Continue contributing to 401k or pay off debts

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chewy8k
Posts: 2
Joined: Tue Aug 13, 2019 11:55 pm

Continue contributing to 401k or pay off debts

Post by chewy8k » Wed Aug 14, 2019 12:00 am

Hi bogleheads first time posting here, just curious if I could get some help/insight on my wife and I financial situation. I’ve been in the workforce 2 years, and her for a little less than a year after graduating with professional degrees. I do not have any student loans and I'm capped at 7% to contribute to my 401k due to being a “high income earner” in my company and there is no match for my 401k. I’ve still opted to contribute the 7%. She has no match currently, but we have opted to contribute the maximum of 19k for the 2019 year, and she will get a 6% match starting November 2019. We plan to continue contributing the maximum for her 401k. My question is should we continue to contribute to our 401k’s or stop and pay extra towards her student loans? Thank you for your time and help bogleheads, please let me know if you guys need any additional information.

Age: both 29

His income: 136k/yr
Her income: 120k/yr

Mortgage: loan amount 382k @4.25% 30 years, home value 487k

Car loan: balance 27k at 520/mo, 3.49% interest

Her Student loan: 200k balance @4.08% 10 year repayment plan = 2117/mo

His 401k through Merrill Lynch: 26k
(70% Global equity index fund, er 0.06%/ 30% us equity index fund (Russell 3000), er 0.30%/ 10% US bond index fund, er 0.02%
Her 401k through Vanguard: 11k
(70% Vanguard core equity fund (S&P 500), er 0.06%/ 20% International equity index fund (FTSE developed all cap ex us index), er 0.10%/ 10% US Bond index fund, er 0.06%

lakpr
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Re: Continue contributing to 401k or pay off debts

Post by lakpr » Wed Aug 14, 2019 4:56 am

With 256k per year income, you are only saving 26k per year even if you max both of your 401k contributions (19k for her, 7k for you being HCE). That's only 10% savings rate.

You should continue this, AND pay down the student loans. There is no reason you cannot do this.

While on the topic of savings, have you thought about the backdoor Roth for each of you? With 256k income, you are firmly beyond the phase out limits for contributing to a Roth IRA directly. However, you can do a 2-step process.

1. Contribute $6k for each of you to a traditional IRA. Note that you are unable to deduct this contribution for your taxes as your income is too high (non-deductible contribution).
2. After the contribution settles (2 days later), call the custodian and convert that contribution to a Roth IRA.
3. File Form 8606 with the IRS at the tax time; you will pay taxes only on the gains between step 1 and step 2.

This would shelter $12k per year into Roth, which over a period of 30 years will grow to nearly $800k on which you will never have to pay taxes again.

Edited to add: both your 401k choices are excellent, continue to contribute to just those funds you have chosen. Once you have "maximized" the 401k contributions and the backdoor Roth IRAs, you should attack the car debt first, then the student loans, and lastly the house debt. For the next few years, at least until the student debt is gone, I would suggest you forget about any taxable account investing.

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Brianmcg321
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Re: Continue contributing to 401k or pay off debts

Post by Brianmcg321 » Wed Aug 14, 2019 7:08 am

With your incomes, you should be able to max out both 401ks, AND, pay off your debt in a reasonable time.

If you wrote down a budget and went on a beans and rice diet, you could easily have this all paid off in less than two years.

HomeStretch
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Re: Continue contributing to 401k or pay off debts

Post by HomeStretch » Wed Aug 14, 2019 7:42 am

Do you have an emergency fund (EF) of at least 6 month expenses in a high yield savings account?

Whether to save less and shift the money to debt repayment is not the key area to focus on. Rather take an in-depth look at your expenses which are high to see where you can cut. You need to spend less, save more and put more towards your debt repayment.

Do you have the ability to Increase income to pay off debt more quickly?

Your spend rate excluding savings (11% of gross income) is about $227k (89%) per year. Debt payments are ~19%, payroll and income taxes probably ~25% and spending on everything else is ~$115k (~45%). Analyze where the $115k is going.

dziuniek
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Location: Corrupticut

Re: Continue contributing to 401k or pay off debts

Post by dziuniek » Wed Aug 14, 2019 8:30 am

Additionally, consider refinancing your mortgage?

I see 3.675% today for a 30yr - that would free up some monthly cash for student loans/investing.

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CyclingDuo
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Re: Continue contributing to 401k or pay off debts

Post by CyclingDuo » Wed Aug 14, 2019 8:32 am

chewy8k wrote:
Wed Aug 14, 2019 12:00 am
Hi bogleheads first time posting here, just curious if I could get some help/insight on my wife and I financial situation. I’ve been in the workforce 2 years, and her for a little less than a year after graduating with professional degrees. I do not have any student loans and I'm capped at 7% to contribute to my 401k due to being a “high income earner” in my company and there is no match for my 401k. I’ve still opted to contribute the 7%. She has no match currently, but we have opted to contribute the maximum of 19k for the 2019 year, and she will get a 6% match starting November 2019. We plan to continue contributing the maximum for her 401k. My question is should we continue to contribute to our 401k’s or stop and pay extra towards her student loans? Thank you for your time and help bogleheads, please let me know if you guys need any additional information.

Age: both 29

His income: 136k/yr
Her income: 120k/yr

Mortgage: loan amount 382k @4.25% 30 years, home value 487k

Car loan: balance 27k at 520/mo, 3.49% interest

Her Student loan: 200k balance @4.08% 10 year repayment plan = 2117/mo

His 401k through Merrill Lynch: 26k
(70% Global equity index fund, er 0.06%/ 30% us equity index fund (Russell 3000), er 0.30%/ 10% US bond index fund, er 0.02%
Her 401k through Vanguard: 11k
(70% Vanguard core equity fund (S&P 500), er 0.06%/ 20% International equity index fund (FTSE developed all cap ex us index), er 0.10%/ 10% US Bond index fund, er 0.06%
$609,000 in debt! :shock:

Stop the 401k (with no match) contributions and throw everything you can at the loans.

The $2637 per month currently going to the auto and student loans is what we would enhance and attack with a vengeance.

Pay off that car loan ASAP with your income level. Then focus on paying off that huge student loan amount. Getting those payments off your chests will free up the current $2637 monthly debt payments going towards them, plus whatever extra you throw at it from your income level.

Once those are paid off, that leaves you with just the mortgage in terms of debt payments and frees you up to go back to the 401k max contributions, non-deductible tIRA ----> Roth conversions, and taxable account investing. You will catch up rather quickly at that point and most likely it could coincide with increasing income levels since you are both just starting out in your positions. Meanwhile, the auto/student loan debts represent an albatross around your necks for reaching financial security.

Cut way back on household/lifestyle spending and knock out the auto/student loan debts in the next 2-3 years with everything you can throw at that debt. Then turn around and leverage your income levels on building your retirement and taxable account investing. Retiring the auto/student debt alone will free up $31,644 per year that you could be throwing at investments.
"Everywhere is within walking distance if you have the time." ~ Steven Wright

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Tamarind
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Re: Continue contributing to 401k or pay off debts

Post by Tamarind » Wed Aug 14, 2019 8:42 am

Welcome! Congratulations on those new high incomes. I bet it feels good to see your hard work in school pay off. :sharebeer

To set yourself up for success with your new combined incomes, you should be saving a minimum of $50k per year together, and I would advise you to save much more. That includes:

Establish an emergency fund with 3-6 months of expenses in a high yield savings account. Try to get to 3 months this year and 6 months by the end of next year.
Max each 401k as allowed by HCE rules: 19k her + 9.5k his
Max two backdoor Roth IRAs: 6k each

You should also have a plan to pay off the student loans and car loan within three years at most. Finish the student loan first since it's at a higher rate.

As you finish each debt, start putting the same amount you were contributing to pay debt into a taxable brokerage account. Right now, in spite of those big paychecks, you two have a negative net worth. But those salaries give you a very large shovel with which to dig yourselves out.

If this feels completely impossible, tell us more about your monthly budget and where your money is going right now.

Topic Author
chewy8k
Posts: 2
Joined: Tue Aug 13, 2019 11:55 pm

Re: Continue contributing to 401k or pay off debts

Post by chewy8k » Wed Aug 14, 2019 12:04 pm

lakpr wrote:
Wed Aug 14, 2019 4:56 am
With 256k per year income, you are only saving 26k per year even if you max both of your 401k contributions (19k for her, 7k for you being HCE). That's only 10% savings rate.

You should continue this, AND pay down the student loans. There is no reason you cannot do this.

While on the topic of savings, have you thought about the backdoor Roth for each of you? With 256k income, you are firmly beyond the phase out limits for contributing to a Roth IRA directly. However, you can do a 2-step process.

1. Contribute $6k for each of you to a traditional IRA. Note that you are unable to deduct this contribution for your taxes as your income is too high (non-deductible contribution).
2. After the contribution settles (2 days later), call the custodian and convert that contribution to a Roth IRA.
3. File Form 8606 with the IRS at the tax time; you will pay taxes only on the gains between step 1 and step 2.

This would shelter $12k per year into Roth, which over a period of 30 years will grow to nearly $800k on which you will never have to pay taxes again.

Edited to add: both your 401k choices are excellent, continue to contribute to just those funds you have chosen. Once you have "maximized" the 401k contributions and the backdoor Roth IRAs, you should attack the car debt first, then the student loans, and lastly the house debt. For the next few years, at least until the student debt is gone, I would suggest you forget about any taxable account investing.
Thank you for the response everyone. Yes we are planning to fund a backdoor roth this year and contribute the maximum. Do you have any recommendations on what fund to invest in a roth ira? I was planning on opening one through vanguard for her since her 401k is already through vanguard, and fidelity or merrill edge for mine.

To answer the question about being able to increase income, our profession is very saturated and difficult to pick up extra hours. I do not see our wages increasing anytime soon in the near future.

As far as an emergency fund we only have 6k in a HYSA as of now as we spent 16k on a rental property investment in South Carolina where my parents live (we live in California) as a 50/50 partner (paid cash for the property) and the property is renting for 650/mo. My plan was to also invest in cash flowing rental properties to provide extra income and diversify.

SheReadsHere719
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Re: Continue contributing to 401k or pay off debts

Post by SheReadsHere719 » Wed Aug 14, 2019 2:57 pm

Welcome to the forum chewy8k. My recommendations below for maximum simplicity and swift debt payoff:

• Since your high incomes are relatively new, sit down and chart out exactly how much $ you have to use towards debt repayment each month
• I would cease her 401k contributions (or drop down to 1%) for August – October, and funnel those funds towards building up an emergency fund with 6-8 months' expenses
• Increase her 401k contributions back to 6% to get the match in November (free money)
• Continue paying off the car loan and/or the student loan. You can likely knock out the car loan quickly, which has a psychological advantage (“debt snowball”). Or, you can tackle the student loans and pay the least amount in interest (“debt avalanche”). You should weigh the pros and cons and decide on a strategy that suits you
• Are the student loans private or federal? If private, have you considered refinancing? There may be lower interest rates available, which would allow you to knock these out even faster
• Once the loans are gone, restart 401k maximum contributions
• After that, then fill up Backdoor IRAs. Fund selection: keep it simple with a 3-fund portfolio or a Target Date Fund
• Only after all steps above are completed would I consider additional rental properties, and only after considerable research and immersion in the topic

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Watty
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Re: Continue contributing to 401k or pay off debts

Post by Watty » Wed Aug 14, 2019 3:33 pm

lakpr wrote:
Wed Aug 14, 2019 4:56 am
You should continue this, AND pay down the student loans. There is no reason you cannot do this.
+1000

In your likely tax brackets maxing out any deductible retirement accounts is a high priority and would not take a real high percentage of your income.

You are only two years out of grad school and you likely lived on a small fraction of your current income then.

You don't need to totally live like a grad student now but compared to that if you live as if you were "just" making $120K a year you can quickly have the car and student loan paid off.

This will also prepare you to live on one income if you need to in case one of you is laid off, or you have kids and need to have a stay at home parent for a while. If you plan on having kids you should be prepared to live on one if you need to since if the kid has even temporary and monir health problems using daycare may not be practicable or possible.

Buying such an expensive car ($35K+ ???) was a mistake when you have a net worth of somewhere around negative $100K.

Having a car loan is sometimes a necessity but you could have gotten a perfectly fine new car for the low $20s. Plan on saving up to pay cash for future cars. Paying something like $35K in cash for a car is painful enough that buying a less expensive car will look a lot better until you have a high net worth.

One thing I have done for years is to keep a simple spreadsheet where I list my assets and debts to calculate my net worth each year on January 1st. That way I can see my progress over the years. I would start doing that now and then update it each year on January 1st.

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9-5 Suited
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Re: Continue contributing to 401k or pay off debts

Post by 9-5 Suited » Wed Aug 14, 2019 3:49 pm

Assuming a 25% effective total tax rate on your $265K gross income, you are earning $192,000 net of taxes. I would do the following with that:

1. Invest ~$38,000 to max out your available retirement account contributions (401K, Backdoor Roth IRA)
2. Invest ~$75,000 to pay down debt
3. Live on ~$79,000, above the average HH income in the US so very achievable without major sacrifice

That way you don't sacrifice any progress on retirement accounts but also become debt free excluding the house in 3 years. Sounds pretty good to me!

cherijoh
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Re: Continue contributing to 401k or pay off debts

Post by cherijoh » Wed Aug 14, 2019 3:50 pm

chewy8k wrote:
Wed Aug 14, 2019 12:04 pm

Thank you for the response everyone. Yes we are planning to fund a backdoor roth this year and contribute the maximum. Do you have any recommendations on what fund to invest in a roth ira? I was planning on opening one through vanguard for her since her 401k is already through vanguard, and fidelity or merrill edge for mine.

To answer the question about being able to increase income, our profession is very saturated and difficult to pick up extra hours. I do not see our wages increasing anytime soon in the near future.

As far as an emergency fund we only have 6k in a HYSA as of now as we spent 16k on a rental property investment in South Carolina where my parents live (we live in California) as a 50/50 partner (paid cash for the property) and the property is renting for 650/mo. My plan was to also invest in cash flowing rental properties to provide extra income and diversify.
You are putting the cart before the horse IMO by putting money into rental properties BEFORE funding your 401ks and paying off debt. That is a perfectly fine idea for an investment after you macx out all tax-advantaged plans and only have your own mortgage to worry about debt-wise. Tax law limits the amount of tax-advantaged space and puts an expiration date on filling it. You will never get it back I you don't max out each year. In calculating rereturns from your rental property you have to account for the opportunity cost of carrying extra debt.

Olemiss540
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Re: Continue contributing to 401k or pay off debts

Post by Olemiss540 » Wed Aug 14, 2019 4:21 pm

Why delay asking this question until after buying a $500k house and signing up for a 520 dollar car payment?

I would have dropped the 100k house downpayment, and 520 car payment on top of the student loan payment, continued to live like a college student for 1 year and cleaned the slate to start your life off debt free and in great position to never have to fight over financial stress.

I would personally stop all retirement contributions except the 6% match if you could payoff the student debt in 2-3 years and could stick to the plan with no further lifestyle creep. In 2 years, focus on supercharging investments with 80-85k per year moving forward to catch back up.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

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grabiner
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Re: Continue contributing to 401k or pay off debts

Post by grabiner » Wed Aug 14, 2019 8:13 pm

While I am generally a strong advocate of paying off loans, your rates are low enough that I would recommend maxing out retirement accounts, and using the rest of your savings to pay off the debts.

The reason is that putting money in the retirement accounts is a permanent benefit. You can earn a bit more by paying off the car than by investing in a low-risk bond fund in your 401(k), but once the car loan is gone, the money in the 401(k) will still be growing tax-deferred, and you won't be able to add your car payments to the 401(k) contribution because of the limits.

One possibility to improve your debt: if you can pay off the car loan, and refinance the mortgage to 15 years, that won't change your cash flow much but will significantly reduce the interest you pay on the mortgage.

Whether you refinance or not, the mortgage should be the last debt you prepay. At the moment, you are probably deducting some of that mortgage interest at 24% (the mortgage interest plus $10K in state and local taxes exceeds the standard deduction, even if you don't donate to charity), so the return on a mortgage prepayment is only 3.21%, and it is a very-long-term return.
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CyclingDuo
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Re: Continue contributing to 401k or pay off debts

Post by CyclingDuo » Wed Aug 14, 2019 8:13 pm

Olemiss540 wrote:
Wed Aug 14, 2019 4:21 pm
Why delay asking this question until after buying a $500k house and signing up for a 520 dollar car payment?

I would have dropped the 100k house downpayment, and 520 car payment on top of the student loan payment, continued to live like a college student for 1 year and cleaned the slate to start your life off debt free and in great position to never have to fight over financial stress.

I would personally stop all retirement contributions except the 6% match if you could payoff the student debt in 2-3 years and could stick to the plan with no further lifestyle creep. In 2 years, focus on supercharging investments with 80-85k per year moving forward to catch back up.
Bingo!!!
"Everywhere is within walking distance if you have the time." ~ Steven Wright

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