it?

Second, we have a combined savings/stocks of $69,000. We could liquidate either: a) the majority of the account (~$40,000) or b) the entire loan amount, which would leave us with $15,000 in a savings account. Or perhaps it doesn't make sense to liquidate the taxable stock account, and only contribute a subset of our money from the savings account.

I imagine our decision could greatly impact our ability to retire early, so I wanted to make sure that we are informed with the various options and what makes the most sense. I'm hoping someone with more experience and knowledge than myself could chime in.
« Last Edit: November 12, 2018, 05:27:38 AM by ThePhilosopher »

TomTX

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #1 on: November 10, 2018, 01:30:10 PM »
We've had an influx of the "DEBT BAD" folks, perhaps too much Dave Ramsey influence.

Emotionally - I get it. I don't like debt either.

The investment order advice is rational. If the rate on your debt is low enough, focus on investments instead. The debt will eventually be paid off, and you are very likely to be ahead by taking that approach.

MDM

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #2 on: November 10, 2018, 06:44:25 PM »
I'd assume that this order is based of solid math and statistics, so I imagine we should stick to it?
Yes, with a couple of caveats:
- as noted in Investment Order, "these are guidelines not rules."
- there are lies, damned lies, and statistics.

In other words, based on historical performance, following the suggested order is likely but not guaranteed to work best for all.

chasesfish

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #3 on: November 10, 2018, 06:54:46 PM »
Can you repost the student loan rate and what your state/federal tax rate(s) are?

Both are good answers.

Personally we got our liquid savings to $100k AND maximized our pre-tax accounts before paying down the loans fast.  Our rates were in the 3.5% range and we were in a high combined tax bracket.


ketchup

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #4 on: November 10, 2018, 07:31:25 PM »
It sounds like you should max the tax advantaged accounts.  You didn't post the specific rate on the loans but unless it's obscene that's probably the best course of action.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #5 on: November 10, 2018, 08:14:45 PM »
Can you repost the student loan rate and what your state/federal tax rate(s) are?

Both are good answers.

Personally we got our liquid savings to $100k AND maximized our pre-tax accounts before paying down the loans fast.  Our rates were in the 3.5% range and we were in a high combined tax bracket.

I must have overlooked posting the loan specifics. Her student loan is $54,000 averaging a 5.68% interest rate. I’ve updated the original post too.
« Last Edit: November 10, 2018, 08:17:24 PM by ThePhilosopher »

lightbeard

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #6 on: November 10, 2018, 08:58:13 PM »
I recommend running the numbers instead of using rules of thumb as this is a math problem. Here is a calculator I wrote for a similar problem:

http://lightbeard.github.io/debtvsinterest.html

For example, when:

Months left for loan term, T=36
Loan payment, M = $200
Principle payment amount, P = $170
Expect # of principle payments per month (how aggressive you will be), n = 2
Market interest rate (e.g. VTI), r=7%

Savings from paying off debt = $5,154.42
Savings from investing instead = $4,561.39

In this case, there is almost 1k more savings by paying off debt.

Note: the calculator assumes the income freed up from an early loan payoff would be invested in the market.
« Last Edit: November 11, 2018, 06:35:11 AM by lightbeard »

ketchup

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #7 on: November 10, 2018, 09:34:46 PM »
I recommend running the numbers instead of using rules of thumb as this is a math problem. Here is a calculator I wrote for a similar problem:

http://lightbeard.github.io/debtvsinterest.html

For example, when:

Months left for loan term, T=36
Loan payment, M = $200
Principle payment amount, P = $170
Expect # of principle payments per month (how aggressive you will be), n = 2
Market interest rate (e.g. VTI), r=7%

Savings from paying off debt = $5,154.42
Savings from investing instead = $4,561.39

In this case, you'd save almost 1k more by paying off the debt.

Note: the calculator assumes the income freed up from an early loan payoff would be invested in the market.
You'd need to include OP's marginal tax rate to paint a full picture here.

Viking Thor

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #8 on: November 10, 2018, 09:53:54 PM »
The numbers clearly favor investing.

Invested in stocks for long term you would expect better than 5.68% rate of return.

Plus it's much better from a tax perspective- reduces your tax burden now. Sure you will pay taxes on the future but likely at a much lower income level in retirement (which wou!d reduce your effective tax rate).

A lot of people justify paying off debt when suboptimal because it "feels great". Of course everyone should do what makes them happy, whether that's suboptimal finance decisions, designer handbags, etc.

lightbeard

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #9 on: November 11, 2018, 06:49:23 AM »
Comparing the interest rate of the loan to the interest rate of the market is a common misconception because it highly depends on how close the loan is to the end of the term.

The way to really compare the two options is to calculate how much money you would have in the bank on the day the loan would naturally pay off with both options. Why on that day? Because by paying off the loan instantly there are two sources of savings (1) the interest saved by making a principle only payment but also (2) the income freed up from the current date until the date you would normally pay off the loan which can now be freed up for investment.

Without knowing how many payment periods are left on the loan term, we can only speculate as to what to advise the OP. We don't have all the information.
« Last Edit: November 11, 2018, 06:55:55 AM by lightbeard »

TomTX

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #10 on: November 11, 2018, 07:27:10 AM »
Comparing the interest rate of the loan to the interest rate of the market is a common misconception because it highly depends on how close the loan is to the end of the term.

Using "interest rate" instead of something like "expected rate of return" when referring to the stock market is a common misconception.

JGS1980

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #11 on: November 11, 2018, 08:17:49 AM »
Max out the pretax contributions to the degree that it provides you with tax benefits (do the math). Once your marginal tax rate is <6%, then pay off loans with extra income.

Alternatively, calculate how much you’d need to pay off your loans in 10 years, pay that amount each month. The rest of available income, max out the pretax advantaged accounts.

Note that if you get your AGI low enough, there will be additional benefits to contributing to a traditional IRA as well.

Hope this helps,

JGS

Traditional IRA deduction limits for 2018

Filing status   2018 modified Adjusted Gross Income   Tax deduction
Married filing jointly or qualifying widow or widower   
If you're covered by a workplace retirement plan: $101,000 or less

If your spouse is covered: $189,000 or less
Full deduction up to contribution limit
If you're covered by a workplace retirement plan: More than $101,000 but less than $121,000

If your spouse is covered: More than $189,000 but less than $199,000
Partial deduction
If you're covered by a workplace retirement plan: $121,000 or more

If your spouse is covered: $199,000 or more
No deduction

MDM

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #12 on: November 11, 2018, 11:00:43 AM »
Once your marginal tax rate is <6%....
Perhaps you mean something other than "marginal tax rate"?

JGS1980

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #13 on: November 11, 2018, 12:39:14 PM »
Once your marginal tax rate is <6%....
Perhaps you mean something other than "marginal tax rate"?

I’m sure there’s a smoother way to say “once tax benefits are no longer worthwhile...”

MDM

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #14 on: November 11, 2018, 01:13:58 PM »
Once your marginal tax rate is <6%....
Perhaps you mean something other than "marginal tax rate"?

I’m sure there’s a smoother way to say “once tax benefits are no longer worthwhile...”
Focusing on tax benefits misses the primary point of comparison between investing vs. paying debt: the expected investment return vs. the debt interest rate.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #15 on: November 11, 2018, 02:33:50 PM »
I've added more information about the student loan, namely the minimum payment and loan term.

Focusing on tax benefits misses the primary point of comparison between investing vs. paying debt: the expected investment return vs. the debt interest rate.

In this case, isn't the scenario slightly more complex than comparing the expected investment return to the debt interest rate? Since all of my additional investments would be in the form of HSAs, 401ks, 457(b), and Traditional IRA, I'd also have to have to take into account the fact that these contributions would be tax free in terms of deposit and growth. Also, the contributions could lower my income tax rate, but I'm not sure how relevant that would be to this scenario.
« Last Edit: November 11, 2018, 02:37:16 PM by ThePhilosopher »

MDM

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #16 on: November 11, 2018, 04:28:12 PM »
In this case, isn't the scenario slightly more complex than comparing the expected investment return to the debt interest rate?
Slightly more complex is correct: it's the after-tax return vs. the after-tax interest cost.

Quote
Since all of my additional investments would be in the form of HSAs, 401ks, 457(b), and Traditional IRA, I'd also have to have to take into account the fact that these contributions would be tax free in terms of deposit and growth. Also, the contributions could lower my income tax rate, but I'm not sure how relevant that would be to this scenario.
Other than the HSAs, which are completely tax exempt if used for medical expenses, it's the tax-free annual growth that distinguishes those from taxable accounts.  At some point one, either contribution or withdrawal, one pays taxes on the contribution amount.  Thus there is a slight, but not huge, edge to tax-advantaged investing over taxable investing.

This appears in the investment order as the difference between step 2 vs. step 7.

Boofinator

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #17 on: November 11, 2018, 05:19:12 PM »
OP, I haven't seen your marginal tax rate. Can you post? https://taxfoundation.org/2018-tax-brackets/

Viking Thor

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #18 on: November 11, 2018, 05:31:29 PM »
The tax advantage is not just in tax free growth although that's part of it; 401k etc has enormous tax advantages and is high in the investment order list because of this.

There are two additional tax advantages:
1. Able to invest more upfront which will also grow tax free, since you get the upfront tax break.
2. For most people and especially high income / mustacian types - lower tax rate on back end in retire when income is lower. I.e. Hypothetical example - if you make $100k now and spend $30k, and in retirement you would spend (inflation adjusted) $30k, you would be paying a much higher tax rate now if you paid off loans, vs putting in tax advantaged account and then paying in retirement when income is lower.

Viking Thor

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #19 on: November 11, 2018, 05:50:47 PM »
I recommend running the numbers instead of using rules of thumb as this is a math problem. Here is a calculator I wrote for a similar problem:

http://lightbeard.github.io/debtvsinterest.html

For example, when:

Months left for loan term, T=36
Loan payment, M = $200
Principle payment amount, P = $170
Expect # of principle payments per month (how aggressive you will be), n = 2
Market interest rate (e.g. VTI), r=7%

Savings from paying off debt = $5,154.42
Savings from investing instead = $4,561.39

In this case, you'd save almost 1k more by paying off the debt.

Note: the calculator assumes the income freed up from an early loan payoff would be invested in the market.
You'd need to include OP's marginal tax rate to paint a full picture here.
You don't need to know the term; you only need the market return vs interest rate. If market return is higher that will always win (without factoring in the tax breaks which will always favor tax advantaged and widen the gap even more in its favor).

If in your calculation 5.68% interest savings beats 7% market rate of return then your calculations are incorrect and one of the variables is off.

Boofinator

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #20 on: November 11, 2018, 06:32:31 PM »
I'll update this with more precise figures once OP posts their expected marginal tax rate, however you are pretty much guaranteed to get a better return by first maxing out your tax-deferred (traditional) 401k and/or IRA before paying off the student loans at that interest rate. There are a few variables here that affect expected return (tax rates, investment choices, plan expense ratios), and if you fill us in here we'll point you in the direction that will minimize your expected time to financial independence.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #21 on: November 12, 2018, 05:19:46 AM »
I'll update this with more precise figures once OP posts their expected marginal tax rate, however you are pretty much guaranteed to get a better return by first maxing out your tax-deferred (traditional) 401k and/or IRA before paying off the student loans at that interest rate. There are a few variables here that affect expected return (tax rates, investment choices, plan expense ratios), and if you fill us in here we'll point you in the direction that will minimize your expected time to financial independence.

Boofinator, below are some more details. Let me know if I am missing any details. I've updated the original post too.

  • Expected marginal tax rate: wife and I's combined taxable income $114,000. Since we are filing jointly, this places us in the 22% bracket.
  • My investment choices: S&P 500 index fund with an expense ratio of .45%. Currently placing 7% of my income in 401k. ($5,460 of the max $18,500 contribution - 29% of possible)
  • Wife's investment choices: S&P 500 index fund with an expense ratio of .03%. Currently placing 6% of her income in 457/401k. ($2,340 of the max $18,500 contribution - 12% of possible)

A few more notes: there aren't any total stock market indexes available in our 401k/457s, so I've opted for S&P 500 indexes instead. This is recommended by jcollins as the best alternative (https://jlcollinsnh.com). I plan on maxing out my HSA next year, but as it stands, the above are our only pre-tax contributions to date.
« Last Edit: November 12, 2018, 05:26:48 AM by ThePhilosopher »

Apple_Tango

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #22 on: November 12, 2018, 05:40:52 AM »
I wouldn’t liquidate anything. You guys make over 6 figures, would it not be possible to plop down $25,000 per year into the debt? It will be cleared up in about 2 years just by using your income. You can still contribute to your  401ks at the same time. If you can live on about $25,000-$35,000, you can do it!

AccidentalMiser

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #23 on: November 12, 2018, 06:23:42 AM »
Lots of people running lots of numbers for you.  As a "Philosopher," you should also consider the philosophical aspects of what you're talking about.  With all due respect to TomTX, this forum used to recognize "DEBT BAD" as well.  We've possibly moved beyond that to become statisticians and spreadsheet wizards.

The numbers will work out closely either way.  The "investment order" is very valuable as a guideline but it makes unstated assumptions and doesn't account for the emotional burden that debt carries for most humans.  In my case, I would pay off the student loan or split the difference with paying off the debt very early and funding pre-tax accounts. 

An additional factor is that paying off debt returns its benefit no matter what happens to you or the economy or the world and does not depend on the health of the SP500.  It provides real benefits which you will realize immediately.  It'll also free up that $600+ for investing.

Good luck to you!!

Lady SA

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #24 on: November 12, 2018, 10:38:55 AM »
I haven't seen anyone suggest refinancing the loan to a lower rate? Check out Sofi or Earnest and run the numbers to see if refinancing is better than just keeping the loan as-is.

Fwiw, my DH and I refinanced all of our loans with earnest and then split our monthly surplus roughly equally between our SLs and investments. Any income increases after that then went 100% toward investments, so over time our surplus has begun weighing heavily towards investing (while still paying extra on our loans). A similar system may work for you.

Boofinator

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #25 on: November 12, 2018, 10:52:17 AM »
From tax-deferred savings, you essentially get two returns: the initial bump from tax savings, plus the ongoing market returns (minus expenses). The initial bump is easy to calculate and guaranteed: 1/(1-federal%-state%)-1; if we assume you have a 3% state income tax, that would give you an immediate return of 33% by investing in tax deferred.

Now let's compare possible results of tax-deferred versus paying off the loan. The only way the loan might win is if the tax-deferred investments drop by 25+%, and the subsequent long-term return is less than 7%. This hasn't happened in the history of the US stock market, and even though I expect a crash at some point, it is unlikely to be that bad. Plus you will be averaging in each paycheck, so after the big crash you will be buying stocks cheap.

And the final cherry for tax-deferred savings is that they are unlikely to be taxed in retirement if you retire early as a Mustachian. And if you retire at full retirement age, you'll be one rich dude who could care less about a few taxes.

I highly recommend maxing out tax-deferred before paying off debt at that interest rate. The odds really are that favorable for tax-deferred investments. I don't personally gamble, but I would if there was a roulette wheel where you win if you land on red or black, plus the payout is 5x your bet (you lose landing on 0 or 00). The expected returns really are that favorable for tax-deferred investments over paying low-interest rate debt.

The S&P 500 is a good investment, so go that route. I also like to have a mix of international, but that is a contentious debate and it isn't guaranteed that a world mix will beat US over the long term.

You're probably close to the line for being able to fully deduct traditional IRA (https://www.irs.gov/retirement-plans/plan-participant-employee/2018-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work); if you can that's another excellent bucket for tax-deferred savings. I would do it this year, and worst-case if you are over the deduction limits you can easily recharacterize as Roth when you do your taxes.

TL;DR: Max all tax-deferred buckets before paying off your debt at that interest level. Future you will thank current you.

Raenia

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #26 on: November 12, 2018, 11:03:07 AM »
You mentioned that the average rate on the loan is 5.68%, is that a single loan at that rate or multiple smaller loans, some with higher or lower rates?

seattlecyclone

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #27 on: November 12, 2018, 11:39:03 AM »
Note that at your income level, student loan interest up to $2,500 annually is tax-deductible. At a 22% tax rate, that knocks $550 off your interest payment, which in turn brings your effective interest rate down to 4.66%. This percentage will actually go down slightly as you pay off your loan, until your interest payments hit that $2,500 mark.

However also note that you're not super far into the 22% bracket after considering the standard deduction and the student loan interest deduction, so if you both max out your workplace retirement accounts there's a high probability that you'll go back down to the 12% bracket.

AccidentalMiser

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #28 on: November 12, 2018, 03:07:12 PM »
Note that at your income level, student loan interest up to $2,500 annually is tax-deductible. At a 22% tax rate, that knocks $550 off your interest payment, which in turn brings your effective interest rate down to 4.66%. This percentage will actually go down slightly as you pay off your loan, until your interest payments hit that $2,500 mark.

However also note that you're not super far into the 22% bracket after considering the standard deduction and the student loan interest deduction, so if you both max out your workplace retirement accounts there's a high probability that you'll go back down to the 12% bracket.

Is it deductible even if you don't itemize?

MDM

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #29 on: November 12, 2018, 03:11:50 PM »
Note that at your income level, student loan interest up to $2,500 annually is tax-deductible. At a 22% tax rate, that knocks $550 off your interest payment, which in turn brings your effective interest rate down to 4.66%. This percentage will actually go down slightly as you pay off your loan, until your interest payments hit that $2,500 mark.

However also note that you're not super far into the 22% bracket after considering the standard deduction and the student loan interest deduction, so if you both max out your workplace retirement accounts there's a high probability that you'll go back down to the 12% bracket.

Is it deductible even if you don't itemize?
Yes.

It will go on line 33 of https://www.irs.gov/pub/irs-dft/f1040s1--dft.pdf, assuming one meets the maximum income requirement.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #30 on: November 12, 2018, 05:40:27 PM »
I haven't seen anyone suggest refinancing the loan to a lower rate? Check out Sofi or Earnest and run the numbers to see if refinancing is better than just keeping the loan as-is.

Fwiw, my DH and I refinanced all of our loans with earnest and then split our monthly surplus roughly equally between our SLs and investments. Any income increases after that then went 100% toward investments, so over time our surplus has begun weighing heavily towards investing (while still paying extra on our loans). A similar system may work for you.

We have tried refinancing her loans with SoFi, unfortunately, the rate they offered was higher than her current interest rate. We could look into Earnest.

I like the way you split your payments. I'd definitely like to pay more than the minimum balance, as I can't imagine keeping the student loan around for its full length.

You mentioned that the average rate on the loan is 5.68%, is that a single loan at that rate or multiple smaller loans, some with higher or lower rates?

There are few loans at a higher rate ~6.2%, one much lower (3.2%), and largest one at 5.3%. We are paying off the highest interest rates first, followed by the mid range one. I'm in no rush to pay off the low, albeit small interest rate loan.

Note that at your income level, student loan interest up to $2,500 annually is tax-deductible. At a 22% tax rate, that knocks $550 off your interest payment, which in turn brings your effective interest rate down to 4.66%. This percentage will actually go down slightly as you pay off your loan, until your interest payments hit that $2,500 mark.

However also note that you're not super far into the 22% bracket after considering the standard deduction and the student loan interest deduction, so if you both max out your workplace retirement accounts there's a high probability that you'll go back down to the 12% bracket.

Thanks for the insight seattlecyclone! I hadn't considered the student loan interest tax-deduction. And I think you are right; if we maxed out our tax-deductible accounts, we would be either in the 12% range or have a very small amount that is taxed higher.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #31 on: November 12, 2018, 06:01:07 PM »
From tax-deferred savings, you essentially get two returns: the initial bump from tax savings, plus the ongoing market returns (minus expenses). The initial bump is easy to calculate and guaranteed: 1/(1-federal%-state%)-1; if we assume you have a 3% state income tax, that would give you an immediate return of 33% by investing in tax deferred.

Now let's compare possible results of tax-deferred versus paying off the loan. The only way the loan might win is if the tax-deferred investments drop by 25+%, and the subsequent long-term return is less than 7%. This hasn't happened in the history of the US stock market, and even though I expect a crash at some point, it is unlikely to be that bad. Plus you will be averaging in each paycheck, so after the big crash you will be buying stocks cheap.

And the final cherry for tax-deferred savings is that they are unlikely to be taxed in retirement if you retire early as a Mustachian. And if you retire at full retirement age, you'll be one rich dude who could care less about a few taxes.

I highly recommend maxing out tax-deferred before paying off debt at that interest rate. The odds really are that favorable for tax-deferred investments. I don't personally gamble, but I would if there was a roulette wheel where you win if you land on red or black, plus the payout is 5x your bet (you lose landing on 0 or 00). The expected returns really are that favorable for tax-deferred investments over paying low-interest rate debt.

The S&P 500 is a good investment, so go that route. I also like to have a mix of international, but that is a contentious debate and it isn't guaranteed that a world mix will beat US over the long term.

You're probably close to the line for being able to fully deduct traditional IRA (https://www.irs.gov/retirement-plans/plan-participant-employee/2018-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work); if you can that's another excellent bucket for tax-deferred savings. I would do it this year, and worst-case if you are over the deduction limits you can easily recharacterize as Roth when you do your taxes.

TL;DR: Max all tax-deferred buckets before paying off your debt at that interest level. Future you will thank current you.

Boofinator, all around awesome points! You gave me a lot to think about, I really appreciate it.

I believe my MAGI is too high to have a fully deducted traditional IRA (due to lower 401k contributions), but it may be worth funding it anyways if you can convert it to a Roth.

Boofinator

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #32 on: November 13, 2018, 08:46:53 AM »
I believe my MAGI is too high to have a fully deducted traditional IRA (due to lower 401k contributions), but it may be worth funding it anyways if you can convert it to a Roth.

If you are unsure whether you can fully deduct a traditional, you can contribute but then decide to "recharacterize" if you find during tax season you are over the deduction limit. https://www.irs.gov/retirement-plans/ira-faqs-recharacterization-of-ira-contributions

If you are fairly certain you will exceed the deduction limit for traditional, just contribute to Roth to begin with. No need to perform a "conversion", unless you are very high income (this is the "backdoor Roth"). https://investor.vanguard.com/ira/roth-conversion

TomTX

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #33 on: November 13, 2018, 07:51:23 PM »

  • Expected marginal tax rate: wife and I's combined taxable income $114,000. Since we are filing jointly, this places us in the 22% bracket.
  • My investment choices: S&P 500 index fund with an expense ratio of .45%. Currently placing 7% of my income in 401k. ($5,460 of the max $18,500 contribution - 29% of possible)
  • Wife's investment choices: S&P 500 index fund with an expense ratio of .03%. Currently placing 6% of her income in 457/401k. ($2,340 of the max $18,500 contribution - 12% of possible)

A few more notes: there aren't any total stock market indexes available in our 401k/457s, so I've opted for S&P 500 indexes instead. This is recommended by jcollins as the best alternative (https://jlcollinsnh.com). I plan on maxing out my HSA next year, but as it stands, the above are our only pre-tax contributions to date.

Does your wife have access to both a 401k and 457? If so, typically you can contribute the max ($18,500 for 2018) to each of them, not just one. Is her employer a government entity? There are some additional risks with the 457 if the employer is not.

Given the lower expense ratio of the investment options, I would focus any extra contributions to her 401k, and possibly 457.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #34 on: November 14, 2018, 04:41:47 PM »
I believe my MAGI is too high to have a fully deducted traditional IRA (due to lower 401k contributions), but it may be worth funding it anyways if you can convert it to a Roth.

If you are unsure whether you can fully deduct a traditional, you can contribute but then decide to "recharacterize" if you find during tax season you are over the deduction limit. https://www.irs.gov/retirement-plans/ira-faqs-recharacterization-of-ira-contributions

If you are fairly certain you will exceed the deduction limit for traditional, just contribute to Roth to begin with. No need to perform a "conversion", unless you are very high income (this is the "backdoor Roth"). https://investor.vanguard.com/ira/roth-conversion

Great information! I'd like to make my contributions to a Traditional IRA if possible, since I plan to use the Roth conversion ladder to access the funds pre-59 1/2. Are you able to to withdraw directly from a Roth IRA pre-59 1/2 with the same 5 year waiting period?


  • Expected marginal tax rate: wife and I's combined taxable income $114,000. Since we are filing jointly, this places us in the 22% bracket.
  • My investment choices: S&P 500 index fund with an expense ratio of .45%. Currently placing 7% of my income in 401k. ($5,460 of the max $18,500 contribution - 29% of possible)
  • Wife's investment choices: S&P 500 index fund with an expense ratio of .03%. Currently placing 6% of her income in 457/401k. ($2,340 of the max $18,500 contribution - 12% of possible)

A few more notes: there aren't any total stock market indexes available in our 401k/457s, so I've opted for S&P 500 indexes instead. This is recommended by jcollins as the best alternative (https://jlcollinsnh.com). I plan on maxing out my HSA next year, but as it stands, the above are our only pre-tax contributions to date.

Does your wife have access to both a 401k and 457? If so, typically you can contribute the max ($18,500 for 2018) to each of them, not just one. Is her employer a government entity? There are some additional risks with the 457 if the employer is not.

Given the lower expense ratio of the investment options, I would focus any extra contributions to her 401k, and possibly 457.

She does have access to a 401k and 457. She is a government employee as well, so I don't think she will incur the additional risks.

I didn't realize that the max contribution was separate between the 401k and 457. Extremely useful information TomTX!

seattlecyclone

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #35 on: November 15, 2018, 12:23:53 PM »
Great information! I'd like to make my contributions to a Traditional IRA if possible, since I plan to use the Roth conversion ladder to access the funds pre-59 1/2. Are you able to to withdraw directly from a Roth IRA pre-59 1/2 with the same 5 year waiting period?

Having a Roth IRA prior to retirement does not in any way prevent you from executing a Roth conversion ladder from your traditional IRA. In fact, any direct contributions to Roth IRAs can be withdrawn at any time with no tax due. It's convenient to have some amount of money that is freely/cheaply withdrawable to cover the first five years of your Roth ladder. Direct Roth contributions can be part of this.

JGS1980

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #36 on: November 15, 2018, 01:19:41 PM »
So Philosopher, in the end, what have you decided to do?

TomTX

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #37 on: November 15, 2018, 06:49:35 PM »

Does your wife have access to both a 401k and 457? If so, typically you can contribute the max ($18,500 for 2018) to each of them, not just one. Is her employer a government entity? There are some additional risks with the 457 if the employer is not.

Given the lower expense ratio of the investment options, I would focus any extra contributions to her 401k, and possibly 457.

She does have access to a 401k and 457. She is a government employee as well, so I don't think she will incur the additional risks.

I didn't realize that the max contribution was separate between the 401k and 457. Extremely useful information TomTX!

Realize that the 457 is unique in that there is no age requirement for withdrawal without penalty. As soon as she leaves employment with that employer, she can draw from it with no penalty.

I would suggest trying to max out the 457.

One other caveat with the 457: I suggest not using Roth in the 457 if you intend to access the money early. It gets complicated, as you do get taxed (regular income tax) on Roth growth for any withdrawals before age 59.5 and typically you cannot specify that you are only withdrawing contributions.

ThePhilosopher

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #38 on: November 18, 2018, 05:10:55 PM »
So Philosopher, in the end, what have you decided to do?

First, we are now tracking all our expenses month to month in a spreadsheet. I want to get a true grasp of what our spending habits are and how much we have in excess each month. The original post is a solid estimate, but it is exactly that... an estimate.

Second, we are going to raise on tax-deferred investments. First and foremost, we are going to invest a far larger percent in my wife's 457 and secondary into my 401k. Her 457 has lower expense ratios and also features the ability to serve as an early withdraw account during early retirement, so we want to heavily invest here. In addition, we will both be maxing out our HSAs going forward.

After out additional contributions, in combination with a better understanding of our spending and possible optimizations, we will then contribute the remainder of our taxed income towards her student loans. The idea of paying the minimum and keeping her loans around for 10 years doesn't appeal to us. Instead we are taking the middle ground: increasing tax-deferred contributions and accelerating the loan payoff. Luckily this is possible. I had been contribution taxed money to stocks and building up our savings account with extra money. By eliminating the taxed stock contributions and feeling comfortable with our savings account size, we can now start diverting that money.


Does your wife have access to both a 401k and 457? If so, typically you can contribute the max ($18,500 for 2018) to each of them, not just one. Is her employer a government entity? There are some additional risks with the 457 if the employer is not.

Given the lower expense ratio of the investment options, I would focus any extra contributions to her 401k, and possibly 457.

She does have access to a 401k and 457. She is a government employee as well, so I don't think she will incur the additional risks.

I didn't realize that the max contribution was separate between the 401k and 457. Extremely useful information TomTX!

Realize that the 457 is unique in that there is no age requirement for withdrawal without penalty. As soon as she leaves employment with that employer, she can draw from it with no penalty.

I would suggest trying to max out the 457.

One other caveat with the 457: I suggest not using Roth in the 457 if you intend to access the money early. It gets complicated, as you do get taxed (regular income tax) on Roth growth for any withdrawals before age 59.5 and typically you cannot specify that you are only withdrawing contributions.

We are extremely excited having realized the potential of her 457. Since early retirement is part of the plan, we are going to make sure maximum yearly contributions are made to this account. And thank you for the Roth/457 heads up. The more we can learn by others' experiences and avoid making them ourselves, the better :)
« Last Edit: November 18, 2018, 05:12:32 PM by ThePhilosopher »

tyler2016

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #39 on: November 19, 2018, 09:59:43 AM »
Student loans are typically not dischargable through bankruptcy. What if you get sick and can't work? What if a drunk driver with no money and insurance breaks your spine?

The last thing you will need when dealing with another major financial problem is one that you can't get out of. I would contribute just enough to get matching contributions and then wipe out the student loans

Boofinator

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Re: Max tax advantaged accounts or wipe student debt?
« Reply #40 on: November 19, 2018, 04:58:48 PM »
Student loans are typically not dischargable through bankruptcy. What if you get sick and can't work? What if a drunk driver with no money and insurance breaks your spine?

The last thing you will need when dealing with another major financial problem is one that you can't get out of. I would contribute just enough to get matching contributions and then wipe out the student loans

I don't agree with using this outlook. If one gets sick and can't work, which is extremely unlikely, they can generally apply for social security disability benefits. Meanwhile, if absolutely necessary to pay the student loans, they can pull money out of tax advantaged accounts and take the 10% penalty (but still come out ahead because presumably they would be in a much lower tax bracket). So even with this black swan event, they'd likely pull ahead with tax-advantaged savings.