Author Topic: Retirement vs Loans: Probably a simple question, just want verification.  (Read 2429 times)

clarkai

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I'm not sure my actual question is actually worth an entire write up, so you can skip the the QUESTION at the bottom. Bolded for easy finding.



Life Situation:

We are a married couple, living in Washington state, in our late twenties. I'm joining a new school district for my second year of teaching; since we moved for my job, my partner doesn't have a job yet. No dependents or children, though we would like to foster older kids/teens in the near-ish future.

Gross Salary/Wages: $46k, plus optional days brings it to ~$51k. (more once my partner gets a job)

Pre-tax deductions: None, at this point, that's what the post is about!

Taxes: Income tax: ~$7k (estimate)

Current expenses, by month:

Rent: $950
Union Dues: $100
Health Insurance: $344
Retirement: $?
Water/Garbage: $120? (Just moved, so don't know our average yet)
Electricity: $120? (Just moved, so don't know our average yet)
Cellphones: $80
School Loan: $490
Gym/hobbies/health: $300 (yes, this is a lot, but it's also very important to both of us. More detail would reduce my anonymity greatly, which I'm not comfortable with.)
Food: $200-300
Pets: <$30
Household stuff: $100 (we haven't furnished the house yet, so this is inflated)
Transport: $45 (we don't have a car, but our bikes need some repair so this will probably be larger in September. Plus we use the bus sometimes)
Left over: ~$690.


Assets:
~5k inheritance sitting in a mutual fund(? It's not mine, so I never really found out the details, but I do know that if we need it, we can spend it)
~5k retirement from last year.


Liabilities:
Educational loan: 40k from 2015, interest rate ~5% (actually 5.1% on half, and 5.9% on the other). Payments are about $490 as stated above. Current balance is ~38k. I want to pay this off. Quickly.


Specific Question(s):

Background to question:

I'm trying to figure out my retirement allocations vs educational loan repayment. I have access to a 401a, a 403b, and a DCP.

For the 401a, there is no employer match, it's instead a combination of a defined benefit and we're required to put in between 5% and 15% of our income. We are only allowed to pick our percentage once. Because of this, I think it may be best to simply do the 5% minimum so that I can dump more of my money into my loans until they are paid off. Additionally, the paperwork the district provides is incomplete, doesn't talk about fees, and I'm going to have to call them to figure that out, which I will soon.

For the 403b, there are certain providers I have to pick from, which can be found here: http://osd.wednet.edu/media/osd/payroll/2016%20Authorized%20Investment%20Providers%20403b.pdf. This one I can choose to enroll in now, or later, and can change the amount I put in when ever I'd like.

We also have a DCP (457 plan), which I ignored at first, because it had a fancy handout, and my instinct is that if someone is trying to sell me something, they're probably making money off of me. Anyway, it's a 457. We again can choose, and I saw fee rates from .02% to .2%. This again seems to be something that I can enroll in when I want, and change how much I'm contributing.

ACTUAL QUESTION:

- Right now, my thinking is that given the high interest rates (5.1% on about 20k and 5.9% 17k)(this is a hair-on-fire debt emergency, is it not?) on the school loans, I should just do the minimum 5% on the 401a, and put off the 403b and 457 plans until I've paid off the loan, and put as much as I can into the loan. I hate that they won't let me change the % contribution for the 401a, but given the high interest debt I don't believe that it's reasonable to be putting money into investments rather than my debt.

Everything I've read said to pay off loans first if their interest rates were >5%, and both of mine are, but to do that, I'm stuck with the 5% of income withdrawal for my 401a forever, which seems really awful/stupid. Can some one just tell me that yes, I should do the minimum and pay off the loans as quickly as possible, and once that's done put the near third of my take home pay into various investment vehicles. Or, conversely, no, and why?

Additional questions/thoughts:

- Once the loans are finished, it seems like the next step is to increase our savings from 5k to 18k, and after that, I can start thinking about the 403b vs the 457. Although honestly I think I'm ok with a smaller emergency fund than that, but they did say 6 months of expenses...

- Meanwhile, I need to decide how to allocate the 5% I am putting into the 401a. That I'm confident I can figure out on my own.

- Once hubby gets a job, the plan is to put at least 50% of his money into savings, if not closer to 100%. But he probably won't be making as much as me for another few years.

Rufus.T.Firefly

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Yes, I agree. Pay off the loans. That's a guaranteed, immediate return on investment. It reduces your leverage and makes your financial life generally less risky. Plus it feels great!

You'll have ways, other than the 401(a), to stack up your money after you get this done. And at that point, if you really are saving so much money that you run out of tax sheltered vehicles, that's what we call "good problems." Then you just stick the extra in a taxable account and keep rolling.

seattlecyclone

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5% is sort of borderline. You might do better prioritizing the loans, you might do better investing. Neither option is bad, and one will probably only be a little bit better than the other regardless.

I would say that if your salary is high enough to allow you to pay your bills, max out all of your retirement accounts and still have money left over, you might want to prioritize the retirement accounts since you can't go back later and make contributions for this year. However you have three workplace retirement buckets to fill up plus an IRA is always an option, and your salary isn't super high, so if you really want the debt gone it's not a bad idea to focus on that now. You'll have plenty of time to contribute to retirement once the debt is gone.

Can you give more details about that 401(a) plan? You can only pick your contribution percentage once? A defined benefit plan can be a pretty sweet deal if you plan to stick around long enough to get fully vested in it. What if you don't? Personally, if the plan looked like it would be a pretty good deal regardless of how long I stayed in that job I might go for the maximum contribution amount. Increasing that percentage from 5% to 15% won't affect your loan payoff date by a whole lot, and you might later regret choosing a lower percentage just to focus on short-term loan payoff.

MDM

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Gross Salary/Wages: $46k, plus optional days brings it to ~$51k. (more once my partner gets a job)

Pre-tax deductions: None, at this point, that's what the post is about!
See the case study spreadsheet (CSS) to enter your own numbers, but it appears that ~$12K into pre-tax 401/403/457 plans will drop your federal income tax to $0, with >25% savings rate on that $12K:


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For the 401a, there is no employer match, it's instead a combination of a defined benefit and we're required to put in between 5% and 15% of our income. We are only allowed to pick our percentage once. Because of this, I think it may be best to simply do the 5% minimum so that I can dump more of my money into my loans until they are paid off. Additionally, the paperwork the district provides is incomplete, doesn't talk about fees, and I'm going to have to call them to figure that out, which I will soon.
Yes, need more info on this.

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For the 403b, there are certain providers I have to pick from, which can be found here: http://osd.wednet.edu/media/osd/payroll/2016%20Authorized%20Investment%20Providers%20403b.pdf. This one I can choose to enroll in now, or later, and can change the amount I put in when ever I'd like.
Fidelity is likely your best option.

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We also have a DCP (457 plan), which I ignored at first, because it had a fancy handout, and my instinct is that if someone is trying to sell me something, they're probably making money off of me. Anyway, it's a 457. We again can choose, and I saw fee rates from .02% to .2%. This again seems to be something that I can enroll in when I want, and change how much I'm contributing.
A 457 is a great deal for an early retiree - immediate access to funds upon retirement.

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Everything I've read said to pay off loans first if their interest rates were >5%....
See the 'Investment Order' tab in the CSS mentioned above: it's not ">5%", it's ">5% above the 10 year Treasury rate.  As seattlecyclone notes, it's a close call but you might tilt the scale in favor of the tax-advantaged investments.

Good luck!

clarkai

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Quote
For the 401a, there is no employer match, it's instead a combination of a defined benefit and we're required to put in between 5% and 15% of our income. We are only allowed to pick our percentage once. Because of this, I think it may be best to simply do the 5% minimum so that I can dump more of my money into my loans until they are paid off. Additionally, the paperwork the district provides is incomplete, doesn't talk about fees, and I'm going to have to call them to figure that out, which I will soon.
Yes, need more info on this.

First off, Thanks for the detailed response! I did a bit of digging today and found more information on the 401a funds that I can choose from. That's this page, and if you scroll down, there is a table that shows all the fees (hopefully) for each of my options. Of these, the " U.S. Large Cap Equity Index Fund" has the lowest fee at 0.1163%. It's pdf of info is here: https://docs.retirementpartner.com/fundov/WASH_US_LGCP_EQ_IDX_FD.PDF

I like that it's an index fund; I don't like that I don't know enough about investing to tell if this is a good one or not. Is that a low enough fee that I should max it (theoretically), given that it's tax sheltered? I just keep thinking about Vangaurd at 0.05%, but that's not tax sheltered.

Thank you for helping me out with this!

secondcor521

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Is that a low enough fee that I should max it (theoretically), given that it's tax sheltered? I just keep thinking about Vangaurd at 0.05%, but that's not tax sheltered.

Thank you for helping me out with this!

Yes it is; it's probably a good first choice.  Where you are at, the bigger things to worry about for now are establishing good budgets and spending plans for your immediate bills, then saving as much as you can, then worrying about taxes, then asset allocation.  Fees that are under, say, around 0.25%, should be lower on your priority list for now.

As to your original questions, I would put the minimum of 5% into the required investment - flexibility and security now are more important than optimizing that, and as someone else said you'll have plenty of options for places to save money.

If you have employer matching anywhere, I would invest whatever needed to get that, but then after that I would pay off the loans before investing further.  5.x% after-tax and risk-free is an appealing rate of return.  If your taxes were such that you were able to deduct your SL interest, though, if that dropped your effective rate of return down into the 3.x% range, then that might be something to sway you back the other way.  But I doubt that is the case because with your income your marginal rate isn't going to be that high.

Good luck!

letired

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Quote
We also have a DCP (457 plan), which I ignored at first, because it had a fancy handout, and my instinct is that if someone is trying to sell me something, they're probably making money off of me. Anyway, it's a 457. We again can choose, and I saw fee rates from .02% to .2%. This again seems to be something that I can enroll in when I want, and change how much I'm contributing.
A 457 is a great deal for an early retiree - immediate access to funds upon retirement.

+1 to the 457. It sounds like you should probably be worrying more about the loans right now, but when you are in a position to, take a good look at the 457. They can be AMAZING accounts if you are planning on retiring early. I no longer have access to one, but I coo over the little bit of money I stashed in one whenever I look at it. I can pull that money out without penalty at any time!

SwordGuy

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Surely to Gawd you mean "can only do this one PER YEAR" not "can only do this once."  Please tell me you misunderstood the limitations or I misunderstood you...

clarkai

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Surely to Gawd you mean "can only do this one PER YEAR" not "can only do this once."  Please tell me you misunderstood the limitations or I misunderstood you...

They were quite specific that it was a once and done deal. And told stories of people who's life situations had changed and needed to change their contribution, and couldn't. Direct quote from their handbook: "Once your rate is set, you can change it only when you change employers". And payroll made sure to tell us that "employer" meant "school district". Soooooooo, yeah. Seems super dumb to me, and I see no reason why it should be this way. It's an element of frustration, as you may be able to detect.

clarkai

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Hi,

Am I correct in making the assumption that you fall under TRS plan 3?  This is what I find for Washington state teachers.

If this is accurate than this document applies to you:
http://www.drs.wa.gov/member/handbooks/trs/plan-3/t3hbk.pdf

From the guide here I would not choose the flat 5% option but rather one of the scaling options so you can pay down high interest rate loans now but get to take advantage of the higher contributions later (see page 4 of the linked to PDF and I'd recommend option B or C).

I sure do envy you with the options, once your loans are paid off, to deposit potentially 15% of pay into the 401a, $18000 into the 403b, $18000 into a 457 and $5500 into an IRA!  (not enough envy to become a teacher though :P  ).

You need 10 years of service to lock in your pension at 1% per service year based on the document I linked to.

You're right about the non-flat rates; last year (I moved districts over the summer) I had picked 10%, and I guess I was just discounting them in my head because they are less than I'd like to put. But you're right, for my situation they are a better option than the flat 5%. It's frustrating that they won't let me change options, because I'd really like to just shove 15% in- once the loans are payed off.

I do have a lot of options! Which is great, but also a lot to think about as I'm starting a new job. It's a good problem to have!

I do intend to work for at least 10 years, and I also intend to enjoy my time as a teacher to the fullest.

frugaliknowit

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Re: Retirement vs Loans: Probably a simple question, just want verification.
« Reply #10 on: August 29, 2016, 10:18:31 AM »
My opinion:  Anything with a 4% or greater "hurdle" (as in loan) that does NOT have a match is a no brainer:  Pay off the debt.