Author Topic: Talk me into it (or out of it)  (Read 6943 times)

odput

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Talk me into it (or out of it)
« on: July 30, 2014, 07:49:31 AM »
The fundamental question is "should I cash out my old 401(k) to pay off student loans?"  It would be super nice to not have this payment anymore, but I can't bring myself to actually do it.

I currently have ~$50k in student loans(down from almost $90k, facepunch I now know, but what's done is done and master's degrees are expensive), to which I am paying $1200/month (which is a healthy overpayment) with a plan accelerating principal payments to ultimately have the balance paid in full by the end of 2016.  Taking into account the 10% penalty and 28% taxes, my previous employer 401(k) will pay this balance in full (but that's about it...it will net right around $50k).  Conventional wisdom says "no way, leave the money to grow", and before I found MMM I would have (and incidentally have IRL) followed this to the letter.  Now I am questioning all assumptions, as "conventional wisdom" is for conventional people.  I have been reading and researching on MMM (among others) for nearly 2 years now, so I think we are a bit beyond conventional understanding of finances.  My wife and I have a solid handle on our expenditures, and are fully aware of the spiraling deathtrap of consumerism, and especially consumer debt, so this move will NOT be used for lifestyle inflation, which I believe is the primary reason why the mainstream stuff says to leave it alone.

The $1200/month is a full 25% of our monthly expenditures, so making this payment disappear would instantly double our savings rate.  It would also allow me to restart investing, as it is currently on hold in effort to pay down the SL's (and my new employer doesn't have a 401(k) plan).  My wife's 401(k) won't need to be touched for this, and we have lots of springy debt (available credit lines) and a small cash cushion (~$5k) for emergencies should they arise.

So, mustachians, talk me into it (or not, as the thread title suggests).  Am I too far ingrained in the conventional wisdom?  Or can it be smart for me to take the gains from the recent market run-up, along with the penalty and taxes in order to be free of this anchor and start dollar cost averaging into what could be a coming market correction, or is this me trying to time the market?

Gone Fishing

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Re: Talk me into it (or out of it)
« Reply #1 on: July 30, 2014, 08:00:22 AM »
 A 38% haircut and the inability to ever go back and reap those tax benefits?  My first inclination is, HELL NO! Not to mention the student loan interest is deductable.

What rate are you paying on your student loan? If it is low enough, it might not even make sense to be paying extra on it at all. 

We recently paid off a student loan that was 10 years old.  We never paid any more than the minimum due because the rate was so low, it didn't make sense to pay any more.

« Last Edit: July 30, 2014, 08:02:11 AM by So Close »

odput

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Re: Talk me into it (or out of it)
« Reply #2 on: July 30, 2014, 08:04:28 AM »
About $5k of it is at 2.35% (obviously not overpaying that portion) but the rest of it is at 6.8%

I'm already sick of paying it every month, I couldn't imagine going back to minimum payments and carrying it until 2022

shotgunwilly

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Re: Talk me into it (or out of it)
« Reply #3 on: July 30, 2014, 08:12:06 AM »
Don't do it.

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Re: Talk me into it (or out of it)
« Reply #4 on: July 30, 2014, 08:25:03 AM »
6.8% is probably high enough to justify accelerated payments, but do not fall on your own sword just to make a mistake go away.  Remember that 6.8% is probably closer to 5% when you consider the tax savings.  What you could do, if it is really a monkey on your back, is reduce your 401(k) contributions to the minimum required to get the full match (100% gain), put expenses on lockdown, and put every penny possible towards the big loan. Declare war!  At $1200/mo, I figure you have about 43 months to go, at $1500/mo-33 months, at $2000/mo-25 months, $2500/mo-20 months.   

It will be hard-If it was easy anyone could do it!  Hopefully your degree got you a pretty good job.  Reflect on this often. Hopefully you wll get a raise over the next several years which will help as well.  Focus every decision on increasing your net worth, not decreasing your debt.       

alwayslearning

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Re: Talk me into it (or out of it)
« Reply #5 on: July 30, 2014, 08:33:41 AM »
Are you in public service? Could you qualify for the 10 year loan forgiveness? How close are you to retirement?

6.8% is pretty high. I would consider this a debt emergency and find any extra $ (side job, reducing expenses, tax refunds, etc.) to pay it off. You will feel so much better after they are paid. Believe me, it's possible. My DH and I paid off $150k in student loans and saved thousands in interest.

Use powerpay.org (a free online resource to calculate how much extra payments will save you on your loan).

6.8% is probably high enough to justify accelerated payments, but do not fall on your own sword just to make a mistake go away.  Remember that 6.8% is probably closer to 5% when you consider the tax savings.  What you could do, if it is really a monkey on your back, is reduce your 401(k) contributions to the minimum required to get the full match (100% gain), put expenses on lockdown, and put every penny possible towards the big loan. Declare war!  At $1200/mo, I figure you have about 43 months to go, at $1500/mo-33 months, at $2000/mo-25 months, $2500/mo-20 months.   

It will be hard-If it was easy anyone could do it!  Hopefully your degree got you a pretty good job.  Reflect on this often. Hopefully you wll get a raise over the next several years which will help as well.  Focus every decision on increasing your net worth, not decreasing your debt.       

+1 ^ This is great advice.

Philociraptor

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Re: Talk me into it (or out of it)
« Reply #6 on: July 30, 2014, 08:37:06 AM »
Do NOT cash out that 401k! Taxes will eat you alive, and that money could grow tax free until retirement! Keep it in there. At your tax rate you should also consider maxing out for 401k. That's what we're doing next year. If we both max out our 401k's we can use deductible IRA's and bring ourselves all the way down to the 15% bracket, saving us over $8k in taxes per year, more than we pay on interest on our student loans (~$70k left).

neo von retorch

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Re: Talk me into it (or out of it)
« Reply #7 on: July 30, 2014, 08:42:12 AM »
Assuming you can't deduct the interest payments for some reason, and $1200 is just the 6.8% portion (payment + extra), a $45,000 loan will take you until around February 2018 to pay off, with total interest payments of about $5730. Within 2 years, August 2016, you'd have reduced your balance to about $20,000. I'd love to watch a loan drop $1000+ each month. Maybe look at your net worth over time. Do you use Mint.com?

By February 2018, your 401k might be worth $100-110k. Is that worth giving up to pay off a $45k loan? See we at MMM are "different from the conventional approach" in a variety of ways, and one is that if you keep your expenses low, you'll eventually get that 401k money without paying a lot of taxes. (Even before 59.5, you could do a Roth pipeline conversion, after early retirement, to get the money at a very low tax rate, or pay none at all.)

I used to have thousands of dollars of credit card debt and tens of thousands of automobile debt. It was a little painful, but it sure was nice to watch those balances drop each month! Looking at my net worth over time is one of the things that keeps me relatively "smart" with my money rather than throwing in the towel and making dumb purchases (and money decisions - both of which I still sometimes do, but they don't make me happy!)
« Last Edit: July 30, 2014, 08:45:41 AM by neogodless »

odput

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Re: Talk me into it (or out of it)
« Reply #8 on: July 30, 2014, 08:51:49 AM »
Hopefully your degree got you a pretty good job.  Reflect on this often.

Thanks for that...sometimes I forget that indeed although the loan balance is high, the payoff (salary) is much higher.

Are you in public service? Could you qualify for the 10 year loan forgiveness? How close are you to retirement?

No public service, so no forgiveness.  I just turned 29, although that doesn't strictly speaking answer your other question.  Right now I'm trying to find ways to get the savings rate up, and haven't projected a FIRE date yet.  I just know that my FIRE number is $1.5M (high around these parts I know) and NW just recently crossed $100k, so we've got a way to go yet.

Seems like the sweeping advice is that my inability to pull the trigger is justified...I'll stick to the accelerating plan, and obviously any "extra" money that comes our way will be thrown at it, so it should be gone even before the planned end date of 12/2016.

I have a very complicated net worth spreadsheet that I have been keeping since before I discovered MMM.  While it has been somewhat motivating watching the balances go down constantly, it is also kind of laughing at me that it is still there (and still large)

Gone Fishing

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Re: Talk me into it (or out of it)
« Reply #9 on: July 30, 2014, 09:03:06 AM »


I have a very complicated net worth spreadsheet that I have been keeping since before I discovered MMM.  While it has been somewhat motivating watching the balances go down constantly, it is also kind of laughing at me that it is still there (and still large)
[/quote]

If it is laughing at you it is not helping.  Put a good plan in place for the debt, put it on automatic payment, then forget about it for 6-12 months and focus on another area ripe for improvement (food/utilites/gas ect).  When you come back to it, there will be meaningful progress.  When we were paying off the student loan, I had it on auto-draft and no statements, so all we got was an annual interest statement for our taxes. 

RelaxedGal

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Re: Talk me into it (or out of it)
« Reply #10 on: July 30, 2014, 09:26:10 AM »
The fundamental question is "should I cash out my old 401(k) to pay off student loans?" 
[...]
Taking into account the 10% penalty and 28% taxes, my previous employer 401(k) will pay this balance in full.
[...]
It would also allow me to restart investing, as it is currently on hold in effort to pay down the SL's (and my new employer doesn't have a 401(k) plan). 

Don't do it.  Keep doing what you're doing, pay the 6.8% loan(s) off quickly, but don't lose 38% on the 401K money AND be unable to put money into a new retirement plan.  Math-wise it makes sense to stay the course.   Unless stress over the student loans is causing sleepless nights and health problems, don't do it.   If your well being is on the line it's another issue, but it sounds like you're OK with staying the course so if you have the tenacity, do it.

JCfire

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Re: Talk me into it (or out of it)
« Reply #11 on: July 30, 2014, 09:36:43 AM »
One way to answer this question is this -- how high would the student loan interest rate have to be for it to be worthwhile for you to cash out that 401k to pay it off?

Cashing out the 401k means you pay 38% up front plus 7% annual expected earnings.  Lets say the student loan will otherwise be paid off in one lump sum 10 years from now.  In that case the rate that makes it worthwhile is basically 7% plus 38%/10, so 10.8% (before even considering tax-deductability of student loan interest, if applicable).

If you think you'll be paying off that student loan principal evenly over the next 10 years instead of just one big lump sum at the end of the period, things are much different.  The average amount of time that the principal will be outstanding is just 5 years in that scenario (paying some off this year to average out the tiny bit that's still left over 9 years from now).  So the rate that makes it worthwhile in that scenario is about 7% plus 38%/5, or roughly 15%! 

6.8% is nowhere near the point where you should consider this.

frugaliknowit

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Re: Talk me into it (or out of it)
« Reply #12 on: July 30, 2014, 09:48:24 AM »
NO, NO, NO!  Oh, and NO!  Am I clear on that?  Forget use of capital comparisons.  This is your future.  Target the highest rate first, while paying the minimum on the lower rate loan.

NoraLenderbee

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Re: Talk me into it (or out of it)
« Reply #13 on: July 30, 2014, 09:55:38 AM »
You are doing very well with your debt right now. You only have to keep it up for two more years. Two years is not a lot, though I understand you are sick of making payments. But before you know it, you'll have that loan paid off AND still have you 401k growing. Hang in there!

rocksinmyhead

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Re: Talk me into it (or out of it)
« Reply #14 on: July 30, 2014, 10:10:00 AM »
I know you already accepted this as the answer but DON'T DO IT!!!!!!!!! :)

The $1200/month is a full 25% of our monthly expenditures, so making this payment disappear would instantly double our savings rate. 

personally, I counted my student loan payments as part of my savings rate. you're still increasing your net worth!

also, sorry if you've already seen these threads but I found them SUPER helpful in figuring out the 401k vs. student loan payoff thing (I was in a very similar situation, started with $70k of loans with similar interest rates, also 28% tax bracket):
http://forum.mrmoneymustache.com/ask-a-mustachian/u-s-tax-withholding-questions
http://www.mrmoneymustache.com/forum/welcome-to-the-forum/optimize-your-taxable-income

to quote myself from one thread:
I think this will really help improve my overall savings/discipline. I was getting kinda complacent about my sloppy budget (spend waaaaaayyyy too much going out to the bar, and I really don't need to buy clothes ever anymore at this point, so I should just stop) because I felt so good about my progress on my student loans. hopefully this will psychologically put the pressure on to be able to throw more at those, while I have maxing out the 401k on automatic. wish me luck!!!

not implying you have a sloppy budget by any means, but I personally am more motivated by paying off debt than almost anything else, so maxing out my 401K FIRST really made me put the pressure on to save even more money than before to throw at the debt, if that makes sense. just another angle to consider!

KittyFooFoo

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Re: Talk me into it (or out of it)
« Reply #15 on: July 30, 2014, 10:22:38 AM »
I made some simplifying assumptions to compare your two choices: 1) continue with $1200 payments 2) empty the 401k and put your $1200/mo into cash savings

Basically, assume that all the money you have in the world is this 401k (~$77k, enough to cover $50k after 10% penalty then 28% tax) and the debt, and that your only savings  (the idea is that everything else will remain constant).  I assumed 6.8% on your loans and 7% on investment returns.

Option 1: After 3.5 years, you have 0 debt and $98.5k in your 401k
Option 2: After 3.5 years, you have 0 debt and $56.9k in cash savings from your extra $1200/mo

Emptying your 401k will cost you over $40,000 in the first 3.5 years alone (after which it will CONTINUE to cost you, because you'll still be forfeiting investment gains).

BlueHouse

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Re: Talk me into it (or out of it)
« Reply #16 on: July 30, 2014, 10:41:13 AM »
It would be super nice to not have this payment anymore
+1 for all other posts. 
Isn't it strange, though, that although you're not a conventional consumer anymore, (potential) irrational decisions are still driven by a desire to have something (no debt) before you can really afford it?  Maybe thinking of it that way will make those monthly payments easier to swallow.  Good luck! 


odput

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Re: Talk me into it (or out of it)
« Reply #17 on: July 30, 2014, 10:43:33 AM »
I made some simplifying assumptions to compare your two choices: 1) continue with $1200 payments 2) empty the 401k and put your $1200/mo into cash savings

Basically, assume that all the money you have in the world is this 401k (~$77k, enough to cover $50k after 10% penalty then 28% tax) and the debt, and that your only savings  (the idea is that everything else will remain constant).  I assumed 6.8% on your loans and 7% on investment returns.

Option 1: After 3.5 years, you have 0 debt and $98.5k in your 401k
Option 2: After 3.5 years, you have 0 debt and $56.9k in cash savings from your extra $1200/mo

Emptying your 401k will cost you over $40,000 in the first 3.5 years alone (after which it will CONTINUE to cost you, because you'll still be forfeiting investment gains).

This is a good analysis...I couldn't quite figure out how to quantify it like that.  Thanks!

personally, I counted my student loan payments as part of my savings rate. you're still increasing your net worth!

Interesting...I know I've seen thread titles like "How do you calculate your savings rate" floating around but never much bothered to read them.  Maybe, since I'm more focused on increasing my savings rate at the moment, I should count the principal payment as part of my savings rate?  Or am I just fooling/lying to myself then?

It would be super nice to not have this payment anymore
+1 for all other posts. 
Isn't it strange, though, that although you're not a conventional consumer anymore, (potential) irrational decisions are still driven by a desire to have something (no debt) before you can really afford it?  Maybe thinking of it that way will make those monthly payments easier to swallow.  Good luck! 

That's one hell of a perspective!  I'll have to think on that one for a bit...

Cheddar Stacker

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Re: Talk me into it (or out of it)
« Reply #18 on: July 30, 2014, 11:25:21 AM »
personally, I counted my student loan payments as part of my savings rate. you're still increasing your net worth!

Interesting...I know I've seen thread titles like "How do you calculate your savings rate" floating around but never much bothered to read them.  Maybe, since I'm more focused on increasing my savings rate at the moment, I should count the principal payment as part of my savings rate?  Or am I just fooling/lying to myself then?

Any principal payment on debt should count as savings. It's increasing your net worth right?

Here's a simple way to look at it that I didn't see mentioned yet: 10% penalty > 6.8% interest rate. At your income level/tax bracket you can't deduct SL interest so take that out of the picture completely.

In addition to that, cashing out a 401k not only creates penalties and tax, but it increases your income/AGI and a lot of people either don't realize this, or they forget it. Married filing jointly and 28% bracket equals $150K +. Cashing out an $80K 401k plan might put you into the $250k + range which brings the new 3.8% Medicare tax into play. You also might start being phased out of exemptions and itemized deductions.

This isn't just 28% + 10%, you also need to consider all the ancillary effects.

fallstoclimb

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Re: Talk me into it (or out of it)
« Reply #19 on: July 30, 2014, 12:49:13 PM »
Yeah OP this is a terrible idea.

I get that you're sick of your student loans.  I'm sick of mine too.  I had 70K @ 6.8, now down to 8K, to be paid off in the next 2 months.  I put at least 2K towards the loans every month, which was over a third of my total 'spending'. 

I didn't read all your specifics, if you posted them at all, but can you possibly pay more than $1200 a month?  Maybe ease up on saving to increase overpayments?  100K net worth seems a bit high for someone your age in 50K of debt, are you not focused enough on finishing off these loans that you are so sick of?  Just keep making payments.  The end of 2016 is not that far away. 

I calculate two rates each month - a savings rate and a 'savings' rate that includes my entire loan payment.  Doing that might help you be at peace with the remaining payoff time.

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Re: Talk me into it (or out of it)
« Reply #20 on: July 30, 2014, 01:22:27 PM »
Is this a trick question?   

The only answer is that your hair is on fire so pay off the student loan by eating rice and beans, walking to work and living in a shack.  But do not touch your 401K!   Just make sure your 401 is invested in some good stuff. 

A smart,  hard working cat like you should be able to knock those loans out in less than a year.  Then you will be so accustomed to staching 4K per month, you will continue to do so until in 6-9 years you are FI.   

odput

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Re: Talk me into it (or out of it)
« Reply #21 on: July 30, 2014, 01:43:33 PM »
Man, glad I asked...I would have poured over this for a long time.  I thought I had read somewhere that there are certain very rare circumstances where this makes sense, and was looking if there was some math that could back that up.  Apparently, the math works out to show quite the opposite.  I was weighing the "lump sum with financial penalty" vs the "payment plan with emotional penalty" (longer repayment).  I don't think the emotional drain of continuing on with the plan is worth $40k+

Thanks for all the responses

Lis

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Re: Talk me into it (or out of it)
« Reply #22 on: July 30, 2014, 03:21:47 PM »
Thanks for asking this :) As someone who recently graduated and is watching her 401k grow (yay!) almost to the point that it matches what I owe in SL, the temptation is there! Logically I know it doesn't make sense, but man it would be lovely to be able to save and invest that extra money!

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Re: Talk me into it (or out of it)
« Reply #23 on: July 30, 2014, 03:26:27 PM »
Is this a trick question?   

The only answer is that your hair is on fire so pay off the student loan by eating rice and beans, walking to work and living in a shack.  But do not touch your 401K!   Just make sure your 401 is invested in some good stuff. 

A smart,  hard working cat like you should be able to knock those loans out in less than a year.  Then you will be so accustomed to staching 4K per month, you will continue to do so until in 6-9 years you are FI.

^ That's my vote.