Pay Tuition with Student Loans vs. Retirement Savings

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brau0300
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Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 5:58 pm

Hi there,

I've spent a little time researching my question on google, but I haven't found a satisfactory answer that includes justification for the conclusion.

I'm entering graduate school and I currently have around $30k in Roth IRA retirement savings and $30k in 401k savings (which I currently plan on rolling into a Traditional IRA when I leave my employer and then into my Roth IRA during my second and final year of graduate school when I have no income).

I am debating whether to fund my education with retirement savings or student loans. For my first year I have qualified for ~$16k in subsidized student loans for which the government will pay my interest during my two years of school. After graduation the interest rate for these loans will be ~4% fixed.

Beyond the subsidized loans, I have qualified for some federal unsubsidized Stafford loans which are fixed at 6.8%. It looks like I can get private loans from the college credit union at ~6% variable with no origination/prepay fees.

I will have no other debt when I enter school and I will graduate at the age of 27.

I've been struggling with different ways to think about this.

By taking out student loans, I would preserve the long term compounding on my retirement savings which should hopefully occur at a greater rate than the interest accruing on my student loans (especially when you consider the tax deduction on student loan interest).

However, I am also fond of the idea of graduating with minimal debt and having additional buying power after graduation.

How would you guys approach this problem, and more importantly, why?

I am sort of leaning towards a hybrid approach where I use some of my retirement savings to avoid private variable rate student loans.

Thanks for your advice!

Johm221122
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Johm221122 » Thu May 24, 2012 7:06 pm

My first though was how much of a emergency fund do you have?

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 7:12 pm

I have ~4k in my savings account right now for emergencies.

Johm221122
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Johm221122 » Thu May 24, 2012 7:21 pm

I would hold on to money untili graduate and am fully employed.Then pay high debt quickly from income

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momar
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by momar » Thu May 24, 2012 8:29 pm

How much do you expect to be making when you graduate? Will you be maxing a 401k and an IRA from year 1, and then for the rest of your life? Will you have a spouse and earn enough to max out his/hers too? Would you also be able to pay off your debt quickly? If so, you may prefer to take out loans since you will be space constrained.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

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SpecialK22
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by SpecialK22 » Thu May 24, 2012 8:34 pm

brau0300 wrote: How would you guys approach this problem, and more importantly, why?

I am sort of leaning towards a hybrid approach where I use some of my retirement savings to avoid private variable rate student loans.
I would agree with your hybrid approach of avoiding the 6% private variable loans, but taking out the 4% fixed subsidized loans. Variable at 6% just seems too risky to take on.

Johm221122
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Johm221122 » Thu May 24, 2012 8:50 pm

SpecialK22 wrote:
brau0300 wrote: How would you guys approach this problem, and more importantly, why?

I am sort of leaning towards a hybrid approach where I use some of my retirement savings to avoid private variable rate student loans.
I would agree with your hybrid approach of avoiding the 6% private variable loans, but taking out the 4% fixed subsidized loans. Variable at 6% just seems too risky to take on.
He could always pay debt if he had too,but he can't get money back in emergency.With no job I'd play it safe

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 9:10 pm

momar wrote:How much do you expect to be making when you graduate? Will you be maxing a 401k and an IRA from year 1, and then for the rest of your life? Will you have a spouse and earn enough to max out his/hers too? Would you also be able to pay off your debt quickly? If so, you may prefer to take out loans since you will be space constrained.
I do have a wife and we are thinking about having kids after graduation, but we are willing to wait on purchasing a home. Median income coming out of the program is ~120k, and if my wife can work for a year before starting a family her income will be ~40k. I am confident we can max the retirement savings if we don't have the large student loan debt, but not certain otherwise.

I think I'm a bit reluctant to take out a lot of loans (including the federal) even if it is the correct thing to do strictly "numbers-wise". The idea of having a large student loan debt coming out is a bit scary to me, even if we can afford to pay it relatively quick. I would prefer to re-accumulate retirement savings quickly - but I would like to be able to quantify how much less efficient it is to start from 0 retirement savings after school vs. keeping my $60 retirement savings but picking up $60k in debt (depending on whether my wife is able to find good work while I'm school there may be some additional loans necessary).

I didn't fully understand your space-constrained comment.

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 9:16 pm

Johm221122 wrote:
SpecialK22 wrote:
brau0300 wrote: How would you guys approach this problem, and more importantly, why?

I am sort of leaning towards a hybrid approach where I use some of my retirement savings to avoid private variable rate student loans.
I would agree with your hybrid approach of avoiding the 6% private variable loans, but taking out the 4% fixed subsidized loans. Variable at 6% just seems too risky to take on.
He could always pay debt if he had too,but he can't get money back in emergency.With no job I'd play it safe
Is it really frowned upon to treat a Roth IRA as part of your emergency fund? I mean obviously it's not 100% liquid, but in a true emergency you're not really worried about 30+ years out.

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momar
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by momar » Thu May 24, 2012 9:18 pm

People who earn a lot of money and save a lot are often constrained by how much tax advantaged space they have, right now $22k/year per adult (typically). If you don't plan to contribute 27k or 44k per year, depending on if your wife is working, then you can always "recover" the tax advantaged space you are forgoing.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

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SpecialK22
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by SpecialK22 » Thu May 24, 2012 9:35 pm

Johm221122 wrote: He could always pay debt if he had too,but he can't get money back in emergency.With no job I'd play it safe
Maybe. I certainly agree with you that liquidity is always a concern, but a loan at 6% variable in today's environment is horrid and to be avoided. He would still have a fair amount of liquidity (probably around emergency fund size) if he only takes out the federal loans.

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 9:49 pm

momar wrote:People who earn a lot of money and save a lot are often constrained by how much tax advantaged space they have, right now $22k/year per adult (typically). If you don't plan to contribute 27k or 44k per year, depending on if your wife is working, then you can always "recover" the tax advantaged space you are forgoing.
I'm think I understand, but I'm not 100% certain. Are you saying that if we don't intend on saving 44k a year from graduation until retirement, we can view any difference (44k-what we intend to save) as space for recovering our current retirement savings if I were to spend them on school.

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momar
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by momar » Thu May 24, 2012 9:57 pm

brau0300 wrote:
momar wrote:People who earn a lot of money and save a lot are often constrained by how much tax advantaged space they have, right now $22k/year per adult (typically). If you don't plan to contribute 27k or 44k per year, depending on if your wife is working, then you can always "recover" the tax advantaged space you are forgoing.
I'm think I understand, but I'm not 100% certain. Are you saying that if we don't intend on saving 44k a year from graduation until retirement, we can view any difference (44k-what we intend to save) as space for recovering our current retirement savings if I were to spend them on school.
Yes, exactly. Just direct the money you would have been paying on your loans as additional contributions to these accounts.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Thu May 24, 2012 10:12 pm

momar wrote:
brau0300 wrote:
momar wrote:People who earn a lot of money and save a lot are often constrained by how much tax advantaged space they have, right now $22k/year per adult (typically). If you don't plan to contribute 27k or 44k per year, depending on if your wife is working, then you can always "recover" the tax advantaged space you are forgoing.
I'm think I understand, but I'm not 100% certain. Are you saying that if we don't intend on saving 44k a year from graduation until retirement, we can view any difference (44k-what we intend to save) as space for recovering our current retirement savings if I were to spend them on school.
Yes, exactly. Just direct the money you would have been paying on your loans as additional contributions to these accounts.
Thanks for the advice. Is it then appropriate to assume that if we were diligent in recovering the spent savings we would only be forgoing ~5 years (the recovery period) growth compounded out to retirement age, of course assuming there is growth?

Can this then be viewed as the cost of choosing to pay out of retirement savings vs. taking out loans, or am I missing important details?

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momar
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by momar » Thu May 24, 2012 10:16 pm

brau0300 wrote:
momar wrote:
brau0300 wrote:
momar wrote:People who earn a lot of money and save a lot are often constrained by how much tax advantaged space they have, right now $22k/year per adult (typically). If you don't plan to contribute 27k or 44k per year, depending on if your wife is working, then you can always "recover" the tax advantaged space you are forgoing.
I'm think I understand, but I'm not 100% certain. Are you saying that if we don't intend on saving 44k a year from graduation until retirement, we can view any difference (44k-what we intend to save) as space for recovering our current retirement savings if I were to spend them on school.
Yes, exactly. Just direct the money you would have been paying on your loans as additional contributions to these accounts.
Thanks for the advice. Is it then appropriate to assume that if we were diligent in recovering the spent savings we would only be forgoing ~5 years (the recovery period) growth compounded out to retirement age, of course assuming there is growth?

Can this then be viewed as the cost of choosing to pay out of retirement savings vs. taking out loans, or am I missing important details?
You are only forgoing the difference between the interest paid for the loans and the growth of your savings (plus any taxes/penalties triggered by tapping your accounts). Considering the short time period and current yields, it is very possible that you would come out ahead if you are taking out loans @ 4% and 6.8%.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

Bob's not my name
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Bob's not my name » Fri May 25, 2012 3:32 am

brau0300 wrote:(especially when you consider the tax deduction on student loan interest)
brau0300 wrote:Median income coming out of the program is ~120k, and if my wife can work for a year before starting a family her income will be ~40k.
Student loan interest is deductible only up to $2,500 (or the interest on about $36,000 of debt), and only if your MFJ AGI is under $120,000. Even then, it would cut your effective interest rate from 6.8% to 5.1% if you're in the narrow slice of people who qualify but are in the 25% bracket, or 5.8% if you're in the 15% bracket (which is likely for MFJ grossing $130,000 and maxing two 401k's or grossing $115,000 and maxing one 401k).

Your plan to take advantage of subsidized loans but pass on unsubsidized and private loans is good. I didn't know 4% subsidized loans were available.

You can withdraw from a TIRA penalty-free to pay for school. You say "I'll have no income" in your second year of school, but will your wife? In any case, it's a pity you contributed to a Roth IRA instead of a TIRA (or more traditional 401k) because you are right that those three low income years (two school years straddling three calendar years) provide a low-tax opportunity to convert TIRA to Roth.

brau0300
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by brau0300 » Fri May 25, 2012 9:45 am

Bob's not my name wrote:
brau0300 wrote:(especially when you consider the tax deduction on student loan interest)
brau0300 wrote:Median income coming out of the program is ~120k, and if my wife can work for a year before starting a family her income will be ~40k.
Student loan interest is deductible only up to $2,500 (or the interest on about $36,000 of debt), and only if your MFJ AGI is under $120,000. Even then, it would cut your effective interest rate from 6.8% to 5.1% if you're in the narrow slice of people who qualify but are in the 25% bracket, or 5.8% if you're in the 15% bracket (which is likely for MFJ grossing $130,000 and maxing two 401k's or grossing $115,000 and maxing one 401k).

Your plan to take advantage of subsidized loans but pass on unsubsidized and private loans is good. I didn't know 4% subsidized loans were available.

You can withdraw from a TIRA penalty-free to pay for school. You say "I'll have no income" in your second year of school, but will your wife? In any case, it's a pity you contributed to a Roth IRA instead of a TIRA (or more traditional 401k) because you are right that those three low income years (two school years straddling three calendar years) provide a low-tax opportunity to convert TIRA to Roth.

Thanks for pointing out the limitations of deducting student loan interest. It turns out that for graduate students, Stafford loans always have a 6.8% interest rate, regardless of whether they are subsidized or unsubsidized, not the 3.4% that undergraduate students are eligible for; this is an important detail I had previously missed. Perkins loans (which I have no idea how I was able to qualify for), are fixed at 5% and the government pays the interest while you're in school as well. I must have been delirious yesterday, because I also thought I had read that Perkins loans were fixed at 4%.

In any case, I think I've decided to for sure take all subsidized loans that are offered to me. Assuming Congress doesn't change the rules, as a graduate student I won't be able to qualify for any subsidized loans in my second year. There's still some variability in what type of job my wife will find when we move, but I am leaning toward paying any remaining shortfall out of retirement savings during the first year as opposed to taking out unsubsidized (6.8% fixed)/private loans. It's not certain my retirement savings will beat that 6.8% fixed over the next few years, and I strongly value the flexibility of not *needing* to pay as large of a debt obligation every month after graduation. In the event of an emergency, I should still have some short term savings as well as the ability to use my retirement savings (if I'm in truly dire straights). I know this is less than ideal, but it's a risk I'm comfortable with assuming.

Thanks everyone for your valuable insight, I appreciate it!

Bob's not my name
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Bob's not my name » Fri May 25, 2012 11:57 am

brau0300 wrote:when we move
You might find this useful: http://www.bogleheads.org/forum/viewtop ... =2&t=87683

It's about using a TIRA to travel through time and space.

Pandrew
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Pandrew » Thu Jul 05, 2012 1:17 pm

I am going through this exact same dilemma. My wife will finish school 1 year before me and hopefully be able to find a job for around 40k a year. I will be a year later and hopefully find a job for around 100k. We have only 30k in retirement/investment accounts, and are debating how much of that to use vs taking out loans at 6.8%. It sounds like you have found a pretty good middle ground. I think we will probably keep about half of our savings in reserve and use the other half to minimize the amount of student loan debt we graduate with. Does that make sense, or would we be better off committing to either one or the other? If we went with purely taking out federal loans, we are looking at a total of about 45k in loans when we graduate. Even if we deplete our savings, we will still probably have to take out 10 or 15k in loans...

mlipps
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by mlipps » Thu Jul 05, 2012 4:09 pm

Please note that as of July 1, 2012, there are NO subsidized loans for graduate students. This will probably dramatically change both of your calculations.

Articles here:
http://www.thestreet.com/story/11606057 ... n-end.html

and

http://www.chicagotribune.com/business/ ... 4922.story

Pandrew
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by Pandrew » Thu Jul 05, 2012 9:40 pm

Yep, that was a real kick in the pants. It factored heavily into my decision to not go entirely on loans. That was the original plan... My investments aren't making 6.8% so I don't mind using up a good portion of that money rather than take out loans. Not the best time to be in grad school...

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JupiterJones
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Re: Pay Tuition with Student Loans vs. Retirement Savings

Post by JupiterJones » Fri Jul 06, 2012 10:06 am

brau0300 wrote: I am debating whether to fund my education with retirement savings or student loans.
Another option, of course, would be to wait a bit longer to enter grad school and instead save up the money to pay for some or all of your tuition out-of-pocket.

I'm guessing you're probably not going to like that option. Most people don't. :D But still, it's something to consider (and could even be a third part of your "hybrid" approach).

JJ
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