Payoff Student Loans or Save?

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richmondam
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Payoff Student Loans or Save?

Post by richmondam » Tue Oct 24, 2017 10:48 pm

Hi, I have $140K in student loans at 5.25%. I expect to have some free cash flow in the next couple of years, and am trying to decide whether to pay off the debt or save and invest. Investments are with an RIA right now, and current bull market not withstanding I expect to get consistently average market returns over time. Any thoughts would be appreciated - thanks!

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Thanks everyone for the great insight! I'm a newbie here so adding the additional info as requested:

1. Interest on student loans is not deductible for me given income phaseout.
2. Effective tax rate last year was 25%, I expect it to be 33% for 2017. State is 5.75%
3. Free cash flow should be roughly $10K per month.
4. Many have commented on tax deferred plans. I am currently maxing out 401K, HSA, and Roth IRA through the backdoor.
Last edited by richmondam on Wed Oct 25, 2017 8:02 am, edited 1 time in total.

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warowits
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Re: Payoff Student Loans or Save?

Post by warowits » Tue Oct 24, 2017 11:04 pm

richmondam wrote:
Tue Oct 24, 2017 10:48 pm
Hi, I have $140K in student loans at 5.25%. I expect to have some free cash flow in the next couple of years, and am trying to decide whether to pay off the debt or save and invest. Investments are with an RIA right now, and current bull market not withstanding I expect to get consistently average market returns over time. Any thoughts would be appreciated - thanks!
At 5.25% I would pay off the loan. Your effective rate may be lower because of the tax write off, but I would still pay it off. If your income will soon be to the point where you can't invest in a roth IRA later there may be an argument for investing some now while you still can. In general though, pay it off.
There are an army of people whose pay checks depend on convincing people to invest in ways that are against their self interest. This forum is the volunteer army that fights back!

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Watty
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Re: Payoff Student Loans or Save?

Post by Watty » Tue Oct 24, 2017 11:17 pm

There is a wiki on this choice;

/wiki/Paying_ ... _investing

Unless you have some sort of possible loan forgiveness program then it is only a question of when to pay off the student loan not if you should pay it off.

5.25% is not a good rate so I would pay it off. Once it is paid off you can then invest your "loan payment" each month so over time that will tend to even things out with making more investments now.

Rotarman
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Re: Payoff Student Loans or Save?

Post by Rotarman » Wed Oct 25, 2017 6:37 am

I think the answer depends on how likely you are to be able to perform 1099 side work. If you can, you can generally increase your tax deferred contributions by opening a solo 401k and by having high employer contributions. Check out WCI post on the issue and you'll see you can easily get combined IRA,HSA,457 etc >60k of tax advantaged space (which I think most would consider sufficient savings). If you think your earnings will be all W2 and no access to large employer match, 457, CBP, etc then I would strongly consider maxing your available tax deferred space before paying off student loans.

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ruralavalon
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Re: Payoff Student Loans or Save?

Post by ruralavalon » Wed Oct 25, 2017 7:35 am

richmondam wrote:
Tue Oct 24, 2017 10:48 pm
Hi, I have $140K in student loans at 5.25%. I expect to have some free cash flow in the next couple of years, and am trying to decide whether to pay off the debt or save and invest. Investments are with an RIA right now, and current bull market not withstanding I expect to get consistently average market returns over time. Any thoughts would be appreciated - thanks!
About how much extra cash flow annually? What is your tax bracket, both federal and state? Is the interest tax deductible for you? Is any of the student debt to be forgiven?

You can simply add this to your original post using the edit button, it helps a lot if all of your information is in one place.

A possible priority plan could be:
1) If a work-based plan offers an employer match, contribute enough to get the full employer match every year; then
2) part of the extra extra cash flow to pay off the 5.25% student debt, and part to an IRA.
The reasoning is that both employer match and IRA annual contribution limits are on a use-it-or-lose-it basis.

This depends somewhat on the approximate amount of the extra cash flow. Please see the wiki article "prioritizing investments".
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

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BolderBoy
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Re: Payoff Student Loans or Save?

Post by BolderBoy » Wed Oct 25, 2017 9:38 am

richmondam wrote:
Tue Oct 24, 2017 10:48 pm
I am currently maxing out 401K, HSA, and Roth IRA through the backdoor.
Since you are already doing this, I'd pay off the student loan in earnest.
“Where you stand, depends on where you sit” - Rufus Miles | "Never underestimate one's capacity to overestimate one's abilities"

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ruralavalon
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Re: Payoff Student Loans or Save?

Post by ruralavalon » Wed Oct 25, 2017 9:47 am

richmondam wrote:
Tue Oct 24, 2017 10:48 pm
Hi, I have $140K in student loans at 5.25%. I expect to have some free cash flow in the next couple of years, and am trying to decide whether to pay off the debt or save and invest. Investments are with an RIA right now, and current bull market not withstanding I expect to get consistently average market returns over time. Any thoughts would be appreciated - thanks!

-------------------------------------------------------------------------------------

Thanks everyone for the great insight! I'm a newbie here so adding the additional info as requested:

1. Interest on student loans is not deductible for me given income phaseout.
2. Effective tax rate last year was 25%, I expect it to be 33% for 2017. State is 5.75%
3. Free cash flow should be roughly $10K per month.
4. Many have commented on tax deferred plans. I am currently maxing out 401K, HSA, and Roth IRA through the backdoor.
With that additional information, I think it's clear that all extra cash flow should be go to paying off the $140k student debt @ 5.25%.

You are already maxing the tax-advantaged plans. The only alternative to paying off the loans would be taxable investing, which could not predictably give you a 5.25% return on investment.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

bargainhuntingking
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Re: Payoff Student Loans or Save?

Post by bargainhuntingking » Wed Oct 25, 2017 1:37 pm

There is a good Boglehead wiki on this topic that discusses the nuances of this decision:

/wiki/Paying_ ... _investing

I just took some money off the table from the equity run up over the past 8 years and applied it to my existing student loan, which is consolidated at 1.625%. Was it a good financial decision? Probably not at that low interest rate, but I viewed the capital gains as free money and it gives me peace of mind to know that I applied the gains to my only existing debt. If the market crashes next week and my capital gains disappear, at least I realized those gains and put it to good use. That peace of mind trade off is worth it.

Pigs get fat, hogs get slaughtered...

richmondam
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Re: Payoff Student Loans or Save?

Post by richmondam » Wed Oct 25, 2017 10:54 pm

Thanks everyone, this helps a ton. I was leaning toward paying off the loan over the next year or so, and agree that paying off the loan and saving on the additional interest will be a great move.

ZWorkLess
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Re: Payoff Student Loans or Save?

Post by ZWorkLess » Wed Oct 25, 2017 11:11 pm

Absolutely pay off the loans.

THEN, save.

You've got 5.25% guaranteed return on the loans you pay off. You can't beat that anywhere.

No question. Pay off the loans.

Only exception: If your employer offers a "match", then contribute enough to get your match. Then, the rest goes to pay down the loans.

blastoff
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Re: Payoff Student Loans or Save?

Post by blastoff » Thu Oct 26, 2017 8:26 am

If it will only take a couple years to pay off, one could argue to delay an extra 6mo if meant taking advantage of tax free retirement accounts... especially if their limits with be in your way immediately after paying off loans.

But, I agree, at least put the bulk of savings toward loans.

Chadnudj
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Re: Payoff Student Loans or Save?

Post by Chadnudj » Thu Oct 26, 2017 8:53 am

ZWorkLess wrote:
Wed Oct 25, 2017 11:11 pm
Absolutely pay off the loans.

THEN, save.

You've got 5.25% guaranteed return on the loans you pay off. You can't beat that anywhere.

No question. Pay off the loans.

Only exception: If your employer offers a "match", then contribute enough to get your match. Then, the rest goes to pay down the loans.
I'm going to disagree here, slightly. OP said his income is high enough that he doesn't get to deduct student loan interest. If he's in that bracket, he/she probably should be maxing out his/her traditional 401k ($18k now; $18.5k starting 2018) to reduce his/her taxable income (and get the full match, if there is any), and should still do the backdoor Roth IRA ($5.5k) because that's use it or lose it space. And OP should probably build a 3-6 month emergency fund, too.

After OP does that, though, then it makes sense to pay off the loans before investing in taxable accounts.

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ruralavalon
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Re: Payoff Student Loans or Save?

Post by ruralavalon » Thu Oct 26, 2017 9:12 am

Chadnudj wrote:
Thu Oct 26, 2017 8:53 am
ZWorkLess wrote:
Wed Oct 25, 2017 11:11 pm
Absolutely pay off the loans.

THEN, save.

You've got 5.25% guaranteed return on the loans you pay off. You can't beat that anywhere.

No question. Pay off the loans.

Only exception: If your employer offers a "match", then contribute enough to get your match. Then, the rest goes to pay down the loans.
I'm going to disagree here, slightly. OP said his income is high enough that he doesn't get to deduct student loan interest. If he's in that bracket, he/she probably should be maxing out his/her traditional 401k ($18k now; $18.5k starting 2018) to reduce his/her taxable income (and get the full match, if there is any), and should still do the backdoor Roth IRA ($5.5k) because that's use it or lose it space. And OP should probably build a 3-6 month emergency fund, too.

After OP does that, though, then it makes sense to pay off the loans before investing in taxable accounts.
OP already maxes the 401k, HSA and backdoor Roth IRA.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

richmondam
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Re: Payoff Student Loans or Save?

Post by richmondam » Mon Oct 30, 2017 11:59 pm

Something else came to mind that I would like run by you guys. I agree about the need to pay off the loan at 5.25%, but would I be giving up the benefits of compounding even if I made less than that return between my stock and bond allocation?

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