Roth IRA or Grad School Tuition?

[GlassStash]

My wife is enrolling in graduate school, with a tuition price tag of ~$20k per year for 2 years (i.e. $40k). My job has a 401k w/ no match: 401(k) - $0, with an employer contribution of 6%; Max both Roth IRAs, remainder going to SL debt @ 6.8%.

Question: Is it better to borrow the price of tuition, $40k @ 5.41% Gov't unsubsidized, or dial down the Roth IRA contributions and SL payments to attempt to pay as much of the tuition as possible out of pocket?

Pros to paying out of pocket: $40k less debt taken on, less SL payments to make once wife has a job.

Cons to paying out of pocket: sacrificing $22k of valuable Roth IRA space, skipping 2 years of investing, far less liquid position in case some emergency occurs

To me, it seems like the ability to have cash on hand, max both IRAs, and still pay off our SL debt w/in 5 years of wife graduating would be the best choice. Thoughts? 

[Joel]

At a 5.41% interest rate, that debt begins to be at the level where I do not feel investing is worth the risk. Personally, I would do what I could do avoid taking on debt at that rate. There's plenty of time in your future career to contribute to retirement accounts.

[Argyle]

I agree -- I'd avoid the debt.

I hope your wife is getting a professional degree.  For grad school in academic subjects, the standard advice is never to go unless the school is paying for you.  They don't do that for professional degrees, however. 

[GlassStash]

@ Joel: I thought I would get a response like this, but I wanted to make sure. Does the expected time it would take to pay off the loan change your analysis or no? It seems that a loan pay off period of 20 years would weigh very differently than a pay off period of less than five years. Maybe I am just trying to convince myself...

@Argyle: Her degree is indeed in a professional field. We would never incur such debt for a Master's in Art History (or something similar).

Thank you both for your responses.

[Joel]

Timeline has nothing to do with my opinion. I am looking purely at mathematics and guaranteed returns.

You are getting a guaranteed 5% return by paying for tuition instead of taking on debt. Whereas you are hoping to get a 5% return in your IRA over that time period. It's possible that your IRA will outperform the debt during that time period, but it's also possible that it won't. Personally, 5% is pretty much my threshold where I don't think the risk of investing is worth not paying off the debt.

Time is not a factor. My opinion is purely based on the math. Guaranteed returns vs. risk.

[phred]

Borrow?  With the overall economy still iffy?  No, no, no.  Maybe spend more time seeking fellowships, tuition grants.

Also, you are funding retirement.  What are you doing to fund early retirement?

[GlassStash]

@ Joel: Well said, thanks again.

@phred: I disagree with your premise, as I have a steady job and my wife's field has 100% employment placement. The overall economy is steadily building in the right direction (6.6% unemployment) and I am comfortable with our EF. Once my wife finishes school we anticipate being able to save 50-60% of our take home pay, which will put us in great shape to reach FI.

[GlassStash]

It seems a similar question has been answered on the boglehead forums. Interesting perspectives.

 http://www.bogleheads.org/forum/viewtopic.php?f=2&t=128343&p=1885914

[letro]

Ask the wife to get a graduate teaching or research assistantship which pays tuition and stipend.

[Argyle]

For a professional school the assistantships are typically not offered, and if they are, they will be highly competitive and already offered to the top students.  In my field they are available only to PhD students, not MA students.  Of course she should look out for any opportunities, but my guess is that they are not there.

[GlassStash]

Ask the wife to get a graduate teaching or research assistantship which pays tuition and stipend.

She has applied, we are just waiting for the answer on those. That would obviously make our situation/decision much easier.

[GlassStash]

Upon further review, it seems that duration of loan payment period should be taken into consideration.

Using the compound interest calculator at http://mustachecalc.com I have input 3 scenarios:

1) $40k loan @ 5.41% w/ 10 year pay period = $51,878.82 total amount paid. (11,878.82/40,000 = 29.7% premium paid for the loan)

2) $40k loan @ 5.41% w/ 5 year pay period = $45,743.16 total amount paid. (5,743.16/40,000 = 14.4% premium paid for the loan)

3) $40k loan @ 5.41% w. 1 year pay period = $41,181.83 total amount paid. (1,181.83/40,000 = 3% premium paid for the loan)

As you shorten the time period it takes you to pay off the loan, you (significantly) reduce the total amount you pay for the loan and the premium you pay for the privilege of borrowing the money. With this in mind, isn't it prudent to take into account duration of time paying back the loan? A 9 year difference in such a period, as illustrated above, significantly reduces the % premium one would pay.

(If I am interpreting these numbers wrong or how these loans work, please feel free to call me out. I completely agree with the basic idea that getting a 5.41% return by not taking out the loan is favorable to a possible higher return through investments....but the numbers above make it seem like far less of a ROI savings if the pay period is shorter).

[grantmeaname]

Percentage premium is not a real metric because it ignores the time value of money. A more productive way to think about it is to look at it as a process. Each year, every dollar that you invest instead of paying your loan off, you're getting a highly variable return that averages around 7% and borrowing money at 5.41%; every dollar that you pay down the loan with instead will give you a guaranteed 5.41% return but you'll lose the opportunity cost of the money, which is what you could have done with it otherwise. If you pay it down over five years you're just making the stock market vs. fixed return payoff for a longer time.

[kevins]

Don't forget there is an instant 1% fee on all student loans.  So a $40,000 loan would have a $400 instant fee.

Once your wife is out of school there is a 6 month grace period.  Once that period is over the interest accumulated will be capitalized into the interest.  Now the interest accumulated during school is now having interest accumulating on it.

On my wife's loan of about $30,000 at 6.8% the monthly interest comes to be about $100 a month.  If you do take the loan try to at least pay the interest each month.  It will help you at tax time.  Also try to pay some of the college tuition out of pocket as you can deduct that from your taxes.

I am not sure what type of graduate school it is, but I would try to do everything I could to pay out of pocket knowing how annoying student loans are now.