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Old 08-05-2010, 04:01 PM   #21
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I'm not really sure about the IRA issue. I imagine you will earn too much to be eligible to contribute to a traditional IRA. For a Roth, you will likely be at a lower tax bracket when you ER versus today (correct me if I'm wrong there). So you may be able to "save" on taxes, or at least break even on taxes by buying tax efficient index funds in a taxable account later (and pay down debt now) versus investing in a roth now and extending the term of the loan.

It's only $5000 a year, so not a huge deal in the grand scheme of things. If it was me, I would probably skip the Roth and prepay the student loans to guarantee myself an 8% tax free return on the money now.

The dollar amounts are probably big enough here that you may be best served by putting together a spreadsheet to investigate your different alternatives and see if there is much difference between your alternatives.
Check your language

anyone can contribute to a traditional IRA if they have earned income in that tax year. Whether a person can DEDUCT that contribution on their tax return is what get phased out with income.

The Roth contributions phase out at about the same incomes as the tax deduction on a traditional IIRC, but that does not prevent contributing after tax to the traditional.

This means if you put $5000 into a traditional IRA and it grows to $6000, you have $5000 which is withdrawn tax free and $1000 which is taxed at withdraw. Keep good records to show this.
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Old 08-05-2010, 04:44 PM   #22
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Check your language

anyone can contribute to a traditional IRA if they have earned income in that tax year. Whether a person can DEDUCT that contribution on their tax return is what get phased out with income.

The Roth contributions phase out at about the same incomes as the tax deduction on a traditional IIRC, but that does not prevent contributing after tax to the traditional.

This means if you put $5000 into a traditional IRA and it grows to $6000, you have $5000 which is withdrawn tax free and $1000 which is taxed at withdraw. Keep good records to show this.
Yes, your distinction is correct but your statement regarding the income limits for Trad IRA deductibility phaseouts is wrong.

There is a distinction between eligibility to CONTRIBUTE and eligibility to DEDUCT traditional IRA contributions. You can contribute to the limits when you have earned income. Deductibility is fully allowed for MAGI's of $56000 and phases out at MAGI's above that up to $66000, where no deductibility is allowed. These thresholds apply to taxpayers who have 401k's available to them from their employer and are single.

For the same taxpayer, MAGI's up to $105,000 allow the full $5000 contribution to a Roth, and that contribution limit phases out to zero at MAGI's of $120,000.

Based on the OP's stated facts I assumed that he would fall above the income limits for DEDUCTIBILITY but below the income limits for Roth contributions. I imagine there are cases where one may want to contribute to non-deductible IRA's instead of Roth's, but my imagination can't produce any examples right now. Assuming the OP is eligible for Roths I would recommend that over a non-deductible IRA contribution. Heck for the OP I would be tempted to recommend regular taxable investments in tax efficient index ETFs or the like versus non-deductible IRA's, if anything to simplify paperwork and tax record keeping requirements. But you would also be paying only cap gain rates (on the actual gains) when you sell your taxable investments versus ordinary income rates on the withdrawal of the growth of your trad IRA contributions. And you can sell your taxable holdings in a tax savvy manner by selling the highest cost basis shares first - not an option with non-ded. trad IRA withdrawals IIRC. My thinking was why would anyone forgo a Roth in favor of a non-deductible traditional, even though the tax laws technically allow it. I think it would be crazy for anyone in that $66000-$105000 MAGI bracket.

I guess I should have phrased my post more clearly! And see disclaimer below of course.
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Old 08-05-2010, 07:06 PM   #23
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Congratulations to the OP for planning to max 401K before s/he even has one to max!

Lots of great advice here, but I didn't see anything about amassing an emergency fund. Is that because the OP lives with parents and presumably does not need one?

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Old 08-05-2010, 08:03 PM   #24
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Understanding the 401k match would be helpful- I realize it fluctuates, but if you put in $15,500, would you possibly get a match of $7750?

Once that is maxed, you have more than enough to put some into an IRA and some into a taxable account and some to debt paydown.

If you are eligible for a Roth, that money grows tax free and is withdraw tax free- both are good things
If you put money into a traditional IRA, you can convert it to a Roth later (your income might exempt you from Roth)
If your only monies outside a 401k are in taxable accounts, you cannot convert that money to a Roth later unless you have earned income in the year you choose to "convert" and these would be contributions (not a conversion), so while capital gains rates look attractive now, in 30 years about 7 Presidents and there administrations will have changed the taxes on taxable investments. Why take that risk- use an IRA.

The 401(k) match is discretionary, but I've been told it has historically been from 60-80%. I was under the impression that it was dollar-for-dollar, but it may be less. I will find out some more details pretty soon, but fully intend to participate when I'm eligable in October.
Great point on the IRA. I will likely not be phased out for the ROTH this year because I am only receiving 8-months of income. As a single filer, the phase out occurs from $106,000-$121,000 MAGI. It is likely that my bonuses will phase me out next year.
I believe that traditional IRAs can be rolled over into Roth IRAs regardless of income, after 2010. (source, Roth IRA - Wikipedia, the free encyclopedia)


EDIT: redudandant after reading p.2 posts.
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Old 08-05-2010, 08:30 PM   #25
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Congratulations to the OP for planning to max 401K before s/he even has one to max!

Lots of great advice here, but I didn't see anything about amassing an emergency fund. Is that because the OP lives with parents and presumably does not need one?

Amethyst
i thought of it, but what are his expenses? when your living with the rents and have very little responsibility, you can shoot from the hip. and i say that with jealousy.

and he does $4k somewhere...that's 8 months of expenses.
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Old 08-05-2010, 08:33 PM   #26
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Of course, sandwiches are a quick, easy way to pack your lunch, and if you mix it up - ham/swiss, turkey/provolone, roast beef/cheddar, you can avoid getting "sick and tired" of sandwiches. One thing I do is prep a pot of chilli, or spaghetti and sauce, maybe a roast in the the slow cooker, a meatloaf, etc. on Saturday or Sunday, then eat that for the week. Warning, though, you'll get sick of this on about Wednesday...

But it IS cheaper, and usually more nutritious than your average junk food meal.
I prefer to take leftovers from dinner the night before. If we go out to eat, I usually cannot eat a full plate (restaurant portions are far too large, but that's another discussion) and get a doggie bag, which I then take for lunch. I make sandwiches when there are no leftovers. I alway bring at least two pieces of fruit.
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Old 08-05-2010, 08:57 PM   #27
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For the $3300 or so each month:

1. Take advantage of whatever amounts of 401k match you think you will potentially get. If the match is 50% of first 6% of base comp, do at least that much. Above that, I would be inclined to say max out your 401k each year (if the 401k has good investment options). I assume your federal rate is at least 25%, and you may have a state income tax also?? So you'll be "saving" 25% on every dollar you put in there.

2. Take what is left after maxing the 401k and pay down debt aggressively. See if you can get some 0% credit cards or some other way to borrow money more cheaply to "refinance" your student loan debt.

The assumption here is that you will have many years of investing ahead of you. Once the debt is gone, you will likely be investing a good bit of money in a taxable investment account. Each year you forgo maxing out the 401k to the limits is some wasted tax-deferred investment capacity that you can't get back. If you stay at your current profession and advance at a typical pace, you will be desperately needing income tax breaks in the future, and paying taxes out of pocket on capital gains and dividends will be expensive. Hence get your money in a tax favored account if you can.
If find #1 to be slightly flawed thinking in some cases. The reason that it wouldn't make sense in my case would be due to the tax write-offs (mostly kids) that we have. I believe that you need to base the calculation not on what your highest Federal tax rate is, but upon what your "effective" tax rate is. That is simply the amount of Federal tax you actually paid (line 60 of the 1040) and divide it by your gross income. In my case, our effective tax rate was only 2.39% just last year, and I believe it was 2.4% the year before that. So for every $100 extra I put into 401K, I didn't pay $2.39 in Federal tax. Not worth it IMHO.
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Old 08-06-2010, 09:29 AM   #28
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If find #1 to be slightly flawed thinking in some cases. The reason that it wouldn't make sense in my case would be due to the tax write-offs (mostly kids) that we have. I believe that you need to base the calculation not on what your highest Federal tax rate is, but upon what your "effective" tax rate is. That is simply the amount of Federal tax you actually paid (line 60 of the 1040) and divide it by your gross income. In my case, our effective tax rate was only 2.39% just last year, and I believe it was 2.4% the year before that. So for every $100 extra I put into 401K, I didn't pay $2.39 in Federal tax. Not worth it IMHO.
As always, you should base decisions on your individual case. I'm assuming the OP is a single taxpayer without kids. And with a large tax liability.

I'm in your camp - very low effective tax rate (roughly 0.4% for federal income tax). Yet a well above median household income. With kids. The average effective tax rate has very little bearing on my decisions, which I base on the margin. Every $100 I contribute to a 401k reduces my federal tax by 15% because my marginal tax rate is 15%, not 0.4% which is my effective tax rate. Of course at some point I could theoretically reduce my income too much such that I would potentially lose out on some non-refundable tax credits. But the biggest credits i currently get as a childed taxpayer is the $1000* per head child tax credit which is fully refundable for me even if I owe no tax.

As a result, I would say I disagree with you regarding the use of your effective tax rate instead of your true marginal tax rate (the marginal tax rate plus any phaseouts of deductions or credits plus starting in 2014 health insurance subsidies). If you are in the 15% or 25% tax bracket, contributing $100 to a 401k will reduce your tax liability by $15 or $25, respectively (ignoring the gain or loss of other deductions due to phase ins or phase outs as your income changes).


*for 2010. Stay tuned for what it will be for 2011, maybe $500, maybe more.
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Old 08-23-2010, 10:42 PM   #29
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Ditto the OMFG at 190K in the hole I would be so freaked out I couldn't function.

Great job getting through school and getting a job in your field. I would be using this time to DIG OUT and fast!!!!! Couldn't think about tax rates past present or future. Discussions of marginal utility are fun in class and amongst friends when the issues are not life and death. Dude this IS A BIG DEAL. Buy your life back get rid of the albatross. If you focus you can get control before you're 30 and be in the drivers seat. Try and be cute and you could be 40 or 50 with a real mess.
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Old 08-25-2010, 12:04 AM   #30
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Hey Landonew, congratulations on the job! I don't know if you remember me or not - we posted back and forth a little a year or so ago, when your initial job offer after you left college didn't pan out.
Anyway, regarding the student loan vs maxing your 401(k). This is completely a matter of personal opinion, but I would address the student loan first.
Although with the employer match, the 401k will most likely net you a larger return than paying down the loan (though the whole thing could also quick easily tank like 2002 or 2008), there are a other factors.
That is a very large loan. You have a window of opportunity while you are living with your parents and your expenses are cheap to get it off your back. Life definately won't always be so cheap - most likely at some point you'll want to start a family, buy a house, etc. If you still have a good chunk of that loan left when you are at that stage, you'll be stuck in a situation where you HAVE to make a good salary just to break even - a pretty stressful situation.
Another factor to look at - risk. While the 401(k) may offer the possibility of more return, there is more risk versus paying down the loan - the 8% you save there is guaranteed. Since you are in a bit of a compromised position with having such a large loan, that's going to affect the pros and cons of you taking on extra risk in return for larger rewards. In my mind - I don't mind a calculated risk, but it's got to be taken from a position of strength.
In the end, you've got to find the best balance between doing what is right for your life in 30 yrs versus doing what is best for where you'll be in 5-10 years.
All this is just my opinion, I think both courses of action have merit.
Best of luck!
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Old 08-27-2010, 10:31 AM   #31
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Hey Landonew, congratulations on the job! I don't know if you remember me or not - we posted back and forth a little a year or so ago, when your initial job offer after you left college didn't pan out.
Anyway, regarding the student loan vs maxing your 401(k). This is completely a matter of personal opinion, but I would address the student loan first.
Although with the employer match, the 401k will most likely net you a larger return than paying down the loan (though the whole thing could also quick easily tank like 2002 or 2008), there are a other factors.
That is a very large loan. You have a window of opportunity while you are living with your parents and your expenses are cheap to get it off your back. Life definately won't always be so cheap - most likely at some point you'll want to start a family, buy a house, etc. If you still have a good chunk of that loan left when you are at that stage, you'll be stuck in a situation where you HAVE to make a good salary just to break even - a pretty stressful situation.
Another factor to look at - risk. While the 401(k) may offer the possibility of more return, there is more risk versus paying down the loan - the 8% you save there is guaranteed. Since you are in a bit of a compromised position with having such a large loan, that's going to affect the pros and cons of you taking on extra risk in return for larger rewards. In my mind - I don't mind a calculated risk, but it's got to be taken from a position of strength.
In the end, you've got to find the best balance between doing what is right for your life in 30 yrs versus doing what is best for where you'll be in 5-10 years.
All this is just my opinion, I think both courses of action have merit.
Best of luck!

Regarding the above, I think that people recommending to max out the 401k are basing it on the current understanding that the matching does not cut out at 6%, or some other contribution level. my 2 cents would be

1. have 6 months+ cash (you are living so cheaply, this shouldn't be hard at this income rate)

1a. (probably this year only) contribute max to ROTH (since you can't do 401k until later in year, and it's a 5k max), you will probably scale out in future due to income, and the option of being able to withdraw contributions in need is a safety feature.

2. Contribute to 401k to the level of employeer matching (as soon as eligible, and if it's not unil late in the year, save hard in cash early in the year so that you can contribute to the absolute limit in the last few months when you are eligible so that you can ensure you maximize you matching income).

3. Pay down debt like a madman.

4. Put aside some money (even just $50 a week) in fun/play money for yourself. This is an investment against burnout, and pays great dividends. If you don't spend it, accumulate it so that you can buy something nice once and awhile for your biking habit.

Other items:

Try to refinance at a lower rate than 8%. May not be possible, but could be the largest single-transaction savings you'll do at this point in your life, as it could save you tens of thousands of dollars.
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Old 08-27-2010, 11:42 PM   #32
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Seems simple enough. There are few relatively safe investments that are going to return you 8% over the next few years, even with a tax deferred edge. Seems to me that paying off the debt at 8% is better right now than saving and earning 5 or 6%.

You're very young and have time to save for your future. In fact, look at paying off the debt as saving. You are in a hole, my friend. Fill that hole before you build a mound of cash next to it, just to push it all in later. You're going to have to do it eventually. Do it now and get it out of the way.
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Old 08-28-2010, 03:24 PM   #33
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Hey Landonew, congratulations on the job! I don't know if you remember me or not - Best of luck!

Thanks for the encouragment, and yes I do remember. It was a very rough time in my life, but I think I am stronger for it. I certainly have a completely different respect for financial security.
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save hard in cash early in the year so that you can contribute to the absolute limit in the last few months when you are eligible so that you can ensure you maximize you matching income).

Thanks for your post. Excellent Ideas, especially the one about saving cash (see below).
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You are in a hole, my friend. Fill that hole before you build a mound of cash next to it, just to push it all in later. You're going to have to do it eventually. Do it now and get it out of the way.
You said it, I have a very large debt.

As for right now, I have decided to defer this decision until December. I intend to make the minimum payment on my loans until the first of the year (jan-2011), and keep the excess in a money market account. In January, I will make a large payment towards my student loans. Just how large will depend on the size of my bonus, my tax situation, and how much I am able to contribute towards my 401(k) in October, November, and December.
I will likely contribute the maximum to my 401(k) and forego the ROTH, but I am not sure yet. Again, the 401(k) match is discretionary at the end of the year. Historically, it has been around 60-70% (or so I am told).
I am very sensitive to se012101's point about planning for the short term (4-5 years). Deferring the decision for 3-4 months will give me some time to better consider my situation as well as get my priorities in order. Everything seems to be happening so fast right now, I just need to slow down and take a deep breath.
Thanks for all your input.
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Old 08-28-2010, 06:54 PM   #34
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Under normal economic conditions, and if you had your own place, I'd say build up an emergency fund, fund the 401K up to the match level, and pay of the debt in that order.

However, with the economy being in such a bad place, you have the option to continue living with parents if things go bad and you lose the job or the bonus don't come through. 8% is so much higher than any type of safe investment return right now that I would really focus on it. Go ahead and start your 401K but I wouldn't really worry about doing anything more than getting the match. The rules may have changed but there are limits to how much companies can put into 401K AFAIK 6% of your compensation. However, if you make more than 110K (which seems plausible) there are often additional restrictions on the combined employee, employer contribution.

I think you want to do what it takes to get all of the free employer money, but with $190K @8% interest I wouldn't sweat not completely maxing out your 401K. I certainly won't bother funding an IRA, or making investments unless the stock market really interests you.
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Old 08-30-2010, 09:22 AM   #35
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Debt liability = $2,000/month (arising from $190,000 (@ 8% APR) in student loans)
I'd concentrate on the loan. 8% is probably better than a market return these days.
Jeez, can I ask what profession is the student loan for?
Makes me feel awfully terrified as a young parent
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Old 09-02-2010, 08:17 PM   #36
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Thanks for the encouragment, and yes I do remember. It was a very rough time in my life, but I think I am stronger for it. I certainly have a completely different respect for financial security.

Thanks for your post. Excellent Ideas, especially the one about saving cash (see below).

You said it, I have a very large debt.

As for right now, I have decided to defer this decision until December. I intend to make the minimum payment on my loans until the first of the year (jan-2011), and keep the excess in a money market account. In January, I will make a large payment towards my student loans. Just how large will depend on the size of my bonus, my tax situation, and how much I am able to contribute towards my 401(k) in October, November, and December.
I will likely contribute the maximum to my 401(k) and forego the ROTH, but I am not sure yet. Again, the 401(k) match is discretionary at the end of the year. Historically, it has been around 60-70% (or so I am told).
I am very sensitive to se012101's point about planning for the short term (4-5 years). Deferring the decision for 3-4 months will give me some time to better consider my situation as well as get my priorities in order. Everything seems to be happening so fast right now, I just need to slow down and take a deep breath.
Thanks for all your input.
Hi landonew. I really don't have much advice to add. I was in a similar position about 4 years ago. Got out of grad school and it took a while to find employment and the student loan bills came rolling in long before that happened. I was in great shape pre-grad school and left in not so great shape.

It was a very hard time for me and I really got down over my circumstances - it was my very own Great Recession before this one came along . And of course I asked all the questions - did I waste my money? Why did I go to grad school? etc.

My advice is to be positive going forward, don't worry about what others your age are doing and set aside some time to enjoy your life. So long as you are motivated, your debt will decrease. So long as you are motivated, your assets will increase. The fact that you are here and recognize your situation says a lot about you. With some steady income, where you are now will look very different 4-5 years from now.
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Old 09-08-2010, 08:41 AM   #37
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I am currently living with my parents ($500/month rent), and intend to continue living with them until I make some headway on my loans.... My employer’s contribution is discretionary at the end of the year, but has historically been between 50-50% match.
My advice in order of priority:

1) Grab every matching dollar your employer has to offer.
2) Consolidate that loan to lower interest if that's possibile.
3) Pay down that loan as fast as you can, keeping expenses to a minimum.*
4) Understand your expenses in ever higher detail, but feel free to splurge on the cheap line items that make you happy. Maybe lunch is that way for you. $120/mo is not much and getting away from the desk is a reward in itself.
5) The longer you go living with low expenses the more you will feel its "normal" for you, and the higher the likelihood that you will be able to keep it up over the long haul.

* If someone offered me a no-risk, guaranteed 8% return, I would put every dime into it and invest nowhere else. You are on the other side of that deal.
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Old 09-14-2010, 12:07 PM   #38
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Here's what I would do:

(1) Max out the 401(k) when you have one available ... I just think there's something good about shaving 15% off of your salary and considering it a "retirement tax" for yourself. I'd contribute up to the maximum tax-deductible amount to an IRA (if no deduction I wouldn't do it right now) or maximum you're eligible for into a Roth.

(2) Throw the rest at the loans.

(3) Investigate whether you can consolidate some or all of those loans at a lower rate. I used the Federal Direct program years ago. You must have some private loans, but the federal loans should be at a lower rate than 8%. And if you do have a mix of private/federal loans, obviously you want to throw your money at the highest rate loans first (which I suspect are the private loans).

I would not save anything in taxable accounts above the 4K you have now, which is a decent emergency fund given your expenses.

Otherwise it seems you are doing all you can. Hang in there!
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Old 09-14-2010, 07:31 PM   #39
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Not sure if anyone else mentioned it....now that you are working, you should be able to get a better rate on at least a portion of your debt. I know 8% is actually pretty decent for an education loan, but I've seen signature loans for less. I have two children in college and it seems like the student loan rates have not dropped along with other loan rates.
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Old 09-23-2010, 12:47 PM   #40
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Today I set up the automatic 401(k) contribution. I qualify for a Roth 401k this year (since I only get 2/3 of my annual salary, started in late April).

I am contributing $4000/month for Oct, Nov, and Dec. This will give me an annual contribution of $12,000 (or about 72%). This will allow me to capture most (hopefully, all) of my employer's match, which is discretionary but has historically been between (50-75%) of the maximum.

One problem... Of the mutual funds offered, the lowest fee is 2% . I don't understand why they don't offer an S&P index or some other passively managed index fund. It’s like going to a restaurant and being forced to order the most expensive thing on the menu. All and all it's still a great deal (they are paying half the tab), just would prefer the chicken instead of the lobster.

I will not be participating in an IRA this year. Instead, I will make a nice lump sum payment towards my student loans (almost like a christmas present to myself).

At the end of the year I will lower the contribution level to $1375, thus allowing me to achieve the maximum tax deduction ($16,500).

Thanks for all the help. I believe this to be a good balance between my short and long term interests (as well as the interests of my mutual fund manager).

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