Author Topic: Reader Case Study - High income & high debt, what to prioritize?  (Read 4059 times)

morningdew

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I'm a long time reader (over a year) and first time poster, so please go easy on me.  :)  Here's my case study with a scary big debt emergency...

Life Situation: Single, no dependents, 31 years old

Gross Salary/Wages: $175,000.00/ year paid biweekly
- Biweekly gross pay: $6,730
- Biweekly net pay: $4,050

Pre-tax deductions:
- Biweekly health insurance: $71
- Biweekly dental insurance: $13
- Biweekly FSA: $19
- Biweekly pre-tax transportation: $35
Total: $103

Annual Taxes (federal, state/ local, FICA, etc.): $66,813

Current expenses:
- Rent: $1810 (HCOL area)
- Utilities: $30
- Groceries: $300
- Restaurants/ Fast Food: $100
- Cell Phone: $42
- Federal Student Loan Payment: $115 (will soon increase to $1322)
- Private Loan A Payment: $85
- Private Loan B& C Payment: $139
- Private Loan D Payment: $81
- Misc.: $300
Total: approx. $3000

Assets:
- Cash: $37,000
- 401k: $8,200
- Roth IRA: $12,000
- Rollover IRA (from old job): $19,000
Total: $76,200

Liabilities:
- Federal Student Loan (Unsubsidized): $79,500 @5.75%
- Federal Student Loan (Subsidized): $42,200 @5.75%
- Private Loan A: $10,800 @3.23%
- Private Loan B: $8,200 @3.73%
- Private Loan C: $8,000 @3.73%
- Private Loan D: $9,100 @3.05%
Total: approx. $158k

Specific Question(s):

I understand I should be prioritizing debt repayment right now, but should I also be investing?  My employer does not offer a 401k match and I have already paid a bunch of the loans down.  I also don't know how long I will stay in this current job, as it is a high burnout job.  I'm doing my best to stay as long as I can, pay off debt, and save.  What recommendations do you have, specifically on the psychological side, on how to pay down the debt without getting super burned out from working so hard just to pay down debt? 

I wouldn't feel comfortable not having a large emergency fund in case I lose my job for whatever reason, so I wouldn't want to just throw my whole cash savings at the debt all at once.  Also, my parents will be needing my help starting in the near future, so I will need to set aside some money for them as well (around $500/ month).  I would like to get a better handle on what steps I should be taking to improve my financial life.  One of my mid to long-term goals is to be able to have the option to do work that is more rewarding and less demanding but doesn't necessarily pay as much, without having to feel unstable financially.

Advice?  Tips?  Am I missing something here?  And anyone in a similar boat and willing to offer moral support?

Thanks all! 

Civex

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #1 on: July 03, 2015, 08:13:00 PM »
Ok, I'm going to take a crack at this. I have a slightly lower gross income, but our household income is a bit above yours and we also carry large student loans.

1. Max out your 401k- generally if you are carrying debt, the advice is to contribute up to the match (which you don't receive) and put the rest towards your debt, but my opinion is that with a large gross income, you will save a large amount on your tax bill by contributing the 18k to the 401k. Which, happily, is barely over 10% of your gross.

2. Max out backdoor Roth IRA. (#1 and #2 are fairly interchangeable)

3. Put the rest of your disposable money towards your two federal loans. A  guaranteed 5.75% return is excellent.

4. Save for house downpayment, or other midterm (5-10 year) goals.

5. Tackle loan remainder.

As to focusing on debt in a high stress job; what works for me is to compare each purchase to the time opportunity cost at my current position. Yes, you are making over $1/minute, so most purchases are trivial, but is X really worth Xtime at your current position. Do make sure you are enjoying life and try to cultivate inexpensive hobbies. Mine are running and cooking. I wouldn't worry too much about minor purchases, but make sure you are making good choices with big picture things; where you live, house you live in, transportation, etc - I wouldn't stress ( and I try not to) on small purchases.

You do have a large emergency fund for a single renter. If you absolutely feel you must carry it, I would think about holding half of it in short duration CDs or bonds or some type of fairly easily accessible investment vehicle. This is just to mitigate the loss of your purchasing power due to inflation. I would consider lowering your emergency fund to $20k- which would cover a 6 month emergency fund and use the remainder to pay down your federal loans. Good luck!

-I totally get the high pressure job, high income, high debt trifecta. I've only been living it a short amount of time, but since I have been able to live very well off <50% of my gross this last year, I have been apply for lower stress jobs in my area. I don't know what kind of pay cut you would take to move to a lower stress position, so its hard to say if it worth it to stick it out for a few years and vanquish your debt, or move into a better position and take extra time repaying your debts. My pay cut is significant (~25%), but will be absolutely worth it.
« Last Edit: July 03, 2015, 08:21:31 PM by Civex »

MDM

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #2 on: July 03, 2015, 08:44:16 PM »
Life Situation: Single, no dependents, 31 years old

Gross Salary/Wages: $175,000.00/ year paid biweekly
Annual Taxes (federal, state/ local, FICA, etc.): $66,813

Advice?  Tips?  Am I missing something here?  And anyone in a similar boat and willing to offer moral support?

morningdew, welcome to the forum.

Unless you are paying ~16% for state/local taxes, that tax number seems high.

Filing Status11=S, 2=MFJ
# of earners1
Total Income$167,412
Std. Deduct.$6,300
# Exempt.1
Exemption$4,000
AGI$167,412
Taxable$157,112
Tax$37,063

Add $7,347 for SS and $2,485 for Medicare and that's only ~$46,900.  Then add state/local.  Note that as state/local gets higher you get to take more in itemized deductions - which is why it takes ~16% to get you up to $66,813/yr....

If you are over-withholding, change your W-4 to something more accurate and put the increased cash flow into the program Civex describes.  Good luck!

morningdew

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #3 on: July 03, 2015, 10:37:23 PM »
Thank you both for your input, Civex and MDM. 

Contributing the max to the 401k is a great idea, as I'll minimize my tax liability and invest at the same time.

What is a backdoor Roth IRA and how does one invest in it?  Is it an alternative to a traditional 401k?  What are the benefits of each?

And to confirm, I basically should not think about investing in real estate/ rental properties until I've paid off my federal loans, right?

MDM

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #4 on: July 03, 2015, 10:44:07 PM »
What is a backdoor Roth IRA and how does one invest in it?  Is it an alternative to a traditional 401k?  What are the benefits of each?
Google "backdoor Roth IRA" - lots of info to read.  Come back with questions if needed.

Quote
And to confirm, I basically should not think about investing in real estate/ rental properties until I've paid off my federal loans, right?
Maybe, maybe not - depends on your risk tolerance and current expertise in valuing real estate / rentals.  If both your risk tolerance and expertise are high you could justify going for a return higher than 5.75%.  Otherwise, take the very decent bird-in-hand return of paying off the high interest loans.

ZiziPB

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #5 on: July 04, 2015, 04:07:39 AM »
Thank you both for your input, Civex and MDM. 

Contributing the max to the 401k is a great idea, as I'll minimize my tax liability and invest at the same time.

What is a backdoor Roth IRA and how does one invest in it?  Is it an alternative to a traditional 401k?  What are the benefits of each?

And to confirm, I basically should not think about investing in real estate/ rental properties until I've paid off my federal loans, right?
Since you have a traditional IRA already (your rollover IRA), backdoor IRA would not work for you. You would have to roll the existing IRA into your 401k, provided your 401k accepts rollovers from IRAs and provided you have some good inexpensive investment choices in your 401k.  Another option would be a mega backdoor Roth if your plan allows after tax contributions and in-service rollovers/withdrawals. But in your case, I would prioritize debt repayment over any complex Roth investment strategies.

If I were you I would max all the tax advantaged investment vehicles you have (the 401k, and see if you can do an HSA) and then throw every spare dollar at the loans.

Monkey Uncle

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #6 on: July 04, 2015, 05:02:56 AM »
Given that you feel like you are burning out, I suggest you start investigating your next position well before you reach the point where you can't take it anymore.  Give yourself time to carefully investigate your options so you can line up something that you can live with and that pays reasonably well.  Think about whether your job change could allow you to relocate to a lower cost of living area such that any pay cut you take would be partially offset by lower housing costs.

little_brown_dog

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #7 on: July 04, 2015, 10:30:27 AM »
if i'm reading this correctly, you have about 12 months of expenses saved (3k/mo X 12 = 36K) in cash. do you need an emergency fund that large? if: 1) the cash is just sitting in a really low interest account, and 2) you feel comfortable with 6 months of emergency expenses, and 3) getting out of debt is your primary financial priority, my recommendation would be to throw 18K of that excess cash towards the debt.

if you go this route, how you use the 18K is up to you. psychologically, it will probably feel pretty great to immediately just pay off 2 of the smaller loans. they will be gone completely, and you'll have 2 fewer bills each month to worry about. this route is not mathematically correct in that it doesn't save you the most money in the long run, but it can be a great motivator as you will see immediate results. financially, it makes most sense to put the 18K toward one of the 5.75% interest rate loans, but you won't get the giddy happiness of immediately destroying a loan.

Civex

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #8 on: July 04, 2015, 11:47:58 AM »

[/quote]
Since you have a traditional IRA already (your rollover IRA), backdoor IRA would not work for you. You would have to roll the existing IRA into your 401k, provided your 401k accepts rollovers from IRAs and provided you have some good inexpensive investment choices in your 401k.  Another option would be a mega backdoor Roth if your plan allows after tax contributions and in-service rollovers/withdrawals. But in your case, I would prioritize debt repayment over any complex Roth investment strategies.

If I were you I would max all the tax advantaged investment vehicles you have (the 401k, and see if you can do an HSA) and then throw every spare dollar at the loans.
[/quote]

I missed the current tIRA- I would consider rolling this into your current 401k if possible (and if it holds decent funds.) This would free up the ability to contribute to a backdoor Roth. Basically you contribute a nondeductible amount to a traditional IRA, and then convert it to a Roth- this allows you to bypass the $115k income limit on Roth contributions. If you can't roll your tIRA into your current 401k, I would consider converting it to a Roth and paying taxes on the $19k (I know less about this, because I have never done it- read up on Bogleheads before completing.) This would allow you access to $5.5k of Roth space that you are otherwise missing.

I respectfully disagree with ZiziPB on not taking advantage of any and all tax advantaged space(specifically the Roth). I would make an effort to fully fund the 401k, backdoor Roth, HSA, and mega Roth if available. This is because you can never go back and maximize this space, and frankly with a 6 figure income there is no reason not to take advantage of these accounts. Backdoor Roths, and the mega Roth really don't take that much extra time. I've spent less than 2 hours(including driving to the post office and mailing rollover checks) on contributing to a mega Roth, and between the backdoor and Mega Roth, I have year to date been able to make over $15k in Roth contributions that would have otherwise been unavailable. Goal is $35k for the year.

I would definitely prioritize the federal loans before any taxable investing, or investment properties. Once the federal loans are payed, whether you focus on the remaining balance or begin outside investments is a personal choice. Completely anecdotal, but I hated being a landlord- the amount of stress it added was not worth the return. For me, I can pick up one or two shifts a month for $1-1.5k (which creates less stress) than having to deal with deadbeat tenants, repairs, and emergency repairs. I'm focusing on minimizing costs, maximizing my investment rates, and lowering stress. To each their own.

Something that hasn't been mentioned, is looking into refinancing your federal rates. SoFi is mentioned frequently, and some private lenders offer decent rates. May be worth looking into.

frugaliknowit

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #9 on: July 04, 2015, 12:02:40 PM »
Since you have an adequate emergency fund and there's no employer match, I would focus on the loans (highest rate first) and forget about any investing until they are all paid off.  In other words, "clean up the mess".

The interest savings are a zero risk return which is great.  Your stress will be reduced as well.

ZiziPB

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #10 on: July 04, 2015, 01:03:58 PM »

Since you have a traditional IRA already (your rollover IRA), backdoor IRA would not work for you. You would have to roll the existing IRA into your 401k, provided your 401k accepts rollovers from IRAs and provided you have some good inexpensive investment choices in your 401k.  Another option would be a mega backdoor Roth if your plan allows after tax contributions and in-service rollovers/withdrawals. But in your case, I would prioritize debt repayment over any complex Roth investment strategies.

If I were you I would max all the tax advantaged investment vehicles you have (the 401k, and see if you can do an HSA) and then throw every spare dollar at the loans.
[/quote]

I missed the current tIRA- I would consider rolling this into your current 401k if possible (and if it holds decent funds.) This would free up the ability to contribute to a backdoor Roth. Basically you contribute a nondeductible amount to a traditional IRA, and then convert it to a Roth- this allows you to bypass the $115k income limit on Roth contributions. If you can't roll your tIRA into your current 401k, I would consider converting it to a Roth and paying taxes on the $19k (I know less about this, because I have never done it- read up on Bogleheads before completing.) This would allow you access to $5.5k of Roth space that you are otherwise missing.

I respectfully disagree with ZiziPB on not taking advantage of any and all tax advantaged space(specifically the Roth). I would make an effort to fully fund the 401k, backdoor Roth, HSA, and mega Roth if available. This is because you can never go back and maximize this space, and frankly with a 6 figure income there is no reason not to take advantage of these accounts. Backdoor Roths, and the mega Roth really don't take that much extra time. I've spent less than 2 hours(including driving to the post office and mailing rollover checks) on contributing to a mega Roth, and between the backdoor and Mega Roth, I have year to date been able to make over $15k in Roth contributions that would have otherwise been unavailable. Goal is $35k for the year.

I would definitely prioritize the federal loans before any taxable investing, or investment properties. Once the federal loans are payed, whether you focus on the remaining balance or begin outside investments is a personal choice. Completely anecdotal, but I hated being a landlord- the amount of stress it added was not worth the return. For me, I can pick up one or two shifts a month for $1-1.5k (which creates less stress) than having to deal with deadbeat tenants, repairs, and emergency repairs. I'm focusing on minimizing costs, maximizing my investment rates, and lowering stress. To each their own.

Something that hasn't been mentioned, is looking into refinancing your federal rates. SoFi is mentioned frequently, and some private lenders offer decent rates. May be worth looking into.
[/quote]
I would normally recommend backdoor or mega backdoor Roth for someone with that level of income, but with over $120k of student loans at almost 6%, I truly think the loans should take priority. As I said, max the 401k and HSA, and then seriously focus on those loans.

PencilThinMustache

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Re: Reader Case Study - High income & high debt, what to prioritize?
« Reply #11 on: July 04, 2015, 01:51:20 PM »
I was in similar position as you.  My approach was to skip the retirement contributions for a year and throw all available money towards student loan debt.  I took the "Dave Ramsey" approach of killing off smaller loans for psychological benefit.  With your relatively thrifty budget, you should have ~75k to throw at your debt this year.  With no match from employer, no ability to deduct the IRA or contribute to Roth IRA, and the risk of investing in equities, I just wouldn't risk it.  As has been said in prior posts, think of money paid towards debt as a guaranteed return on investment equal to the interest rate.  At 5.75%, that's better than my portfolio did last year (considering taxes and expenses).

Now a word about your taxes....WTF?!?  Where do you live?  You need to look hard at your W4 and your recent tax returns.  You're paying 37% of income in taxes and you're only in the 28% bracket.  I would expect your federal taxes to be no higher than 41k, just by back of the napkin calculations with NO deductions whatsoever.  If this isnt an error, you dont need to do much other than MOVE to get a jump start to financial freedom.