Author Topic: Student Loans vs. 401k for taxes  (Read 4275 times)

khotte

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Student Loans vs. 401k for taxes
« on: December 28, 2013, 07:46:48 AM »
So I want to make sure I'm thinking about this correctly.

Let's say you make $60,000/year. And you have $40,0000 of student loans at 7.3% that you are paying down aggressively. Would it be better to pay off your student loans as quickly as possible, or put money into a 401k so you can get from the 25% tax bracket to the 10% tax bracket?

You'd be saving 10% on your taxes vs. paying off your loans at 7.3% AND also paying taxes at 25%.

Currently, I'm paying off my loans and not putting any money into a 401k (no company match).

Let me know what other info you would need to help me calculate this and let me know if I'm thinking about this in the right way. Thanks!

the fixer

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Re: Student Loans vs. 401k for taxes
« Reply #1 on: December 28, 2013, 09:34:26 AM »
I think you should put as much into the 401k as necessary to ensure your income is low enough that you can take the student loan interest deduction (I don't know the income limit off-hand and it's possible you're already below it). In any case I think it's good to contribute at least some to your 401k because before-inflation stock market returns should return better than 7.3%. It's a good hedge.

Rebecca Stapler

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Re: Student Loans vs. 401k for taxes
« Reply #2 on: December 28, 2013, 09:38:18 AM »
I would put it all into numbers, and the answer will be clearer. What's the dollar amount you'd pay on the loan / contribute to the 401(k)? How old are you? Also remember that $2k of your interest payments are tax-free if your income is low enough. So, putting money into the 401(k) might give you even more tax savings.

khotte

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Re: Student Loans vs. 401k for taxes
« Reply #3 on: December 28, 2013, 10:02:35 AM »
@thefixer: Yes my income is already low enough to qualify for the student loan deduction.
@Rebecca: I'm paying $2500/month on the loans now, but if I didn't, I'd contribute the max to the 401k and use the rest for the loans

Joel

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Re: Student Loans vs. 401k for taxes
« Reply #4 on: December 28, 2013, 12:25:03 PM »
I would have a hard time not taking the guaranteed 7% return on paying down the student loans. You don't avoid taxes altogether by contributing to a 401k, you just defer them.

Lans Holman

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Re: Student Loans vs. 401k for taxes
« Reply #5 on: December 28, 2013, 12:36:39 PM »
Just want to double check and make sure you understand how marginal tax brackets work, because from your first post it's not quite clear.  Assuming you're filing as a single person, that 25% only applies to income over 36,000, after you take out your deductions.  I just want to make sure you're not making the classic blunder of thinking that getting below that line somehow leads to a drastic jump in your total liability.

khotte

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Re: Student Loans vs. 401k for taxes
« Reply #6 on: December 28, 2013, 01:37:00 PM »
@LansHolman: Thanks so much. That's what we were missing. Turns out there's not much savings, just a deferment of the difference in tax brackets. Thanks!

Mazzinator

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Re: Student Loans vs. 401k for taxes
« Reply #7 on: December 28, 2013, 06:29:14 PM »
Maxing out a 401k and possibly tIRA could lower your AGI enough for you to benefit bu putting your loans on IbR plan. Which would lower your payments and save you interest* it's based on location and family size.

Try these calculators to see if it is worth it...

http://www.ibrinfo.org/calculator.php

http://www.aie.org/managing-your-money/finance-tools/daily-interest-calculator.cfm

ETA: Quick math with assumptions, approx numbers/guesstimates...
Maxing out both would drop your agi to 34,500 (includes $2500 interest deduction, 17,500 & 5,500)
Ibr payments would drop to about $220/month (interest is $280/month) saves $60/month
$2500 - 1917 = 583 (extra payment to SL) plus less paid in taxes

*What about interest? In some situations, your reduced payment under IBR may not cover the interest on your loans. If so, the government will pay that interest on your Subsidized Stafford Loans for your first three years in IBR. After three years and for other loan types, the interest will be added to the total amount you owe. While your debt may grow if your affordable payments are low enough, anything you still owe after 25 years of qualifying payments will be forgiven.
« Last Edit: December 28, 2013, 07:35:46 PM by Mazzinator »

ultros1234

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Re: Student Loans vs. 401k for taxes
« Reply #8 on: December 29, 2013, 02:57:26 AM »
I have to respectfully disagree with what seems to be the conventional wisdom here. For the mustachian who will be mostly in a lower tax bracket at retirement, I think the straight numbers will typically dictate that filling up the 401(k) first makes you come out ahead, and paying down the loans faster is buying peace of mind, but isn't strictly the best financial decision.

Think about this: Your loans are at 7.3%, which is about the same as the return you'd expect from a moderately aggressive portfolio. So you should be basically indifferent between investing vs. paying down debt even before considering any tax implications.

And the tax implications of increased 401(k) saving will be significant.

This is what DW and I did this year and will do next year, as we are working to pay off substantial grad school debt at 6.55%: We have contributed to my employer's 403(b) and 457(b) until we get underneath the 25% rate. Since we will certainly retire in the 10 or 15% bracket (if rates remain the same), I figure that we have saved at least 10 cents on every dollar of tax-deferred income.

Quote
Just want to double check and make sure you understand how marginal tax brackets work, because from your first post it's not quite clear.  Assuming you're filing as a single person, that 25% only applies to income over 36,000, after you take out your deductions.  I just want to make sure you're not making the classic blunder of thinking that getting below that line somehow leads to a drastic jump in your total liability.

Not a drastic jump in total liability, but certainly a drastic jump in marginal liability. And if you have any taxable investments, landing in the 15% bracket gives you the advantage of being exempt from capital gains tax. Through some clever use of tax loss/gain harvesting, the typical mustachian should be able to avoid paying capital gains taxes almost entirely through this kind of maneuver. Alas, our 'stache is not big enough yet for this bit to be useful, but I am scheming for the future.

chasesfish

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Re: Student Loans vs. 401k for taxes
« Reply #9 on: December 29, 2013, 04:42:22 AM »
I'm on the side of max the 401k, then throw money at the student loans.  This will get your AGI down to $43,000 or so.

The student loans are a real interest expense and even when its tax deductible, its still painful.  However, if you can avoid paying taxes today to defer that payment 50 years into the future, I think its a better use of money. 

Either way, its better than going and blowing the money on a new car