Debt vs HSA/529

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Chief_Engineer
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Debt vs HSA/529

Post by Chief_Engineer » Wed Aug 09, 2017 7:54 pm

Hello everyone. I have a couple questions about whether it makes sense to reduce debt repayment in order to contribute to our HSA and a 529 plan. Here is our relevant information:

Debt: Student Loans $240k at 5-7%
Tax Filing status: Married Filing Jointly with 2 kids (2 and newborn)
Tax Rate: 25% Federal, 4.33% State
State: Indiana
Age: 29, wife 27

HSA:
My wife's employer contributes $2.5k/year into her HSA. We expect to have another birth in 3 years, but are otherwise healthy and do not expect many medical expenses. The most recent birth was just shy of $7k in out of pocket costs.

529:
We have two young kids (and planning on a third). Our kids will likely receive no need-based aid. And given our experiences with student loan debt, we would like to be able to help our kids pay for college. Now normally I wouldn't think of saving for our kids' education while still paying off our loans. But Indiana offers a 20% tax credit on contributions up to $5k (max credit $1k). To me this sounds like free money akin to a 401k match.

Our current plan is to aggressively pay off the student loans in 4.5 years thanks to having a high income in a LCOL area. However, given the above information, would it make sense to fund the HSA and 529? My thoughts are that the HSA has limited contribution space that we lose if we do not make use of it. Moreover, the benefits of the HSA are significant due to the tax bracket we find ourselves in. However, the employer contribution should be more than enough to cover our costs and perhaps fully fund the birth in 3 years.

As to the 529, it seems like we'd be leaving money on the table if we didn't at least contribute enough to maximize the tax credit.

If we fully fund both, it will delay our loan payoff by 9 months and add ~$5.5k in interest payments. If we only fund the 529, it will add 6 months and ~$4.5k in interest.

I welcome your thoughts and wisdom.

clydewolf
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Re: Debt vs HSA/529

Post by clydewolf » Wed Aug 09, 2017 8:20 pm

One nice thing about the HSA is you can spend that money for qualified expenses at any time, there is no schedule.

Indiana offers a lucrative reward for the 529 contribution. Can your parents/in-laws open a 529 for your children? That would have the college savings available for your children while you are paying down your student loans. But it does not help you with your state income tax.

What are you doing about your retirement savings? You need to take care of that before savings in the 529. Time is on your side now.

Chief_Engineer
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Re: Debt vs HSA/529

Post by Chief_Engineer » Wed Aug 09, 2017 8:29 pm

clydewolf wrote:Can your parents/in-laws open a 529 for your children? That would have the college savings available for your children while you are paying down your student loans. But it does not help you with your state income tax.
This is a possibility, but my parents don't have much money to offer and her parents have 8 grandchildren so far.
clydewolf wrote:What are you doing about your retirement savings? You need to take care of that before savings in the 529. Time is on your side now.
We are contributing enough to get the employer match and my wife has a pension. But we are not contributing anything more than that due to the high interest rates of our loans.

The only reason I'm asking about the 529 right now is because of the very generous tax credit.

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grabiner
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Re: Debt vs HSA/529

Post by grabiner » Thu Aug 10, 2017 11:10 pm

Maxing out the HSA and 529 benefit are good ideas, because of the tax subsidy. The HSA has a 28% subsidy (federal and state tax), and the 529 has a 15% subsidy (state tax, deducted from federal). Both will grow tax-free if used for the correct purposes.

How long will it take to pay off the loans? If you pay 7%, 6%, 5%, and 5% for four years, that's enough of a loss (compared to what you could earn risk-free) that it isn't worth contributing to the 529 this year, unless you can refinance the loans to a lower rate.

I would still recommend maxing out the HSA, both because the subsidy is bigger and because it will be a good emergency fund for the inevitable medical costs that come with three children.
David Grabiner

Chief_Engineer
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Re: Debt vs HSA/529

Post by Chief_Engineer » Fri Aug 11, 2017 6:17 pm

grabiner wrote:How long will it take to pay off the loans? If you pay 7%, 6%, 5%, and 5% for four years, that's enough of a loss (compared to what you could earn risk-free) that it isn't worth contributing to the 529 this year, unless you can refinance the loans to a lower rate.
It will take us 4.5 years to pay off the loans. Contributing to the HSA adds 3 months to the payoff, and the 529 adds 6 months.

I looked into refinancing, but it wasn't going to end up saving much money, especially if there are origination fees.
I would still recommend maxing out the HSA, both because the subsidy is bigger and because it will be a good emergency fund for the inevitable medical costs that come with three children.
This is a good point. I think I will definitely contribute to the HSA since federal, state, and FICA add up to a 37% discount.

As to the 529, since we don't itemize it's a 20% discount. But it has a larger impact on our payoff date. This one seems to be a wash financially. The only thing it gains is time in the market.

aristotelian
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Re: Debt vs HSA/529

Post by aristotelian » Fri Aug 11, 2017 7:29 pm

Do not do the 529 while you have 200k student loan debt with a high interest rate. That is the very definition of robbing Peter to pay Paul, and we do not even know that Paul is going to college.

How can you pay off 200k in 4 years in the 25% tax bracket? Do you have a 60% savings rate? Something in this post isn't adding up.

Chief_Engineer
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Re: Debt vs HSA/529

Post by Chief_Engineer » Fri Aug 11, 2017 7:47 pm

aristotelian wrote:Do not do the 529 while you have 200k student loan debt with a high interest rate. That is the very definition of robbing Peter to pay Paul, and we do not even know that Paul is going to college.
I agree. The only reason I'm asking is if it makes sense due to the 20% tax credit. If it doesn't make sense, that's fine. It's why I'm here asking for advice from people wiser than I am.
How can you pay off 200k in 4 years in the 25% tax bracket? Do you have a 60% savings rate? Something in this post isn't adding up.
We live in a low cost of living area. Our plan is to continue living our grad school lifestyle while we pay off loans. Our total living expenses add up to about $55k. Most of that is child care. After taxes that leaves approximately $60k / year to throw at loans.

kinetic2255
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Re: Debt vs HSA/529

Post by kinetic2255 » Fri Aug 11, 2017 8:46 pm

For what it's worth, we are relatively healthy and have a 1 and 3 year old. We recently went to the doctor for the kids 9 times in the span of two months for a variety of ridiculous things. We joked with the pediatrician about calling protective services. I have yet to not spend the full deductible since we've had kids. Our plan (subject to change) is to work on our retirement funds first and then work on the 529s. My suggestion would be to pay down the loans at those interest rates.

aristotelian
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Re: Debt vs HSA/529

Post by aristotelian » Fri Aug 11, 2017 10:04 pm

Chief_Engineer wrote:
aristotelian wrote:Do not do the 529 while you have 200k student loan debt with a high interest rate. That is the very definition of robbing Peter to pay Paul, and we do not even know that Paul is going to college.
I agree. The only reason I'm asking is if it makes sense due to the 20% tax credit. If it doesn't make sense, that's fine. It's why I'm here asking for advice from people wiser than I am.
You would be saving $1K at the cost of $5k. You aren't getting the $5k back, you are spending it on your kids while you have $240k debt. I would keep the $5k.

Finance-MD
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Re: Debt vs HSA/529

Post by Finance-MD » Sat Aug 12, 2017 12:31 am

Have you looked into student loan refinancing options with sofi? Earnest? Citizens?
You should definitely be able to get your rate down substantially, especially if willing to take on a short term (be careful with the high minimum payments).

I've used all of the above companies and got rates at around 5.25% for 20-year fixed loans in the past year... I would have had much lower on a 5 year, especially with a variable rate loan.

Unless student loan refinancing has changed - there are ZERO origination fees. I've done about 8 (?) loan refinances and have never paid a penny.
You can refinance as often as you like.

Do you have a good credit score?

Chief_Engineer
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Re: Debt vs HSA/529

Post by Chief_Engineer » Thu Aug 17, 2017 9:06 am

Finance-MD wrote:
Sat Aug 12, 2017 12:31 am
Have you looked into student loan refinancing options with sofi? Earnest? Citizens?
You should definitely be able to get your rate down substantially, especially if willing to take on a short term (be careful with the high minimum payments).
I looked into SoFi and DRB. I got a preliminary offer (they didn't do a hard pull) of about 5% fixed for a 7 year term, I think. The bulk of my loans are federal loans at 5-6.8%. I'm hesitant to refinance for that small of a rate reduction, especially since I'd lose the federal repayment options should we experience financial difficulties. The short term also concerns me since the higher minimum payments may remove flexibility.

I haven't looked into refinancing my wife's loans because she is in human services and we live in the state that is ranked 50th in pay for her field :oops:(though I must say she has fantastic benefits). However, she only has one large private loan at 8% and the rest around 6% or less.

Perhaps my thinking on this is wrong, but it just didn't seem worth it to me since the high interest loans, which would benefit the most from refinancing, will be paid off first. The numbers seem to indicate little benefit (since we are already planning on rapid repayment), but potential downsides (loss of federal payment plants, forbearance, etc).
Do you have a good credit score?
I don't know my FICO, but I have no bad history and Credit Karma estimates I'm in the high 600s.

Finance-MD
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Re: Debt vs HSA/529

Post by Finance-MD » Thu Aug 17, 2017 1:12 pm

Chief_Engineer wrote:
Thu Aug 17, 2017 9:06 am
Finance-MD wrote:
Sat Aug 12, 2017 12:31 am
Have you looked into student loan refinancing options with sofi? Earnest? Citizens?
You should definitely be able to get your rate down substantially, especially if willing to take on a short term (be careful with the high minimum payments).
I looked into SoFi and DRB. I got a preliminary offer (they didn't do a hard pull) of about 5% fixed for a 7 year term, I think. The bulk of my loans are federal loans at 5-6.8%. I'm hesitant to refinance for that small of a rate reduction, especially since I'd lose the federal repayment options should we experience financial difficulties. The short term also concerns me since the higher minimum payments may remove flexibility.

I haven't looked into refinancing my wife's loans because she is in human services and we live in the state that is ranked 50th in pay for her field :oops:(though I must say she has fantastic benefits). However, she only has one large private loan at 8% and the rest around 6% or less.

Perhaps my thinking on this is wrong, but it just didn't seem worth it to me since the high interest loans, which would benefit the most from refinancing, will be paid off first. The numbers seem to indicate little benefit (since we are already planning on rapid repayment), but potential downsides (loss of federal payment plants, forbearance, etc).
Do you have a good credit score?
I don't know my FICO, but I have no bad history and Credit Karma estimates I'm in the high 600s.

Do you consider a reduction from 6.8% to 5% to be a "small" interest rate reduction?
Did you get a quote on a 20 year term?
federal repayment options are great to have...
you should look in detail in the options with loan refinancing because they often have financial hardship options as well.
how big is your emergency fund?
if you run into financial difficulties, does your EF take care of loan payments as well?

can she refinance the 8% private loan?

can you list the terms on each individual private loan (balance, interest rate, etc.) --- doing so would help provide more useful commentary.

it sounds like your mind is made up though --

Chief_Engineer
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Re: Debt vs HSA/529

Post by Chief_Engineer » Fri Aug 18, 2017 7:58 am

Finance-MD wrote:
Thu Aug 17, 2017 1:12 pm
Do you consider a reduction from 6.8% to 5% to be a "small" interest rate reduction?
Did you get a quote on a 20 year term?
federal repayment options are great to have...
you should look in detail in the options with loan refinancing because they often have financial hardship options as well.
how big is your emergency fund?
if you run into financial difficulties, does your EF take care of loan payments as well?

can she refinance the 8% private loan?

can you list the terms on each individual private loan (balance, interest rate, etc.) --- doing so would help provide more useful commentary.

it sounds like your mind is made up though --
His:
Private - $10k @ 9% var - 20 year
Private - $10k @ 6.7% var - 20 year
Private - $2.5k @ 3.9% var - 20 year
Federal - $57.5k @ 6.8% fixed - 10 year
Federal - $18.5k @ 6.21% fixed - 10 year
Federal - $17.5k @ 5.84% fixed - 10 year
Federal - $800 @ 5.6% fixed - 10 year
Federal - $16.5k @ 5.31% fixed - 10 year
Federal - $2.5k @ 4.5% fixed - 10 year

Hers:
Private - $6k @ 9.75% var - 15 year
Private - $25.5k @ 8.25% var - 15 year
Private - $17.5k @ 4.75% var - 6 year
Federal - $12.5k @ 6.8% fixed - 10 year
Federal - $3k @ 6% fixed - 10 year
Federal - $15k @ 5.84% fixed - 10 year
Federal - $4k @ 5.6% fixed - 10 year
Federal - $5k @ 5.31% fixed - 10 year
Federal - $5k @ 4.5% fixed - 10 year
Federal - $5k @ 3.4% fixed - 10 year

Based on a pre-approval quote from SoFi I can refinance at 5.125% fixed on a 15 year term. This would move up our payoff date from 61 months to 60 months and save $6k in interest payments over the 5 years.

My wife's income is too low to refinance, but I haven't looked into whether I can co-sign for a refinance. Assuming that we could get a similar rate to refinance her high interest private loans, it would save an additional $1k in interest over 5 years. However the payoff date would be the same at 60 months. Adding in her federal loans as well would save $200 more in interest.

At a minimum, I think it is worth it to refinance the variable rate private loans. In the past year alone my wife's private loans have gone up by 0.75% points.

Finance-MD
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Re: Debt vs HSA/529

Post by Finance-MD » Fri Aug 18, 2017 12:17 pm

Chief_Engineer wrote:
Fri Aug 18, 2017 7:58 am
Finance-MD wrote:
Thu Aug 17, 2017 1:12 pm
Do you consider a reduction from 6.8% to 5% to be a "small" interest rate reduction?
Did you get a quote on a 20 year term?
federal repayment options are great to have...
you should look in detail in the options with loan refinancing because they often have financial hardship options as well.
how big is your emergency fund?

Based on a pre-approval quote from SoFi I can refinance at 5.125% fixed on a 15 year term.
Again - did you get a quote on a 20 year term? the interest rate may be very similar

This would move up our payoff date from 61 months to 60 months and save $6k in interest payments over the 5 years.
Are you just focusing on the amount of interest you're paying or are you thinking of your money globally -- the 529 tax deduction saves you a much bigger percentage than the interest; calculate how much money you lose in taxes if you pay the inerest; 10 years from now it won't matter if you paid off your loan in 60 or 61 months, but the money in your 529 and your total net worth may be significantly different

My wife's income is too low to refinance, but I haven't looked into whether I can co-sign for a refinance.
yes - you should try to, especially for the high interest private loans

Assuming that we could get a similar rate to refinance her high interest private loans, it would save an additional $1k in interest over 5 years. However the payoff date would be the same at 60 months. Adding in her federal loans as well would save $200 more in interest.

At a minimum, I think it is worth it to refinance the variable rate private loans. In the past year alone my wife's private loans have gone up by 0.75% points.

If you want to maximize your tax deductions, you have to prioritize your goals. You are at the 25% tax bracket and are eligible for a 20% tax CREDIT on a 529. Your student loan interest may or may not be deductible - i'm not sure where your MAGI is for this deduction. But mathematically speaking, let's rank the best return on your money

(1) 401k up to the match (25% federal + 4.3% state + 100% match)
(2) 529 Tax CREDIT of 20% up to $5000 contribution, max $1000 (20% credit / 25% federal rate = 80% tax deduction ignoring the state tax deduction; this is huge)
(3) HSA (25% federal + 4.3 % state + 6.2% SS + 1.45% medicare; assuming comes out of paycheck)
(4) if MAGI is >$130k, continue 401k and pretax IRA (if eligible) to decrease MAGI to $130k to make sure you max out your student loan interest deduction
(5) 401k and pretax IRA (if eligible) while you are in the 25% federal bracket

all of these above are much higher than your interest rates on loans, especially if they are tax deductible.
(yes, we are gambling on your tax rate at withdrawal, but let's assume you are unlikely to have a marginal tax rate >25% at retirement).

1st, I'd minimize all student loan cash flow expense (minimum payments) as much as possible and meet all those minimums.
- see below for how i would do this.
Then, I'd hit goals #1-#3 and make sure they get done every year
Then I'd choose #4 & #5, but depending on your debt aversion skip to next


After you hit those goals, any extra cash flow, I would "debt snowball" (lowest balance first) or "debt avalanche" (highest interest first) or fill up 401k if not already done

Note - you have the 10 year standard repayment options on your federal loans - you should be able to extend these out longer (e.g. 20 years) without affecting your interest rate at all... there is no reason to have a shorter period with the same interest rate unless you need it to force yourself to pay it down; but you are already committed to paying off faster; so you should do this in the most mathematically beneficial order (e.g. by interest rate, debt avalanche) or by balance (lowest first) to maximize cash flow (debt snowball)

His:
Private - $10k @ 9% var - 20 year - Refinance Sofi 15 year 5.15%, or 20 year if similar interest rate
Private - $10k @ 6.7% var - 20 year - Refinance Sofi 15 year 5.15%, or 20 year if similar interest rate
Private - $2.5k @ 3.9% var - 20 year leave this here, tiny balance, low rate wipe away in a single swoop at some point if interest rate goes up above 5% or if you just want it gone
Federal - $57.5k @ 6.8% fixed - 10 year - Refinance Sofi 15 year 5.15%, or 20 year if similar interest rate
Federal - $18.5k @ 6.21% fixed - 10 year - Refinance Sofi or Change to Federal Extended Repayment
Federal - $17.5k @ 5.84% fixed - 10 year - Refinance Sofi or Change to Federal Extended Repayment
Federal - $800 @ 5.6% fixed - 10 year - Refinance Sofi or Change to Federal Extended Repayment
Federal - $16.5k @ 5.31% fixed - 10 year - Refinance Sofi or Change to Federal Extended Repayment
Federal - $2.5k @ 4.5% fixed - 10 year Change to Federal Extended Repayment

Hers:
Private - $6k @ 9.75% var - 15 year Try to Refi
Private - $25.5k @ 8.25% var - 15 year Try to Refi
Private - $17.5k @ 4.75% var - 6 year Try to Refi; will likely be at 5.15% soon anyhow
Federal - $12.5k @ 6.8% fixed - 10 year - Try to Refi or Change to Federal Extended Repayment
Federal - $3k @ 6% fixed - 10 year - Try to Refi or Change to Federal Extended Repayment
Federal - $15k @ 5.84% fixed - 10 year - Try to Refi or Change to Federal Extended Repayment
Federal - $4k @ 5.6% fixed - 10 year - Try to Refi or Change to Federal Extended Repayment
Federal - $5k @ 5.31% fixed - 10 year - Try to Refi or Change to Federal Extended Repayment
Federal - $5k @ 4.5% fixed - 10 year Change to Federal Extended Repayment
Federal - $5k @ 3.4% fixed - 10 year Change to Federal Extended Repayment


So in summary - what i would do in practice;
1. get all the loans to the lowest minimum interest rates possible over the longest period. This will maximize your cash flow.
Each month, make minimum payments on loans, then take extra cash flow and
(1) fill up 401k match, 529, and HSA
Once these are done; stop contributions to these, and put all extra into
(2) 401k or pretax IRA or extra payments to student loans

If you are unable to refi your wife's loans, starting with the private ones at 8.25% and 9.75%
after that, you may just want to start doing debt snowballs and crossing off one loan after another.

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