Have I reached "capitulation" for considering this?

[Lusitan]

I'm 34 and have been maxing out my 401(k) and my (and my wife's) IRA contributions pretty much since I started working 12 years ago. It's almost religion to me.

I'm still maxing out my 401(k), but this year is the first year the market has me so ... unenthused ... that I'm seriously considering forgoing the IRA contributions this year and instead using that money to do something that I've been considering for a while: paying off a student loan at 5.075% interest.

I know retirement savings is very important, especially in these tax-favored plans. But a guaranteed return of 5.075% is very tempting right now. (Further dampening my enthusiasm for my IRA is that I am not eligible for a Roth IRA or a deductible IRA, so it was only going to be a non-deductible IRA contribution.) I don't qualify for any deduction of the student loan interest.

What do you guys think? If you had to choose between:
- non-deductible IRA contribution
- paying off a 5.075% student loan

Which would you chose and why?

 

[Dawg52]

Well it's almost like trying to decide between a 5% cd or taking your chances in the market. I like paying off debt so I would probably go that route.

 

[W2R]

I'd put it in my retirement account. If you don't add your yearly contribution by the deadline, you can't go back and add it later when you have more money. You can pay off your student loan whenever you want.

Besides, this is (probably) one of those opportunities to buy low.

 

[clifp]

Personally, I think non-deductable IRAs are not a particularly attractive saving vehicles. Given the current tax laws, I'm not sure you don't come out ahead in non-deductable IRA vs sticking the money in index fund with very low distributions and not touching the money for 25-30 years.

A 5.075% risk and tax free return is certainly very attractive. Never the less I think you'll make more money in the market in the next 20+ year. However, if you'll sleep better at night I see absolutely nothing wrong with paying off the student loan.

This is one of those decision where there is no obvious right or wrong answers financially. I'd even go so far to say that some one that claims that X is absolutely better than Y shouldn't be trusted. So it comes down to an psychological decision are you more fearful or more greedy.

 

[2B]

This is a Dave Ramsey type question -- not that he's perfect IMHO. I'll revise his normal answers to my own prejudices.

1. Get an emergency fund of 3 to 6 months of living expenses.
2. Put enough into your 401k to get any company match.
3. Pay off all non-mortgage debt.
4. Max out 401k or IRA - use your judgement on whether to use the Roth versions of either.
5. Get your emergency funds up to one year of living expenses.

From what I see you're at step 3.

 

[Lusitan]

Dawg - interesting comment. I would not be tempted to put my money in a CD earning 5.075% instead of putting it into my (mostly stock) retirement investment stash, yet I'm tempted to pay off a loan at 5.075% instead of investing in the retirement account. Funny how that works!

Want2Retire - yeah, the "add to the IRA for 2008 or lose the chance forever" is the main thing that keeps me in doubt. I feel like in 30 years I will look back and wish I would have dumped more money into the market. But then again, will I notice this little bit? Or am I starting down a slippery slope to skipping IRA contributions?

clifp - I'm probably equal parts fear and greed, which may be a good thing but sure does make for some agonizing decisions! Like you, I'm not sure how much benefit a non-deductible IRA is really going to give me over regular long-term investment in a taxable account.

2B - yeah, I'm maxing out my 401(k) but otherwise I'm at step 3. I wonder if Ramsey has ever considered student loan debt, or whether he just lumps everything into mortgage v. non-mortgage debt. While I don't qualify for deducting the interest on my student loans, there is still some minor benefit to student loans in that I think you can get a deferral on making payments if you experience qualifying economic hardship. Not that I plan on having to invoke that, but it's one thing that makes those loans less scary than some other non-mortgage debt like credit cards etc.

In any case, thanks for the replies all - your perspectives have given me more to think about. Good thing I have some time before April 15th.

Edited to add: another factor at work is probably the instant gratification that comes with paying off that student loan, i.e. reducing my monthly expenses by $100 every month. The non-deductible IRA is purely delayed gratification ...

 

[aaronc879]

I'm 34 and have been maxing out my 401(k) and my (and my wife's) IRA contributions pretty much since I started working 12 years ago. It's almost religion to me.

I'm still maxing out my 401(k), but this year is the first year the market has me so ... unenthused ... that I'm seriously considering forgoing the IRA contributions this year and instead using that money to do something that I've been considering for a while: paying off a student loan at 5.075% interest.

I know retirement savings is very important, especially in these tax-favored plans. But a guaranteed return of 5.075% is very tempting right now. (Further dampening my enthusiasm for my IRA is that I am not eligible for a Roth IRA or a deductible IRA, so it was only going to be a non-deductible IRA contribution.) I don't qualify for any deduction of the student loan interest.

What do you guys think? If you had to choose between:
- non-deductible IRA contribution
- paying off a 5.075% student loan

Which would you chose and why?

If your income is too high to qualify for a ROTH IRA then i'd think you'd have enough money to max out your 401K and still pay a lot extra toward your student loans. I'd max tax deferred accounts then pay off debt then non tax deferred accounts only after debt is gone.

 

[Lusitan]

If your income is too high to qualify for a ROTH IRA then i'd think you'd have enough money to max out your 401K and still pay a lot extra toward your student loans. I'd max tax deferred accounts then pay off debt then non tax deferred accounts only after debt is gone.

Aaron - that's true. I am simultaneously trying to meet several goals (increase emergency fund, save for down payment ... plus I live in a high-cost area) but it's like a game of musical chairs, and the last two goals left standing when the music stops (i.e., when I run out of money to invest) are (1) paying off the student loan and (2) putting it in the IRA, so that's why I'm trying to decide between those two.

 

[Trek]

Pay off the loan. Life is better when you don't have debt hanging over you.

 

[Lusitan]

Pay off the loan. Life is better when you don't have debt hanging over you.

I hear you, Trek. I would very much like to get to "debt free".

A student loan at 5.075% isn't that bad, but boy the interest rate seems high now when I look at the measly rate I'm getting on my emergency-fund CDs and savings accounts.

 

[Dawg52]

I hear you, Trek. I would very much like to get to "debt free".

A student loan at 5.075% isn't that bad, but boy the interest rate seems high now when I look at the measly rate I'm getting on my emergency-fund CDs and savings accounts.

When I was in college(long ago), interest rates on student loans were 3%. I didn't pay that off early. Paid it off according to the payment schedule of 10 years.

 

[aaronc879]

Pay off the loan. Life is better when you don't have debt hanging over you.

I agree with this. Not to say it is the correct way of thinking. You can't go wrong either way. Just don't spend it on a down payment on a yacht or Porsche

 

[Alan]

A student loan at 5.075% isn't that bad, but boy the interest rate seems high now when I look at the measly rate I'm getting on my emergency-fund CDs and savings accounts.

An after-tax return of 5.075% guaranteed is very tempting. Personally, I would pay down the loan.

 

[brewer12345]

Pay off the loan. Life is better when you don't have debt hanging over you.

My student loan which is locked at 1% and change will get paid off at the slowest pace possible while still technically staying current.

 

[Gone4Good]

About 2 years ago I sold a boat-load of Citigroup stock at right around $50 / share and used the money to repay my 5.25% mortgage. At the time many people said that was a stupid trade. Citi was paying a ~4% dividend yield, after all. Well 24 months forward, my mortgage is repaid and I've saved 5 figures in interest. Meanwhile Citi is trading at ~$4 per share and they've cut the dividend to just $0.04 annually. That was one of the best trades I ever made.

Sometimes a sure thing is a sure thing. Nothing wrong with being happy with a bird in the hand.

 

[dex]

I think the OP needs to do an after tax analysis - contribute to 401K & pay off the student loan Vs no 401K contribution and pay off student loan.

My guess is that it is better to contribute to the 401K

TurboTax® Tax Estimator Tool - Free Tax Software Tool to Estimate Your Taxes
Assume Gross $80K with 10% 401K contribution & 5% company match

7300 Taxes with contribution - plus company match of $4,000 net 3,300 outflow
8500 Taxes without contribution - no company match 8,500 net outflow

 

[Gardnr]

I think the OP needs to do an after tax analysis - contribute to 401K & pay off the student loan Vs no 401K contribution and pay off student loan.

My guess is that it is better to contribute to the 401K

TurboTax® Tax Estimator Tool - Free Tax Software Tool to Estimate Your Taxes
Assume Gross $80K with 10% 401K contribution & 5% company match

7300 Taxes with contribution - plus company match of $4,000 net 3,300 outflow
8500 Taxes without contribution - no company match 8,500 net outflow

That's not his choice/dilemma. The question is whether to pay off the SL or contribute to non-ded IRA. He's still maxing the 401K.

 

[samclem]

I think crunching the numbers as they are would probably argue for paying down the student loan. The only wildcards:
-- The government is getting ready to throw around a lot of bailout money, and I wouldn't be surprised if some of it is shoveled toward holders of student loans. This would probably be income-based, and you'd likely not qualify, but stranger things have happened.
-- Inflation: If you believe that the big amounts of money Uncle Sam will be printing to pay off this money-fest will lead to inflation, then you want to be a holder of low-interest debt. It would feel pretty good to have 5% student loans when inflation is 10% per year.

 

[dex]

That's not his choice/dilemma. The question is whether to pay off the SL or contribute to non-ded IRA. He's still maxing the 401K.

Thanks - I'd pay off the student loans but I'd try to still make contributions to the non-ded IRA

 

[Rambler]

...could lead to inflation. No sign of it yet. I'd bet on some deflation before the inflation comes, what with 50% off everything in so many stores, gas prices at their lowest in years, etc. I would bet the next cpi reports will show slowing or reversal of last year's inflation.

I'm all for paying off the debt, since you can't do a roth or a deductable ira. I hate debt, personally. Better to earn interest than pay it. Next would be the mortgage, if you have one. Refi to a lower rate as they come down, and pay that down as well while building your taxable account.

I would stay away from IRAs that are non-deductable...no benefit there. Anythin leftover? Fund a taxable account, targeted for retirement, but that gives you more flexibility, if you need it, and would be the place to draw from first if you retire before 59.5.

R

 

[ERD50]

About 2 years ago I sold a boat-load of Citigroup stock at right around $50 / share and used the money to repay my 5.25% mortgage. At the time many people said that was a stupid trade. Citi was paying a ~4% dividend yield, after all. Well 24 months forward, my mortgage is repaid and I've saved 5 figures in interest. Meanwhile Citi is trading at ~$4 per share and they've cut the dividend to just $0.04 annually. That was one of the best trades I ever made.

Sometimes a sure thing is a sure thing. Nothing wrong with being happy with a bird in the hand.

Hindsight is wonderful.

If it was such a "sure thing" why didn't you short Citi? When you look at it that way, I'd bet that it didn't quite look like a "sure thing", did it?

In the long run, I doubt that it'll make much difference what the OP decides, but I found this line interesting (and relevant to the above):

but this year is the first year the market has me so ... unenthused ...

Well, the time to pay off the debt would have been when the market was at highs. The current dip would *typically* be a better time to invest. You seem to have a bit of a "Buy High, Sell Low" mentality here. I would be more inclined to keep investing now, and pay off the debt when the market looks less attractive. And, if you think the market is not going to go up over the life of that student loan, you should go 100% to cash anyway. Are you doing that?

Just some things to consider.

-ERD50

 

[Lusitan]

Well, the time to pay off the debt would have been when the market was at highs. The current dip would *typically* be a better time to invest. You seem to have a bit of a "Buy High, Sell Low" mentality here. I would be more inclined to keep investing now, and pay off the debt when the market looks less attractive. And, if you think the market is not going to go up over the life of that student loan, you should go 100% to cash anyway. Are you doing that?

Just some things to consider.

-ERD50

Good point, ERD50. I guess I should have stated that my lack of enthusiasm for this year's IRA contribution is due to two things: (a) the current stock market bear and (b) the fact that this would be my first non-deductible IRA contribution.

If I could contribute to a Roth, or a deductible IRA, I don't think I would be struggling with this decision -- I'd make the IRA contribution.

I realize I'm probably doing a little market timing here, which is why I suspect this is a form of market capitulation for me. But it's only a partial capitulation -- I'm sticking with maxing out my 401(k) at least.

But I hadn't thought about the question of "what annual return do I expect on the stock market?" I think a long term annual growth of between 5% and 6% is the best I can hope for (I've had essentially earned zero return during my first decade of investing, but I'm hoping for improved performance that will in the end equal somewhere between 5% and 6% average annual returns). So I guess looking at it that way, paying down the 5.075% student loan is almost like a risk-free way to get exactly what I was hoping to get from the stock market.

Brewer - I do have other student loans at lower rates that I'm not even considering paying off yet (they're at 2.875% ... not as good as yours, but not too bad). I agree, for some of those very low interest rate loans, it makes sense to pay them off as slowly as you can.

Thanks for the replies, all!

 

[Gone4Good]

Hindsight is wonderful.

If it was such a "sure thing" why didn't you short Citi? When you look at it that way, I'd bet that it didn't quite look like a "sure thing", did it?

Wow, pretty snarky for someone who clearly misunderstood what I said.

So I'll rephrase . . . Paying down debt of x% coupon is a sure thing (in my case it was a 5.25% before tax return). Investing money in any risky asset (in my case Citigroup stock) is not a sure thing . . . thus the term "risky asset".

Often times people confuse "expected returns" for actual returns when comparing various investment alternatives. The logic goes, 10% long-run returns for stocks beats a measly 5% cost of debt, so keep the debt and put your cash to work for higher returns. But the actual comparison is between a guaranteed 5% return versus a probability distribution of returns that has a historical mean of ~10%. Put differently, would you prefer a 5% bird in the hand, or 2x in the bush?

If you asked the average guy on the street, would you rather have a 5% annual return guaranteed for the next 30 years or a probability distribution of returns with a historic mean of 10%, I think you'd find a lot of takers for that 5% investment.

Therefore:

Sometimes a sure thing is a sure thing. Nothing wrong with being happy with a bird in the hand.

 

[ERD50]

Wow, pretty snarky for someone who clearly misunderstood what I said.

Sorry, Yrs_to_go, but I didn't intend to be any more "snarky" than your comment appeared to me to be "gloating".

When you say "That was one of the best trades I ever made.", it really isn't of any value for the OP looking forward. In fact, since markets tend to go in cycles, it could be looked at as a contrary indicator.

OK, I see now that I might have misinterpreted your "sure thing" comment as referring to Citi, rather than the 5% payoff. But it still is kind of the same thing. Had Citi gone up, paying off the loan would not have been an advantage, so is it really a "sure thing"? I guess you can say it is a "known thing", or a "predictable thing", but since there is another side to the equation (what you do with the money), the outcome is still unknown. Less risky? Yes, if you define risk as risk of losing your money ( most common usage, but sometimes you need to look at risk of opportunity cost).

If you asked the average guy on the street, would you rather have a 5% annual return guaranteed for the next 30 years or a probability distribution of returns with a historic mean of 10%, I think you'd find a lot of takers for that 5% investment.

No doubt. But that doesn't necessarily mean it is the best long term decision. Lot's of people make poor financial decisions. I'm not saying that example would be a poor one, it depends on your goals, risk/reward tolerance, etc. But I wouldn't go with the popular vote when it comes to making financial decisions for myself.

Probability is what it is, no less, no more. Getting an education in a good field will probably get you a higher lifetime income, not smoking, eating right, keeping fit will probably help you live a longer healthier life, etc, etc, etc.... And, investing in equities over the long term will probably provide higher returns than fixed income sources.

What else can we do, other than chose the path we are most comfortable with (hopefully, after understanding the consequences of the decision)?

-ERD50

 

[2B]

Ok Ok enough already for this whiney thread. It's "copulation" not "capitulation." We established that several months ago.