Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

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BogleCPA
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Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby BogleCPA » Mon Jun 19, 2017 11:00 am

Hi everyone,

New to the forum, just wanted to reach out to get some quick advice.

My question centers around my student loans, and my attempt to weigh paying off my student loans quickly against ramping up my retirement. My wife and I are recently married and just bought our first home, so I feel like I'm at a point where I finally have that first big wave of big expenses behind me (engagement ring, wedding/honeymoon, down payment on first house) and now I want to make sure I am allocating my money appropriately between student loans, retirement, and building back up our cash/emergency fund after the aforementioned recent expenses:

I'll provide some background and details below, but the basic idea is that combined we are currently saving about $800/month to our emergency fund, paying $1,000/month to student loans, and saving $875/month for retirement, and we are unsure if we should reallocate these funds based on our situation:

-His age 27, her age 26
-His salary: $70K (plus approx 10% annual bonus)
-Her salary: $47K
-Emergency fund: balance is currently $15K (as mentioned above, this is lower than usual b/c we recently paid several big expenses related to the wedding and our first home). To build this back up we are adding about $800/month to it currently, so at our current pace we would get it up to around $35K or so in 2 years and then stop these savings and allocate the money elsewhere (student loans or retirement)
-His retirement - balance is $15K - currently contributing $500/month to 401(k)
-Her retirement - balance is $12K - currently contributing $375/month combined to employer's pension and Roth IRA
-Her student loans - she is a state teacher so we are under the plan where she pays an income-based amount ($200 currently) for 10 years and then receives forgiveness for the remainder of her outstanding loan balance.
-His student loans - balance is $42K. Currently paying about $800/month towards it to pay it down as quick as possible. This is where my biggest question(s) pops up. FYI out of the $42K total for my loans, $38K of it is at 6.8%, $2K is at 4.5% and $2K is at 3.4% (so almost all at 6.8%). Couple questions I would love advice on:

1) My loans are currently federal loans which give me the flexibility to be on an income-based repayment plan, so because of this my "required" payments are only $274/month. This eases my mind a bit because I know if emergencies ever pop up, I always have the ability to pay way less than I'm capable of in a given month. However, in a typical month I pay this $274 minimum across all my loans and then throw every remaining dollar I can afford that month towards the loan(s) with the highest interest rate (6.8%). This strategy allowed me to already pay off a loan I used to have that was at 7.9% (!) and now I've made my way down to targeting the 6.8% ones.

However, my thought is that I could probably save a lot of money by refinancing to private loans at much lower interest rates since my income is fairly stable and I work in a field where my salary is growing rather steadily ($52K my first year, up to currently $70K in my 4th year, and will be around $100K by my 8th year if I remain in this role). What are the pros/cons of refinancing and do you agree it would make sense for me, since my interest rates are so high (basically the whole balance is at 6.8%)? How much does it typically cost to refinance student loans and what type of rates could I be looking at after the refinance?

2) In general, how much should I be focused on paying off these student loans compared to saving for retirement? With the loans currently at 6.8% I feel like targeting the loans is a good idea because even the expected rate of return from investments in stocks is barely above that, and the payments towards student loans are a "guaranteed return" of 6.8% on the debt I'm eliminating. But, kind of related to question #1, if I am able to refinance and get the rate down to 3% or something, at that point I would lean more towards wanting to throw more money at my retirement and less towards the loan.

I'd be very grateful for any tips/advice you all are willing to give.

hightower
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby hightower » Mon Jun 19, 2017 11:11 am

Why do you need a 35k emergency fund? How much are your monthly expenses? Unless you're living way above your means, 15k is plenty for an emergency fund at this stage.
If I were you, I would start dumping as much money as possible into your 6.8% student loans and get rid of them asap. While you're doing this make sure you are contributing just enough to your 401k to get your employer match. As soon as the 6.8% loans are gone, you can ease up on the loan repayment a little and start contributing more to your retirement accounts.

Another acceptable option would be to refinance to a much lower rate (less than 4% preferably). The refinance shouldn't cost you anything. It's just a matter of finding a lender and qualifying. Check out www.whitecoatinvestor.com for a list of student loan refinancing companies. If you are able to get them refinanced then you can start focusing more heavily on saving more and just make minimum payments on the loans. Fortunately your loan balance isn't that big for your income.

Good luck and good job on saving so far.

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Meg77
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby Meg77 » Mon Jun 19, 2017 11:22 am

I think you guys are doing a great job, so kudos to being off to a wonderful start financially!

It's hard to feel like you're making much progress when you are splitting your attention and dollars among multiple goals. Personally, I would advocate for the following strategy:

1. Lower/Raise your 401k contributions until you are contributing just enough to get the employer matches.

2. Stop contributing to your emergency fund for now. $15K is a very respectable amount to have in there that will cover all manner of home and car emergencies, and if one of you were to get laid off there would be unemployment insurance, possible severance, the ability to cut all saving and some expenses, the ability to tap Roth IRA tax and penalty free, and also the ability to borrow on credit cards (absolute worst case) at a lower interest rate than you're paying on your student loan. People really overestimate the amount they need sitting around in checking doing nothing, especially if your income is stable.

3. Deplete your emergency fund enough to max out 2 Roth IRAs for 2017 (you have until April 2018 to do this so put it on the backburner for now if you want - but do it). Roth contributions can be taken out tax and penalty free so it can operate as an emergency fund. You can even keep the funds in a money market instead of invest them if it makes you feel better until you get your actual EF back up. But get the money IN while you can - you can only do $5500 per person per year.

4. Chunk all available excess cash flow at the most expensive student loan. Make sure the servicer is allocating extra payments toward principal reduction, NOT TOWARD PREPAYING FUTURE PAYMENTS. Typically they'll tell you you're paid up through some future month in time, but that is NOT what you want - that doesn't reduce your interest, it just allows you to prepay it (you'd be better off not even making extra payments if that's the case).

5. Consider reducing your EF to $2500 or $5000 and putting that extra $10K or so against the expensive loan to wipe it out even faster. This is temporary! Once it's gone you can rebuild cash.


Now, if you can refinance and get a lower rate, do it! Even if you have to take a variable rate, you can have this knocked out quickly enough to justify that. But a guaranteed 6.8% after tax return is pretty hard to beat, even after accounting for the tax benefits of retirement contributions. So I'm all for making wiping that out a top priority. And I don't know that you'll find much success with refinancing at a lower rate - unless you have a graduate degree, in which case drbank and sofi might be good options for you.
"An investment in knowledge pays the best interest." - Benjamin Franklin

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Pajamas
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby Pajamas » Mon Jun 19, 2017 11:37 am

Agree with both of the responses above. Refinance and pay off the student loans that are not forgivable as quickly as possible as you don't have a cash flow problem that would make the higher rates in exchange for lower payments worth it. Pay the loans with the highest rate first (as you have been doing) if you don't or can't refinance. Delaying unmatched contributions to tax-advantaged accounts would be worth it.

Also would add that you might shift your focus from saving specifically for retirement to the larger aim of achieving financial independence, basically the ability to retire (stop working) if you want to and to be open to opportunities when they arise. There may also be other specific goals that you save for such as college for future children or buying a house. Think of retirement accounts as tax-advantaged accounts for long-term investments instead of as "retirement" accounts.

Don't count your future salary chickens until they hatch. Plan for those salary increases you expect, but also plan for not receiving them or changing or losing a job.

MoonOrb
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby MoonOrb » Mon Jun 19, 2017 11:47 am

I'd defer the decision until you know whether you can refi the loans at a much better interest rate. My answer is a lot different if you're paying 4% on these loans instead of 6.8%.

I agree with no further e-fund growth unless there are circumstances you haven't set out in your post.

Tax advantaged space is precious and you can't get it back when gone, so if it's a close call between paying down the loans and funding your tax advantaged accounts, I'd fund those accounts first. But you won't know whether it's a close call until you see if you can refinance. I think there's a bit of a knee jerk reaction to seeing the high interest rate; but you can probably avoid paying that rate simply by refinancing.

BogleCPA
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby BogleCPA » Mon Jun 19, 2017 11:50 am

hightower wrote:Why do you need a 35k emergency fund? How much are your monthly expenses? Unless you're living way above your means, 15k is plenty for an emergency fund at this stage.
If I were you, I would start dumping as much money as possible into your 6.8% student loans and get rid of them asap. While you're doing this make sure you are contributing just enough to your 401k to get your employer match. As soon as the 6.8% loans are gone, you can ease up on the loan repayment a little and start contributing more to your retirement accounts.

Another acceptable option would be to refinance to a much lower rate (less than 4% preferably). The refinance shouldn't cost you anything. It's just a matter of finding a lender and qualifying. Check out http://www.whitecoatinvestor.com for a list of student loan refinancing companies. If you are able to get them refinanced then you can start focusing more heavily on saving more and just make minimum payments on the loans. Fortunately your loan balance isn't that big for your income.

Good luck and good job on saving so far.


Good point, now that I think about it I guess a $35K emergency fund isn't quite necessary. I've probably just gotten used to seeing more money in that savings account because it used to have the money we used for our downpayment in it. I guess as first time homeowners I'm just wanting to make sure we have plenty in there to cover any unexpected repairs. The emergency fund, to me, is in place mainly for unexpected expenses - I have almost zero worry about either of us losing our jobs for any period of time.

My employer's 401(k) match is pretty weak, but they match 25% of all contributions up to 6% of my salary. So if I give 6%, they'll bump it up to 7.5%. Currently I've been saving more like 11% in order to get my $500 per month. But yeah, definitely worth considering reducing my 401(k) contribution to be 6%, pocketing the rest, and putting it towards my student loans.

Thanks for the link about the student loan refinance. I'll give that a look.

BogleCPA
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby BogleCPA » Mon Jun 19, 2017 11:58 am

Meg77 wrote:
3. Deplete your emergency fund enough to max out 2 Roth IRAs for 2017 (you have until April 2018 to do this so put it on the backburner for now if you want - but do it). Roth contributions can be taken out tax and penalty free so it can operate as an emergency fund. You can even keep the funds in a money market instead of invest them if it makes you feel better until you get your actual EF back up. But get the money IN while you can - you can only do $5500 per person per year.

Now, if you can refinance and get a lower rate, do it! Even if you have to take a variable rate, you can have this knocked out quickly enough to justify that. But a guaranteed 6.8% after tax return is pretty hard to beat, even after accounting for the tax benefits of retirement contributions. So I'm all for making wiping that out a top priority. And I don't know that you'll find much success with refinancing at a lower rate - unless you have a graduate degree, in which case drbank and sofi might be good options for you.


Great suggestion on the ROTH IRA's. As I said in my OP, I am new to this forum and still learning about all the different tools/vehicles, and I was not aware that you can take out Roth contributions tax and penalty free (i.e. operate it as an emergency fund, as you said). Seems like a no brainer to use the Roth IRAs (rather than a savings account) as our emergency funds.

As for the student loan refinance, I do have a graduate degree so I will definitely look into drbank and sofi to see what type of rate I'm able to get! Thanks for your response.

mortfree
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby mortfree » Mon Jun 19, 2017 12:12 pm

I would pay off the two $2k student loans first - math aside, really no reason to have these low balances when you have 35k in savings.

kid(s) in future?

If so, I wouldn't go too crazy depleting that 35k in savings. Sometimes putting 5k blocks on debt helps to minimize the shock of a lower savings balance and also allows for you to be prepared in case life happens.

I might not even consider reducing the 401k - you have 800/month left over. contribute 150-300 of that to a Roth (or whatever you're comfortable with).

See how much you can stretch your dollars by spreading them around.

The one thing you don't get back with retirement contributions is time - that is if you don't contribute you have missed out on that chance for a given year. The max is 18k to 401k and 5500 to individual Roth for a reason; you will need to save close to that for a good retirement.

BogleCPA
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby BogleCPA » Mon Jun 19, 2017 12:33 pm

mortfree wrote:I would pay off the two $2k student loans first - math aside, really no reason to have these low balances when you have 35k in savings.

kid(s) in future?

If so, I wouldn't go too crazy depleting that 35k in savings. Sometimes putting 5k blocks on debt helps to minimize the shock of a lower savings balance and also allows for you to be prepared in case life happens.

I might not even consider reducing the 401k - you have 800/month left over. contribute 150-300 of that to a Roth (or whatever you're comfortable with).

See how much you can stretch your dollars by spreading them around.

The one thing you don't get back with retirement contributions is time - that is if you don't contribute you have missed out on that chance for a given year. The max is 18k to 401k and 5500 to individual Roth for a reason; you will need to save close to that for a good retirement.


I know that personal finance is a mixture of math and what makes you feel good emotionally, but for me personally those two small balance loans with the low interest rates aren't adding any additional stress to my life. It's only $4K in low interest rate student loans, compared to $38K in higher interest rate student loans, so if I had $4K to put towards the loans I'd make the math decision (i.e. put it towards the higher interest rates) rather than the emotional decision (taking the lower interest rate debt to zero).

I am definitely going to consider rethinking my strategy related to my emergency fund though. If I keep the emergency at $15K, that opens up an additional $800/month that I've currently been adding to this fund to go towards either retirement or student loans. My gut instinct is to put the additional dollars towards the student loans, but that's part of why I started this thread was to float that idea to others. There's no way I can max out my 401(k) quite yet though. That'd be $1,500/month, and I'm currently only doing $500/month and I already feel like I'm maybe a little too heavy in putting my money towards retirement, relative to student loans.

JGoneRiding
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby JGoneRiding » Mon Jun 19, 2017 12:52 pm

Having 3 loans for federal are you eligible for a federal consolidation? I might start there as you keep the flexibility you mentioned but also could lower rate. Otherwise I would look into private refi and like Meg said I would stop futter contributions to ef (though maybe not deplet it) until big loan is paid

hightower
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Re: Mid/Late 20's - Student Loan Paydown vs Saving for Retirement

Postby hightower » Mon Jun 19, 2017 8:05 pm

BogleCPA wrote:
hightower wrote:Why do you need a 35k emergency fund? How much are your monthly expenses? Unless you're living way above your means, 15k is plenty for an emergency fund at this stage.
If I were you, I would start dumping as much money as possible into your 6.8% student loans and get rid of them asap. While you're doing this make sure you are contributing just enough to your 401k to get your employer match. As soon as the 6.8% loans are gone, you can ease up on the loan repayment a little and start contributing more to your retirement accounts.

Another acceptable option would be to refinance to a much lower rate (less than 4% preferably). The refinance shouldn't cost you anything. It's just a matter of finding a lender and qualifying. Check out http://www.whitecoatinvestor.com for a list of student loan refinancing companies. If you are able to get them refinanced then you can start focusing more heavily on saving more and just make minimum payments on the loans. Fortunately your loan balance isn't that big for your income.

Good luck and good job on saving so far.


Good point, now that I think about it I guess a $35K emergency fund isn't quite necessary. I've probably just gotten used to seeing more money in that savings account because it used to have the money we used for our downpayment in it. I guess as first time homeowners I'm just wanting to make sure we have plenty in there to cover any unexpected repairs. The emergency fund, to me, is in place mainly for unexpected expenses - I have almost zero worry about either of us losing our jobs for any period of time.

My employer's 401(k) match is pretty weak, but they match 25% of all contributions up to 6% of my salary. So if I give 6%, they'll bump it up to 7.5%. Currently I've been saving more like 11% in order to get my $500 per month. But yeah, definitely worth considering reducing my 401(k) contribution to be 6%, pocketing the rest, and putting it towards my student loans.

Thanks for the link about the student loan refinance. I'll give that a look.


From a "seasoned" home owner I can promise you that 15k will be plenty to cover anything your house may require.


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