Author Topic: Reducing student debt vs. non-deductible IRA  (Read 2893 times)

Lentils5eva

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Reducing student debt vs. non-deductible IRA
« on: August 22, 2013, 01:09:10 AM »
Hi, Fellow Mustachians,

Somewhat recent convert here.  Graduated from law school last May with $108,000 in loans.  That's WITH a 2/3 scholarship, so it could have been a lot worse.  Still: crazy! 

My loans went into repayment in Nov '12, and in January of this year I went into ass-kicking mode.  As things stand now:

-Loan 1: VANQUISHED.  $13,500 @ 8.25% interest, paid off in full.  LATER, HOMES.
-Loan 2: PARTIALLY VANQUISHED.  Was $29,000, now $19,000.  Interest of 7.65%.  This is the highest interest-loan and the one we are focusing on with everything we've got.  Currently getting paid down at around $3,000 per month.
-Loans 3 and 4: DON'T THINK WE'VE FORGOTTEN ABOUT YOU, YOU'RE JUST NOT OUR MAIN TARGET YET.  Combined total of $64,000, both at 6.55%.  I've been snowballing Loans 1 and 2, so these have been getting just enough to keep ahead of the monthly interest.

I started this journey paying off $900/month on the loans, and several ratchets later am up to $3,400 per month.  I also just got engaged (hooray!).  My Fiancee (a financial ninja who got me into this whole concept in the first place) wants to chip in another $1,200/month.  I think I can probably up my own contribution some more, so we're contemplating a total monthly payment of $4,800 between the two of us, or $57,600/year.

We're working really hard on the "reducing liabilities" side of the equation, but I can't help but feel that maybe I should be adding more to assets (especially retirement assets, given 3 years of law school where I put away nothing).

Together, we're putting away a total of $28,500 per year in our workplace retirement plans (maxing them out).  Neither of us contributes to an IRA. Our current retirement savings are about $143,000 combined.  We're both in our late 20s.

FIRST WORLD PROBLEM AHEAD:  Our incomes disqualify us from the following: Student loan interest deduction, Roth IRA contributions, traditional IRA contribution deduction.

Here's the question:  Would it be worth paying down loans slightly less aggressively, in order to set more aside for retirement?  The only option that I would have is to put $5,500 into a non-deductible, traditional IRA.  This money would grow tax-deferred.  I would pay taxes on the gains when it comes out. 

As far as I can tell, this stacks up to: Better to payoff debt at 7.65% interest, or put some more funds towards retirement assets (where they might earn 8% over the long haul, maybe, but will at least be growing tax-deferred)? 

Curious to hear what mustachians think.

Thanks!

Lentils

fiveoclockshadow

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Re: Reducing student debt vs. non-deductible IRA
« Reply #1 on: August 22, 2013, 06:46:36 AM »
It sounds like you aren't aware of the backdoor Roth.  You'll want to read up on that, it means that you can in fact contribute to a Roth IRA regardless of income and there is no reason to do a non-deductible IRA (well, except for one day before you convert it to a Roth).

In general order of attack is usually:

1. Ridiculously high rate debt (you don't have that)
2. 401k up to the match
3. Intermediate debt (your student loans probably fit in here)
4. IRA (backdoor Roth in your case)
5. Max 401k
6. Low rate debt

Lines one and two may swap depending on how high the rate is on the debt and how your match is structured.

Lines three through five may be reordered depending on debt interest rate and your tax bracket.  For instance, if you were in a very high bracket and your debt will be retired in a few years anyway and is at a modest rate you might invert them as 401k (pre-tax contribution is good as you are in high bracket now and will be lower in retirement), Roth IRA (you can't do pre-tax but you want to maximize tax sheltered growth), debt (the long term tax benefits of the 401k/IRA outweigh the extra few months of debt interest).

If I was in your shoes I think I'd do the backdoor Roth's.  That's like missing  two of twelve months of debt payment.  You will have all the debt paid in two years even if you do that.  Tax deferred space is precious so don't miss the opportunity.  And Google "backdoor Roth" - that's what you want to do.

Rebecca Stapler

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Re: Reducing student debt vs. non-deductible IRA
« Reply #2 on: August 22, 2013, 08:18:55 AM »
I am going to disagree with the PP and say that focusing on your SLs is the way to go for now. This is partially a gut decision on your part, though. There is something about carrying a massive debt load that can weigh on one's psyche, and getting rid of the SLs will help you feel financially more independent than having $11k more in a Roth, given that you already have a decent amount saved for your age and you are contributing the max to your 401ks.

Given that your current SL interest rates are all above 6% and you can't deduct the interest, paying them off is like a guaranteed 6+% rate of return on your investment. Plus, you have the added security of not being highly leveraged in the event that your income drops significantly or you have a massive unexpected expense. 

Another Reader

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Re: Reducing student debt vs. non-deductible IRA
« Reply #3 on: August 22, 2013, 08:28:25 AM »
+1 for stan's comments.  Student loans are alligators, nipping at your heels.  Get them paid and get on with your life.

ChiStache

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Re: Reducing student debt vs. non-deductible IRA
« Reply #4 on: August 22, 2013, 08:34:00 AM »
DEFINITELY kill the debt first.  You're already maxing your tax advantage retirement accounts, you should feel really good about your current path. No need to deviate.

Full steam ahead!!!

Lentils5eva

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Re: Reducing student debt vs. non-deductible IRA
« Reply #5 on: August 22, 2013, 07:27:28 PM »
Thanks for the advice.  I will check into the backdoor roth situation.  I hadn't even thought of that.  But in any case will continue aggressively to attack the loans.  It feels so good to get them further and further reduced.