To Pay Off Whole Loan Or Slowly Reduce, That Is The Question

[Reece387]

Situation:

• Graduated in April with $8,000 loan debt with an interest rate of 3.4% currently in a 6 month grace period which ends in November. (so thats when interest starts to affect the loans)
• Have a decent job paying $40,000 on salary.
• Currently have around $10,000 in my bank account.
• Have been wanting to invest my money but been hesitant.

Question:

• Should I pay off the loans in its entirety before the grace period ends?

OR

• Pay off loans in small amounts and invest my money elsewhere?

OR

• Do you have any other suggestions which would help me or anyone else in this type of situation?

[Gin1984]

Well first, does your job come with benefits like a 401k? 

[Reece387]

I am eligible to start my 401k in August. I'm still trying to learn about it but it seems like my company matches what I put in.

[Gin1984]

Well personally I'd want to max out my 401k as quickly as I could.  But $18000/5 is $3600 and you gross $3333/month.  But if you could survive on your savings, you'd get pretty damn close.  So, for me, savings would be my top goal, even before debt repayment. Then I would want to have enough to max out my IRA by April (including money from Jan-April). But once you have enough to live on for those five months I'd would start paying it down. 

[Reece387]

I am sure I can live on 10,000 for a whole year. But I don't understand, do you mean that I should invest 100% of my paychecks into the 401k until the end of this year then switch over to an IRA, all while living off of my savings and whatever I don't use from my savings put it into paying the loans?

[innkeeper77]

It's certainly not a bad idea at all, and if you can do it, go for it! Once it becomes January, you would tone down the 401k contributions to max it out over a whole year, sending the rest to an IRA classifying it as 2015 contributions to max out 2015 tax savings. (You can do that in 2016 anytime before tax day) Once you finish that, you would save in the IRA for 2015, max it again, and then pay off your debt. You would then have a ton of savings, be well on your way to paying off the loans, and it would be hard to see this backfiring. If you have extra money in 2016, you can can either pay off debt or save money in taxable investment accounts.

If you run into financial liquidity issues, you can increase your paycheck at any time by decreasing your 401k contributions! Just keep track of how much you have in your bank so you can wait until your next paycheck or two (and make sure you know how long your company takes to adjust 401k withholding, it could take longer than one paycheck in certain companies)

[forummm]

Before you put everything into your 401k, you should determine whether it makes sense to do that. With a $40k salary, and possibly only starting work in April or May, you'll be in the 15% bracket or lower. When did you start your job? If you started May 1, your income would be around $26k. I would definitely put in at least as much as your company will match. If you put in more than $7k or $8k for the rest of the year, you'll be in the 10% bracket. And there's a very good chance that you'll be in the 10% or higher bracket when you pull the money out in retirement. So at that point I would recommend putting $5500 into a Roth IRA (no tax when you pull out the money). I would optimize things this way:
1) Contribute at least as much as your employer will match in the 401k (immediate 100% return!), but no more than a total of $8k for 2015.
2) Contribute $5500 to your Roth IRA (open one at Vanguard)
3) Pay off your student loan with just the minimum payments. That's a pretty low rate, the interest is tax deductible, and you could use some liquidity since you're just starting out.

Then in 2016 you may want to max out your 401k because you'll have a full year to be earning money.

[Reece387]

Why would I not want to go into the 10% tax bracket? Is that bad?

[forummm]

Why would I not want to go into the 10% tax bracket? Is that bad?

The primary advantage to 401ks is that you can avoid paying a higher tax rate now in exchange for paying a lower tax rate later. So if you get into the 10% bracket now and start avoiding the 10% tax rate, there's a decent chance that you would be taxed at a rate higher than 10% when you pull the money out in retirement. I was saying that once you hit the 10% bracket, it was better for you to put the next chunk of dollars into a Roth IRA since that has no tax when you pull it out in retirement. So putting in more than $8k into your 401k isn't necessarily bad, but it could be a suboptimal decision.

[Sibley]

As for the student loan, that interest rate isn't too bad. Make your minimums + some extra to pay it off in a couple years.

And remember, you'll likely get a tax deduction on student loan interest paid.