Roth Contribution or not?

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Roth Contribution or not?

Post by SecretAsianMan » Mon Jul 02, 2007 10:59 pm

I have enough money to make a Roth contribution this year, but I am also starting law school this fall and any money I put in my Roth would force me to borrow that much more money to pay for school. So, in effect, I would be borrowing money to fund my Roth.

I'm wondering if the long-run advantages of having money compounding tax-free in a Roth outweigh the temporary cost of paying 7.5% interest on the student loan for a few years while I'm in school.

Anyone have any comments on the pros and cons of funding my Roth now? Good idea or no?

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Post by PencilWarrior » Mon Jul 02, 2007 11:01 pm

Isn't 7.5% pretty hefty for a student loan? If that's your only option, I would advise against borrowing to invest in the Roth.

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Post by United » Mon Jul 02, 2007 11:10 pm

It depends on when you pay it back and your risk tolerance. Here are some example numbers:

You "borrow" $4,000 at 7.5% interest. Let's assume the stock market returns 7.5% a year and 5 years after taking out the loan you can repay it.

Case A, you borrow:

interest paid over 5 years = 4,000 * (1.075 ^ 5 - 1) = $1742.51
stock gains over 30 years = 4,000 * (1.075 ^ 30 - 1) = $31019.82
net = $29277.32

Case B, you wait:

interest paid over 0 years = 0
stock gains over 25 years = 5,742.51 * (1.075 ^ 25 - 1) = $29277.32
stock gains after taxes = $29277.32 * tax rate
net = much less than 30,000.

Borrowing makes sense mathematically, even assuming low rates of return. The tax-free compounding of an IRA can be worth tens of thousands of dollars in the long run. The interest over 5 years is only $1.7k.

You take a bit of variance for a big tax break. I say it's worth it.

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Post by whitemiata » Tue Jul 03, 2007 7:31 am

Are student loans tax deductible? And would you be able to actually take hte deduction (if you don't itemize then the loan might in effect NOT be tax-deductible for you).

There's another option too (if you will play that game). There are plenty of credit card companies out there that would be more than happy to balance transfer the $4,000 onto one of their teaser products.

Wether you choose a 0% for X months and then transfer the balance again, or you go for one of those 4.99% for the life of the loan deals is up to you.

Do note that many balance transfer offers these days come with minimum finance charges you need to consider. For instance if you can't pay the loan off in a year you might find that a NO-TRANSFER-FEE 4.99 for the life of the loan is much better than a 0% with 3% transfer fee which you might have to transfer again in a year and pay fees once again.

If I were you I'd definitelly work the system and get the best of both worlds.


P.S. The reason the cc companies give these offers is to get you hooked and probably also in hope that you'll pay late thereby triggering monster-charges plus end of the deal - Caveat Emptor.

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Post by White Coat Investor » Tue Jul 03, 2007 8:10 am

I'd make the contribution. You can always withdraw the contribution, and you can even withdraw the earnings penalty free for school, medical problems, or a first house. It's a no-brainer.

Your student loans may be subsidized during school (so effectively 0% for a few years), you may have the opportunity to consolidate them at a ridiculously low 1.9% (that's what it was when I graduated in 2003), and you may make too much money as an attorney to contribute to a Roth for long.

That being said, I wouldn't plan on returns greater than 7.5%. That may or may not happen. But if you are willing to pay some interest to get the money into a Roth account long-term, it may be worth it.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Post by SecretAsianMan » Wed Jul 04, 2007 2:54 pm

Thanks for the comments y'all have left. You've definitely given me some food for thought.
PencilWarrior wrote:Isn't 7.5% pretty hefty for a student loan?
I've been travelling for the last couple months, so I must admit I haven't looked into the loan issue as in-depth as I should have thus far. My understanding, though, is that after Stafford loans, the next best bet are GradPlus loans at 7.5% interest, and that I'll only be able to (hopefully) get lower rates when I consolidate after I graduate. If anybody has any other info. about this, I'd be happy to hear it.

Thanks again for your help...

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Post by Abciximab » Wed Jul 04, 2007 3:13 pm

I was in a similar situation during grad school. I worked during school, but I still had to take out about $100K to cover tution. I maxed out my Roth IRA every year, and I'm glad I did it. I knew I'd be over the Roth contribution limits once I got out of school, so I had to take advantage of the Roth while I still could. If you can get the money to contribute, I think you should.

Also, student loan interest is deductable once you're in repayment, but there's an income cutoff (which I'm sure you'll be over once you graduate). Good luck in school.
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Post by bogglehead » Sat Jul 07, 2007 4:05 pm

I am in the same situation that you're in (starting law school in the fall, have some cash, but need to take out loans) and I think the smartest thing to do it to max out the Roth while we still can now.

I went ahead and maxed out mine as well as one for my wife since as of tax year 2011, we'll be over the income limit and unable to contribute to it any longer. In the long term I think that we'll both be very happy that we borrowed the money to fund the Roth when we get 35+ years of tax-free earnings.

I did the 0% balance transfer on my credit cards, but that game isn't for everyone. If you're a very detail oriented person you can make it work and keep flipping it around (I intend to do this each year until I'm done with school) without missing a beat.

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