Advice? SL/investing/mortgage?

[LovinLifeinFL]

Please forgive me for the length

I'm going to lay out our situation & the scenarios w/ pros & cons that I keep thinking about and I'd appreciate any input and advice.

My husband & I have paid off $109,392.97 (but who's counting?) in student loans (SLs) since 2008 but the large majority of that has been in the last year. Those SLs ranged in interest from 6.8-8.5%.

We still have $177,575.45 left (~$16K of that we are still working on right now & plan to be finished w/i the next few months).
Of that total that is remaining:
~$30K is @4.25% interest, $242.78 minimum each month
~$65K @4.125%, $420.44 minimum each month
and ~$66K @3.625%, $297.92 minimum each month

We also have a mortgage around $268,000 @4.85%.

I currently invest enough in my 401K to get the company match, which is 6%. My husband is not participating in his 401K because his company does not offer a match. We would like to retire at 50-55 & know we won't get there on 3% savings (6% of one of our incomes is about 3% total).

Now that we are getting towards the end of the SLs w/ the absurd interest rates, we can't decide what the next move should be.

1. Keep paying the SLs. This is good because we'd free up an additional ~$960 every month by cutting out the minimum payments. Also, we don't qualify for the SL deduction on our taxes so it'd be nice to stop giving them so much interest $! This is bad because it delays an increase in investing for at least a few years. Also, the mortgage interest rate is higher than these SLs.

2. Beef up the investing to 15-20% and use whatever is left to pay extra toward the SLs. This only makes sense if we can make more on our investments than the interest rate on the SLs. I estimate that if we invest 15%, we'd still have ~$1800 extra every month to put toward the SL. That extra $1800 may decrease when we have kids.

3. Beef up the investing to 15-20% and use whatever is left to pay extra on the mortgage. I like the idea of working on the mortgage because the interest rate is higher than the SLs, and also, the security of having the home paid for if something happens to me or my husband. But trying to pay off $268K is going to take a very long time & we won't have 'little wins' like we do when we crush a SL. Also, we get the mortgage interest deduction on our taxes as opposed to the SL interest deduction that we don't get. (I probably need to see how much the mortgage interest deduction is really helping us on our taxes)

4. Split all the extra income into a third & work on all 3 goals. This is my husband's idea. I'm not a big fan of it because the progress for all 3 will be so slow. I am, however, happy that he is participating in the $ decisions as he usually just leaves it to me so I want to weigh the option and not just dismiss it.

If you're still with me, thank you. I know that was a lot. I tend to obsess over these things and really wanted to paint a clear picture so I could get the best advice. I really enjoy this forum & the wisdom on here so I look forward to hearing your ideas or critiques.

Thank you!

 

[growing_older]

My observations: Tax advantaged savings space such as 401k is limited and if you leave some unused there is no catching up later. Expected return from reasonable 401k asset allocation should exceed expected costs of any of your interest rates (but not guaranteed). Cash flow relief comes only if a loan is eliminated; there's no cashflow advantage to partly paying. Differences in interest rates here are not too significant. You have at least some concern about "something happening" that might have financial consequences. Loan amounts are large enough that paying them off will be a long term effort. It's easier to make specific suggestions if we have specific information such as pay, free monthly cashflow, ages, occupation (to infer expected pay and change over time), etc.

My suggestions: Raise 401k contributions as much as you can and still have adequate cashflow to service loans plus a bit for payoff. Pay minimum on all loans. Direct any extra cashflow into an emergency fund until you have enough in there that you are not so worried about "what if something happens" financially. Once emergency fund is adequate, direct all extra cashflow to whichever loan can be paid off quickest. As a loan is eliminated, redirect that payment plus all free cashflow to the next quickest to payoff. Each loan you eliminate improves your cashflow and reduces your monthly obligation. If you were using 401k for less than maximum allowed, increase contributions each time cashflow improves.

 

[clifp]

I agree with growing older, beef up your 401K is the right idea because contribution are limited.

A key factor in calculation is your income and tax situation given that you've paid $109,392.97 of in 2+ years I am guessing you have some pretty good combined salaries. BTW congrats on paying off that much debt It looks like student loan interest is only deductible for the first $2500 (not sure if this is true) so much of your student loan debt is non deductible making more expensive than your mortgage.

Realistically I think you need to save at least 20% of your salary (including employer match) to retire at 55 with an income similar to your current take home and certainly one of the easiest ways to do this is through a 401K plan. After you have an emergency fund in place I focus on paying of 30K and than the 60K student loan.

I certainly wouldn't worry about paying off your <5% mortgage until those student loans are paid off. If some tragedy happens you guys get in a car accident, lose your job, end up with a pile of medical bill (I know Mr Hawaii sunshine here) , you can always walk away from your house, and declare bankruptcy and erase most of your medical bills. However, those student loan stay with you for the rest of your life.

 

[LovinLifeinFL]

Thank you for your thoughtful replies!!

It's easier to make specific suggestions if we have specific information such as pay, free monthly cashflow, ages, occupation (to infer expected pay and change over time), etc.

Pay ~$190K/yr gross
Current free monthly cashflow ~$4200 (+ $466 when we finish the SL we are currently working on in the next couple months)
Ages: 29
Occupation: me - pharmacist; husband - attorney (in-house counsel)

The "something happening" is a normal concern, I think. However, we both have life insurance & we both make enough income to be ok if the other can't work.

We have 6-8 months of bare bones expenses saved in an emergency fund.

We can invest 20% (20% of $190K is $38K) and still have about $1500 in free monthly cashflow.

The plan that makes the most sense to me at this point, and you two have greatly helped solidify it, is beef up the investments to ~20%. Use the remaining $ to continue paying SLs in order to free up more cashflow. And not concern myself w/ the mortgage at this point because it is so large & will take so long to pay down w/ only $1500 extra each month.

Now, what to do w/ the $38K? Obviously, we have lots of room to increase the 401Ks. However, I am trying to wrap my head around whether or not opening a non-deductible traditional IRA and then converting it to a Roth IRA is a good idea, or if I should be exploring other investment strategies.

I have lots of reading to do...

 

[chinaco]

Congrats on retiring the debt.

Some thoughts.

I would maintain an emergency fund. Paydown other debt and keep it low. Continue to contribute to retire accounts and increase it if possible. I would not overdo the house situation.... buy no more than is needed... ultimately, it is just an ongoing expense.

 

[clifp]

Now, what to do w/ the $38K? Obviously, we have lots of room to increase the 401Ks. However, I am trying to wrap my head around whether or not opening a non-deductible traditional IRA and then converting it to a Roth IRA is a good idea, or if I should be exploring other investment strategies.

I have lots of reading to do...

Maxing out your 401K would be 33K so that probably accounts for ~28K of your 38K savings. The remaining 10K plus some of your additional cash flow gets rid of the 4.25% student loan in a couple of years, which would be another major accomplishment.

IMO non deductible IRA are a major PITA, because of the book keeping rules (although Quicken etc probably simplify this) and the constantly changing rules. I'd be far more inclined to start investing Vanguard index funds, which are extremely tax efficient. For instance over the last decade $10K investment the S&P 500 or total market index fund generated less than <$200 in dividend/year. The tax rate on these is only 15% so we are talking an extra 30 bucks in taxes. Hardly worth the hassles with keep track of the cost basis of traditional vs non deductible IRA rtc.

In 25 years when you guys retire, hopefully that 10K will be worth $80K (historical 9% annual return). God only knows what the taxes laws will be then but traditionally capital gains are treated more favorable than regular income. From my personal experience having money outside of tax sheltered is extremely valuable (I'm still 8 years away from being able to tap into my IRAs without jumping through hoops)

 

[growing_older]

I myself invested in non-deductible IRA and it seemed to be a nice idea to get the money into a tax sheltered vehicle so I didn't have to worry about taxes and each year's gain. In retrospect I regret having done so. A taxable investment in something that generates controlled capital gains would have allowed me the same advantage in terms of current taxation and I could have retained control of when (if ever) I recognize the gains. Instead I am going to get caught up in eventual RMD problems and the fact that I have even more money in the account will only make it worse. In retrospect, additional tax diversification would have been a better idea. With your high incomes and potential high savings rates, you will likely be in the same situation in the future, so I'd suggest avoiding non-deductible IRAs in favor of careful taxable investing instead.

 

[ERD50]

The "something happening" is a normal concern, I think. However, we both have life insurance & we both make enough income to be ok if the other can't work.

Here's a half-formed thought I've had (dangerous, especially when dealing with morbid "if something happened" subjects), but I'll charge ahead anyhow...

As I understand it, SLs are forgiven at death. So if you pay them off, and the dreaded 'something' happens, that money is gone, not forgiven. So I think a case could be made for less life insurance with the SL debt than if it was paid off.

I don't know if the difference in coverage would mean significantly different premiums, but if my assumptions are correct, it would be a (maybe small) financial factor.

Oh, and by 'life insurance' I hope you mean 'term'?

-ERD50

 

[Sandhog]

Now, what to do w/ the $38K? Obviously, we have lots of room to increase the 401Ks. However, I am trying to wrap my head around whether or not opening a non-deductible traditional IRA and then converting it to a Roth IRA is a good idea, or if I should be exploring other investment strategies.

I have lots of reading to do...

I would max out 401k and rest in the Roth IRA or Roth 401k. Good thing about the Roth is that you can take out the original contribution amount before 59 1/2 without penalty since it was post-tax.

 

[Packman]

I like the option of working toward all of your goals. With the good salary you both have, and the high amount of earnings you are able to save - I would:

1. Keep paying the high interest SL until done (few more months).
2. Then, try to max out the 401k savings as you can each contribute $16,500 per year. The tax deferral over 25+ years should be a big advantage and will beat the 4% SL costs. It will also reduce your current tax expense by $10,000. (You can always cut this back if you need money for other living expenses, like children).
3. Contribute the max to a Roth IRA ($5,000 each per year) as you are young enough to reap the non-taxable rewards and you can withdraw principle before 59.5 (since you wish to retire prior to that age).
4. Keep paying the remaining student loans with any excess funds going to the highest interest loans first.
5. Pay only the required amounts toward the mortgage as the interest is tax deductible and it's the "best debt" you have.

As you pay off the SL's, start to invest in some taxable investments as well, like index funds or ETF's. This will give you better flexibility at retirement with taxes and availability of funds to draw from. And these investments will not throw off too much in taxable gains and dividends.

Good luck

 

[norcaldreamer]

I can't help but notice that your situation is very similar to ours (late 20s, DINKs with a parent living with us, and $400-450K in total debt, although our mortgage/student loan ratio and interest rates are different than yours).

We have decided to work on all three options at the same time. We are putting $1500/month into pre-paying our mortgage, $3,000/month into paying student loans, and then putting the rest into investments. Even though progress may be slow, I take some comfort in this "diversification." The loan payments are guaranteed returns, but possibly lower than investment returns. Also, assuming something happens to us, it'll be easier to access a taxable investment account than having all of our money tied up in the house or pre-paid towards the student loans.

We also recently went the backdoor Roth IRA route, which was very easy to do on Vanguard. I think, however, that unlike regular Roth IRAs, you cannot withdraw any trad --> Roth rollover amounts for at least five years. It's probably not a big deal, but something to keep in mind.

 

[W2R]

Something I discovered when saving for retirement, was that almost ANY way that I used my money towards retirement, made a huge difference in comparison with doing nothing. I probably did things in the wrong order, or maybe not, but honestly it didn't make much difference in the long run. Also being frugal makes a huge difference, as you have discovered.

Anyway, I just want to encourage you and to say that whatever you choose just keep working away at this. Before you know it, you'll be debt free and happily retired.

 

[clifp]

Something I discovered when saving for retirement, was that almost ANY way that I used my money towards retirement, made a huge difference in comparison with doing nothing. I probably did things in the wrong order, or maybe not, but honestly it didn't make much difference in the long run. Also being frugal makes a huge difference, as you have discovered.

Anyway, I just want to encourage you and to say that whatever you choose just keep working away at this. Before you know it, you'll be debt free and happily retired.

I 100% agree rule number #1 for retiring early (or now days maybe even retiring at 65) is to spend less than your earn. No other rule is nearly as important.

It doesn't matter that much if you ;pay down student loans, or contribute to a Roth, make double payments on your mortgage, purchase a rental property, buy an index fund, or an active fund, or invest in individual stocks. What matters is that your consumption is less than your earnings.

 

[LovinLifeinFL]

There is a lot of good info here and I really do appreciate the advice. I think I'll bump up both 401Ks to the max as the 1st step and maybe beef up the savings a bit (I'll need to replace my car soon-ish, DH's car should be good for a while), then go from there. I also need to dust off the old copy of Boglehead's Guide to Investing that I got for Christmas a few years ago but never read because I wanted to kill the higher interest SLs 1st. Those loans really have gone a lot faster than I anticipated.

I have so many half-formed questions about index funds and tax shelter and other, probably basic, concepts but I really do need to do some more research since I have no idea what I'm talking about yet.