guitarguy wrote:I just got my annual raise this year, which will take effect on my next paycheck at the end of July (monthly paydates). The raise was 3% and my annual salary is in the low/mid $60k range...so I'll see about $1800/yr and guessing on the math I'll see like $100/m extra after taxes. I'd like to use it to increase savings (or possibly debt reduction) and continue living on my current income figure. My options for allocating it are:
1. Increase 401k savings rate (already at full company match)
2. Save extra after tax and eventually start a second Roth IRA for wife (already maxing 1 Roth)
3. Pay additional extra per month on student loans (low rates from 2.5~3% variable)
Guitar guy, I think you might get different answers.
A lot of people will recommend you attack the debt, especially since the interest rate is variable and because your student loan debt is rather high (approx $41,000). BTW, are you able to deduct from taxes any of your student load payments (see: http://www.getreadyforcollege.org/gpg.cfm?pageid=115
)? If you're above the cutoff, and if you could get below the cutoff by shifting Roth IRA contributions to traditional IRA (if you're below the cutoff) or traditional 401k, there might be some advantage to doing so as it will lower your marginal tax rate.
Anyway, with that level of variable debt, I think you're right on the edge between whether to pay it off or save more in tax-advantaged space.
Personally, I'd rather keep a small to moderate
amount of low-interest
debt on the back-burner and instead put extra money in tax-advantaged savings. Once the year passes (actually, once April of the next year passes), you can never get that money in that precious tax-advantaged space again (I'm echoing what MathWizard wrote). You can probably earn more than 2-3% in a Roth IRA. So, I'd be inclined to pay low-interest debt and invest in IRAs in parallel. I think a lot of Boglehead people here would say "pay the debt first and then invest" but I think there's some motivational aspect to investing and seeing your balances go up. I think that's a personal decision and you have to make the call.
The pay-the-debt-first people will say your priority should be:
1. Contribute to 401k enough to get maximum match
2. Pay down debt
3. Then invest more
They say do #1 because that's free money that you should give away. Well, to me, tax-advantaged savings space is also a valuable thing that you shouldn't give away either. Every year, you can put $17,000 (401k/403b/TSP) + $5,000 (IRA) into tax-advantaged savings (assuming you're within eligibility limits, earning income, under 50 years old, etc.). If you're earning more in the future, you can't go back to the past and put your earnings in for past years when you didn't fill that tax-advantaged space. So take advantage of it every year, in my opinion, before you pay down low-interest
Not to get too academic, but I'd like to see some scenarios of how you'd be better off paying down low-interest debt versus investing (basically, your own personal scenario) to see what's better. Also, since your loans interest rates are variable and not fixed, you should not discount what can/will happen when interest rates inevitably rise. You say you're on course to pay these off within five years, so maybe you'll escape that, but you are taking a bit of a risk. Are there any caps to how much your loans' interest rates can rise?
If you opt for investing over paying down debt, then: Not to throw too much at you, but you might have another option: the deductible Traditional IRA (not Roth IRA) as long as your MAGI is below $92,000 which it might if you're in the 15% tax bracket. Some people would suggest that you might be better off doing more traditional IRA than Roth IRA. It's a tough call. See the links that I posted here (http://www.bogleheads.org/forum/viewtop ... 8#p1431561
) for more perspectives on this.
So, to amend your list, I think the first question is: pay debt or invest (or split the difference). If you decide to invest, then you really have to choose between:
Deductible Traditional IRA (if eligible; see: http://www.moolanomy.com/4172/tradition ... on-limits/
401k - last choice
I'm not sure if you're an automatic choice for Roth IRA. In your profile, there's a case to be made for Traditional IRA as well (if eligible). It might be a coin toss. Read some of those links I posted in the other thread (which I linked to above) and make an informed decision.
Until you're maxing out all tax-advantaged space, I'd fill your 401k last because you have better/cheaper options in an IRA (either Roth or Traditional).