Author Topic: Student Debt/WindFall  (Read 2120 times)

bnadz

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Student Debt/WindFall
« on: January 04, 2018, 11:25:56 AM »
Hello Everyone,

First post and I am in need of assistance. I am 28 and just graduated from university in December. Here is a rundown of my federally subsidized loans:

$5,500 @ 4.66%
$5,500 @ 4.29%
$5,500 @ 3.76%

Total $16,500 @ 4.24%

Next, I have a job lined up in August which pays $78,000 pre-tax with a $6,000 signing bonus and I also recently received a windfall of $20,000.

Finally, I have a rolled over retirement account from an internship with roughly $1,500 in it. It seems that fidelity doesn't have any index funds that have a minimum investment of less the $2,500 so it is currently just sitting there gaining no interest.

Now to my question: Should I pay off my student loans right away with the windfall or should I use part of it as my emergency fund and throw the rest into retirement (meet min invested at least) and pay off the rest of the loan over time with the relatively low-interest rate?

I could also use the signing bonus to pay a large chunk of the loans off and then pay the rest back over time.

Thanks for the help!

neophyte

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Re: Student Debt/WindFall
« Reply #1 on: January 04, 2018, 11:45:57 AM »
First of all, are you working at all now/ are your living expenses covered until August?  (If not, get whatever job you can until then.) No sense paying off the student loans if it means you're putting everything on a credit card to survive until August. 

In your situation I'd be tempted to hedge my bets. Put $1000 into the IRA so you can invest it and put the rest somewhere safe until you've been settled into your job for a month or two (or three? 90 probationary period?) just in case things don't wind up working out. Then once you're settled in there, kill the loans over 4%. Personally I'd probably kill the lower interest one too just to have it out of the way, but some people might advise riding that one out. 
« Last Edit: January 04, 2018, 11:48:37 AM by neophyte »

former player

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Re: Student Debt/WindFall
« Reply #2 on: January 04, 2018, 11:54:50 AM »
Hello, and welcome to the Forums and the Way of the Mustache.

I guess my first question would be: what are you doing in the 7 months until you take up your new job (which, congratulations on) and how are you funding whatever it is?  I don't see how to advise you without knowing that.

My second point is that I remember in the great crash of 2008 a number of people had high-paying job offers yanked from under their feet with no notice.  There's no reason to expect that to happen to you, but being of a financially cautious nature if I were you I'd want some money in hand next summer just in case.

Depending on what you are doing until August, I'd be tempted to pay off as much of the student loans as feels comfortable (they aren't going away, and those interest rates aren't too high but are still a drag). 

Once you are in your job, I'd look at setting your retirement contributions to max out your 401k or equivalent by the end of the year (I'm not in the USA: am I right that 401k contributions have to be from earned income?).  Depending on your cash flow until August you could either put money into an IRA now or from your earned income later.

I think there is the ability to roll a retirement account from a previous employment into an IRA, and if I'm right it would be worth your while to get onto that now.

Disclaimer: I'm not in the USA so the details of all this should be verified by someone else.  In general, you should be looking at the investment order thread started by the immensly knowledgeable areblespy

https://forum.mrmoneymustache.com/investor-alley/investment-order/

Good luck!

Imma

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Re: Student Debt/WindFall
« Reply #3 on: January 04, 2018, 12:26:12 PM »
For now, I'd keep as much cash liquid as I could for about a year from now. You have a job lined up in August, but anything could happen in the next 7 months. The new job also might not be what you want it to be, or things don't work out and you lose your job. This time next year you'll be more certain of your future and then you can decide what to do with your loans. I think it's mostly about what you are comfortable with - at this interest rate, investing vs. paying off debt doesn't make much of a difference. If you could refinance these loans to a lower interest %, the answer would be easier.

The only exception I would make is for your retirement account. If that account needs $1000 to start investing with the money instead of letting it sit doing nothing for you, you need to put that additional $1000 in there - unless that's a really bad idea tax-wise, but as I'm not American I can't advise you about that.

bnadz

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Re: Student Debt/WindFall
« Reply #4 on: January 04, 2018, 12:34:53 PM »
Thank you for the responses!

To answer your questions, I currently have enough funds from prior jobs to hold me over (since I am living very frugal) to a full-time construction job I have starting in March which should cover my living expenses and some travel but nothing else until I start my other job in August.

To the point of job security. I will be working as an engineer for a major utility company and it seems they are somewhat immune to what some other risky sectors go through during economic downturns (at least in the engineering department). As always there is some risk but I feel pretty good about the prospects. Since there is some risk, I wouldn't pay off or start to pay off my loans until I have to, which is 6 months after graduation (June).

In terms of setting up my retirement accounts once I start working, I am pretty sure I can fully max out my 401k with 100% of 6% salary match as well as max out an IRA or Roth IRA, I am still slightly confused as to which is better. Is that a wise decision?

Dang, that link has great info thanks!

nereo

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Re: Student Debt/WindFall
« Reply #5 on: January 04, 2018, 01:25:37 PM »
Welcome

+1 for the investment order former player already posted.  Read and understand it.

Money is fungible, so it doesn't matter that this money comes as a windfall instead of from your salary.
Quote
I am pretty sure I can fully max out my 401k with 100% of 6% salary match as well as max out an IRA or Roth IRA, I am still slightly confused as to which is better.

At a minimum you want to invest enough in your 401(k) to get that 100% match.  IRAs (typically) give you more options than your 401(k), so that's why maxing it out is listed before maxing out your 401(k) in the investment order (#4 vs #5).  Generally speaking if you are earning that much you'll want to go with the tradiational IRA. Read this post to understand why: https://www.madfientist.com/traditional-ira-vs-roth-ira/

Finally, understand that you do NOT have $16,500 in SL at 4.24%, but three seperate notes with three separate interest rates.  At those rates I'd consider paying off the 4.66% note only AFTER maxing out my accounts.  I might pay off the middle note if I still had a surplus of cash, and I'd just let that third note ride (pay the minimum).

your priorities are to first establish an ER fund to your satisfaction and standards, then max out your HSA IRA, 401(k). With your bonus and widfall you have about $100k this year so all of those should be achievable.

Laura33

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Re: Student Debt/WindFall
« Reply #6 on: January 04, 2018, 01:32:08 PM »
First, keep enough accessible cash as an emergency fund. 

After that, I am a huge fan of tax-sheltered accounts -- 401(k)s, HSAs, IRAs, etc.  The thing about these accounts is that you have a limited amount of money you can throw at them each year, and if you don't take advantage of that space, you can't make up for it by contributing more in future years.  And I would argue that that tax-advantaged space is the most important early in your career, when your investments will have the most time to grow and turn into lots more money.  This calculus changes if someone has high-interest debts, but that's not you.

So in your specific situation, I would do the following:

1.  Set aside $1-2K from your starting bonus and/or construction job to cover any moving/startup costs and to provide a mini-EF. 
2.  Use any extra construction income/starting bonus/windfall you can spare to begin funding your 2018 IRA.
3.  Begin paying the minimums on your student loans when they come due.
4.  Once you start your new job, set up automatic paycheck withdrawals to get as close as you can to maxing out the 401(k) and HSA (if you have one) in 2018.
5.  Throw any extra cash at your 2018 IRA to try to max that out, too.*

Then beginning in January and for subsequent years, I would:

1.  Adjust your automatic paycheck withdrawals so you max out the 401(k) and HSA over the course of the entire year. 
2.  Set up automatic withdrawals from your bank account to (i) max out your IRA over the course of the year, and (ii) send maybe another $100/mo to the EF (for as many months/years as you need to get it funded to the point you are comfortable with). 
3.  If you still have extra money left over after funding those things and paying your living expenses, throw that extra money at the loans.

There are lots of details that you can dive into if you want -- e.g., maybe this year you want to do a Roth IRA instead of a tIRA, because your income will be significantly lower.  The most important thing is:  don't let the perfect be the enemy of the good.  What is going to make you succeed is putting as much money as possible toward something that will improve your net worth; the decision of what money you put where and when is trivial by comparison.  So despite my obviously correct :-) advice above, you should pick whichever option feels right to you and just go do it -- any of these options will put you far ahead of the vast majority of your peers.

*Note that you actually have until April 2019 to fund your 2018 IRA.  That is why I am listing this below the 401(k)/HSA option on the priority list:  I assume you will be able to fund everything, but you might not be able to do it all at once, as you'll only have 4 months to max out the 401(k) and HSA.  So if you need to prioritize for cashflow reasons, start by maxing those two accounts, because they close off as of 12/31/18, and then finish up the 2018 the IRA in the first part of 2019. 

eliza

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Re: Student Debt/WindFall
« Reply #7 on: January 04, 2018, 01:52:02 PM »
Everything that Laura33 said, with one addition.

Did you have any earned income in 2017 (perhaps from the internship you mentioned or other work)?  If so, I would strongly consider using some of the windfall money to fund a 2017 IRA (up to max if possible) in between steps 1 and 2 of Laura's plan - you have until April 2018 or the date you file taxes to fund 2017 IRA.

 

neil

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Re: Student Debt/WindFall
« Reply #8 on: January 04, 2018, 02:07:03 PM »
I graduated with ~$15K in debt and ~$20K in the bank.  I left the money in the bank for the following reasons:

- No real backup plan (no financial help possible; maybe a couple family members would let me live for cheap but local job prospects not great)
- Get settled in the "real world" first (you're first to go in a downturn until trained, or the job may not be right for you.  Stay mobile if you need to!)
- Kickstart a bit of investment (don't need a lot, but enough that it will start giving you a comfort level with the concept and the market swings)

I was hired FT in Sept and that let me put the max (50% allowed by corp) into my 401K those first few months.  Cash went into Roth.  If you plan to max every year (live like a student!) then you'll get more bang for your buck by loading those up in year 1.

I had my loans on 15 year repayment (and rates were much lower then - 3.5% when savings earned 4-5% and mortgages were 6) but really, after a few years of raises, equity returns and debt repayment, the note becomes peanuts contributing to returns.  I never had real plans for a house and I lean toward simplification and focus and I chose to nuke it after it became a mid-four figure balance.  There's not really a wrong answer because it's not simply a mathematical question. 

Either way, you're off to a huge head start even thinking about it.  You don't need to rush into anything today.  (2017 IRA contributions can be made until April; other decisions can wait until you are settled.)  Time in the market is important, but forty years from now it won't matter significantly to sit still for a bit before jumping in and changing your financial profile.  You can take the time and learn as much as you can now, develop a plan and execute it when the time is ready.

Laura33

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Re: Student Debt/WindFall
« Reply #9 on: January 05, 2018, 07:19:00 AM »
Everything that Laura33 said, with one addition.

Did you have any earned income in 2017 (perhaps from the internship you mentioned or other work)?  If so, I would strongly consider using some of the windfall money to fund a 2017 IRA (up to max if possible) in between steps 1 and 2 of Laura's plan - you have until April 2018 or the date you file taxes to fund 2017 IRA.

Oooooh, excellent catch!!!  Yes, definitely start with that if you can, as that is the shortest window.

GizmoTX

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Re: Student Debt/WindFall
« Reply #10 on: January 05, 2018, 08:47:26 AM »
When you have a 401k, I don't believe you can also take a tax deduction for a traditional IRA, so fund a Roth IRA.
Transfer your rolled over retirement account where you can invest that $1500, such as Schwab Broad Market EFT. Schwab has a great checking account: no fees, no minimums, free checks, mobile deposit, no foreign transaction fees, & refunds all ATM fees anywhere in the world.
Maintain a 6 month emergency fund in an online bank that pays at least 1%, & link it to your checking account. We like Ally, Synchrony, CIT.

nereo

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Re: Student Debt/WindFall
« Reply #11 on: January 05, 2018, 08:56:28 AM »
When you have a 401k, I don't believe you can also take a tax deduction for a traditional IRA, so fund a Roth IRA.
The above is NOT correct.  You can use BOTH a 401(k) and a tIRA to reduce your taxable burden.
In the OP's circumstances s/he appears to be within the limits deducting a tIRA, making that a likely best option.

info here: https://www.irs.gov/retirement-plans/401k-plans
info here: https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras

eta (for clarity): Whether the OP can take advantage of both a tIRA and a 401(k) depends on his/her filing status and AGI.  For 2018 one can get the full deduction with an AGI $101k (married) or $63k (single) with phaseouts of $121k and $73k, respectively.  Beyond those limits a person can still contribute to a tIRA, but not receive deduct that income (still useful if planning a backdoor ROTH or future conversion pipeline).
Overall it is false to say that a person cannot use both a 401(k) and a tIRA
« Last Edit: January 05, 2018, 09:22:00 AM by nereo »

the_fixer

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Re: Student Debt/WindFall
« Reply #12 on: January 06, 2018, 09:38:19 AM »
I think people have covered it pretty well but one thing I will add is to be mindful of lifestyle creep, it is amazing how easy it is to get sucked in when you are suddenly making more money, your loans are paid off and you start to think to yourself that hey I deserve that new car or fancy thing.

Max out your savings and live like a frugal college student, do not even look at your raises as a way to increase spending just put it away and do not get used to living off of it.

I work for a power and generation co-op and you would be surprised at the options you might have available in your 401k / retirement for example I get a pension and 401k with the ability to do a backdoor Roth. Almost no one at the company uses it and they just rely on their pension.

Also do not listen to the 401k provider they will tell you how great you are doing by putting in 10 - 15% because they are used to talking to people that are planning to retire late in life and not used to people looking at early retirement.

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« Last Edit: January 06, 2018, 09:40:15 AM by the_fixer »

Catbert

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Re: Student Debt/WindFall
« Reply #13 on: January 06, 2018, 02:53:02 PM »
Only thing I can add is to check with your new employer to determine whether or not you can start contributing to a 401k immediately.  Some employers have a 6 month or 1 year waiting period.