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Message
re: Pay off Debt or Contribute to IRA?
Posted on 11/8/18 at 2:54 pm to notsince98
Posted on 11/8/18 at 2:54 pm to notsince98
quote:OK? I also didn't account for an income increase, which is more likely than a decrease, because I can't make any reasonable assumptions regarding when it would occur, and by how much. And he works for the government so that usually entails more job security with less likelihood of an income increase, and often small but consistent increases income, which offsets both the upside and downside risk regarding income and advancement.
Your analysis also requires that income doesn't decrease.
And it's especially hard to account for without knowing what their income is now. And I made a broad assumption for the purposes of the scenarios that their MAGI is in the large range between $77,401 and $165,000. Given the $2,000 in disposable income, with the debt he presented and other expenses that are required to live (housing, food, gas, etc.) I don't think that their income is likely to be much more or less than that large range that covers the majority of individuals fitting his description.
quote:And the whole point of my analysis was that with $2,000 of income to put towards either debt and or retirement, the difference between $1,000 and $2,000 per month towards the debt, would save only $580 and a 9 month difference in the payment timeline.
This is my personal issue with not tackling debt first. It means your are locked in to a minimum income requirement situation and leaves less room to handle life changes. You reduce the flexibility in your life choices.
At the same time, the opportunity costs of not putting the money towards retirement, results in a far greater difference financially. Not to mention, if he's putting it towards a Roth IRA, which I assumed was the case, there is the ability to withdraw the contributions if that is necessary. And if he is putting it towards a regular IRA, then he would have greater tax savings that he could also apply to debt.
So if someone values the peace of mind of getting the debt paid off as soon as possible regardless of the financial implications and the timeline to pay it off, then that's perfectly fine. But I think people should be aware of as many of the costs and benefits of whatever they choose. And that includes the fact that it's not an either/or choice, and one can benefit from getting rid of debt and investing towards their retirement, and limit the opportunity costs of both.
But the problem with your argument, at least how you're presenting it, is that you're arguing some principle in its extreme (all towards debt), and arguing only the benefits of that particular extreme, without considering its costs, and the costs benefit of the alternative and everything in between. Furthermore, you're not even considering how his particular situation impacts the extent that he can maximize those benefits, specifically how much and how frequently he can put towards the debt (since it's not the full amount) within the nature of amortization and decompounding interest.
1
Posted on 11/8/18 at 3:19 pm to notsince98
quote:But the points you're making are applicable to a whole bunch of things, not just debt, which is why some of them are a commonly insured against (disability).
The only point I am making is there is costs to keeping debt that is very hard to quantify and too often people don't consider it.
But again, the problem is that you're pointing out all of these potential risks, and pointing out why not having debt can minimize their impact, but I don't think anyone would disagree with this. It's important to consider risks, and consider how likely or impactful they are for one's own personal situation, it's not useful to argue that one strategy to address these is the only and best way for any particular person without knowing all of those details and considering the alternatives.
And what bothers me about the way your presenting this is that many of those risks could potentially be minimized MORE by investing the money for the future, and in the worst case scenario that there is something so unexpected that an emergency fund is not enough, he can access his contributions to help cover the rest.
AND you're also not considering the fact that on top o being able to access his money on top of of savings, he could also, in a worst case scenario, request for his loans to be put into temporary forbearance, be put onto an income based plan (if one loses a job), or see if his payments can be decreased if he had paid more down some of the principal. Student loan debt and the options they provided, especially if they are federal loans, is different than other debt, most notably the credit card debt. So your one size fits all argument ignores that as well.
Posted on 11/8/18 at 3:41 pm to buckeye_vol
quote:
But again, the problem is that you're pointing out all of these potential risks, and pointing out why not having debt can minimize their impact, but I don't think anyone would disagree with this
You are being obtuse or have avoided every Dave Ramsey thread that has appeared on this board.
Also your reading comprehension is shite. Find where I made a claim that one size fits all. Are you fricking retarded?
This post was edited on 11/8/18 at 3:42 pm
Posted on 11/8/18 at 3:44 pm to notsince98
quote:
Also your reading comprehension is shite. Find where I made a claim that one size fits all. Are you fricking retarded?
Don't get offended that your point was ill thought out.
Posted on 11/8/18 at 5:00 pm to buckeye_vol
quote:
buckeye_vol
I very much appreciated your analysis. Most of your assumptions used are also correct, making it even more impactful and meaningful.
Our income is $110,500. When I say IRA, I am referring to Roth IRA’s.
You pretty much confirmed what I was thinking. The opportunity costs of building my retirement are greater than the costs of saving interest by paying down the loan. I’ve been meaning to do a detailed analysis like you did, but thought I would just start with a basic question here for opinions and you did some nice work for me
As far as what others have said- life is unpredictable and I understand that. But we are fairly stable. I know we both just started new jobs but I’m a CPA and CFE. I feel I have job security but even if something were to happen I have a good resume and qualifications to find work quickly. My wife is also highly qualified. I’m not saying we’re extraordinary but just qualified enough to find decent jobs if the situation needed us to. We don’t have kids, don’t plan on kids for at least two more years.
I mean sure- medical emergency could happen. Some extreme life event could happen. But the money is going into a Roth, so in an emergency we could pull from that. I would even argue that contributing to a Roth is better for planning for the unexpected than paying off debt. Money would be available if needed, whereas it won’t be by paying off debt. The only way that paying off debt helps to plan for the unexpected is if we ever run into a cash flow issue, which right now we have $2k a month extra, so any cash flow issue could just decrease IRA contributions and it’s likely solved.
Posted on 11/8/18 at 6:08 pm to notsince98
quote:You’ve literally only made the argument for putting all towards debt, and despite the OP providing specific information about his financial situations and advice for it, you haven’t addressed any of those specific details. Yet you had no problem providing a bunch of specific risks and scenarios, some of which could irrelevant to the OP (stay home this kids), and all of which are applicable to any financial situation and just a selection of an infinite number of unlikely possibilities, including ones that have upside risk that you conveniently ignore. Furthermore, since HIS scenario invoked investing, and thus keeping his money, which can address those same risks, you conveniently failed to address how putting all towards debt is the better solution.
You are being obtuse or have avoided every Dave Ramsey thread that has appeared on this board.
Also your reading comprehension is shite. Find where I made a claim that one size fits all. Are you fricking retarded?
More telling is that I provided two scenarios based on the two options he was considering and at their bounds (all towards debt; max retirement and rest towards debt) using the information he provided to show the maximum benefits and costs of the two options, to encompass the range of possibilies to fit his needs.
And I only made assumptions necessary for the analysis which have a limited range of possibilities that wouldn’t have much impact on the general comparison, based only on the information he provided and widely available and verifiable data if necessary (market return; population income distribution; tax rates; loan repayment timelines). And I listed those assumptions so he could know where and how they differ from his specifics. And those assumptions were constant, so the debt and investment of the $2,000 is the only variable to impact the outcome.
And yet your response was solely to provide one of the same risks to support the only argument you’ve made, that I didn’t account for a decrease in income. And that not only was something that was impossible to account for, it ignored that I provided a third, baseline scenario, where he didn’t put any money towards debt and retirement, and it wouldn’t have impacted the math itself.
But I’m sure both your response that supports the sole argument you’ve made, and the exclusion of an income increase, which is just as likely, if not more, but that wouldn’t support your argument, is because you aren’t arguing a one size fits all approach .
Posted on 11/8/18 at 7:07 pm to Hammond Tiger Fan
The big question here is whether you'll be able to itemize deductions. If you can, the student debt becomes less expensive ( IRS link) and your IRA contributions aren't taxable either.
That said, stretch out the car note as long as you can regardless. 2% is about the rate of inflation and is less than what you'd get by investing in CD's of similar duration, so there's no need to hurry on that one.
That said, stretch out the car note as long as you can regardless. 2% is about the rate of inflation and is less than what you'd get by investing in CD's of similar duration, so there's no need to hurry on that one.
This post was edited on 11/8/18 at 7:11 pm
Posted on 11/8/18 at 7:09 pm to cgrand
quote:
pay off your debt, while it's easy to do so.
you never know what may come next
Actually that's a great argument for ... building up emergency savings instead.
Edit: Just saw OP's note that the IRA is a Roth. Obviously that changes things quite a bit and if he's planning to use it to build up a e-fund that's a no-brainer.
This post was edited on 11/8/18 at 7:12 pm
Posted on 11/8/18 at 11:08 pm to foshizzle
quote:The student loan interest deduction is the superior above the line deduction (up to $2500) so one can claim it regardless if they itemize or not, as long as one’s MAGI (for a married filing jointly) is below the $165,000 threshold, which is the case for the OP.
The big question here is whether you'll be able to itemize deductions. If you can, the student debt becomes less expensive
Not to mention, besides the opportunity costs of paying off debt instead of investing it, tax implications, and the inflation are things that get too often get overlooked in these discussions.
It’s why I struggle to understand why people would choose a 15 year mortgage instead of a 30 year mortgage, based solely on the interest rate, without considering the cost differences if you took the 30 and paid the same amount as the 15 (putting it towards the principal).
If you look at the average rates of a 30 (5.10) and 15 (4.46) on a $100,000, with the payment of the 15 year, the 30 year will cost $9159 more with 13 extra payments. However, if one can itemize deductions, that difference is even less, and with more years to potentially benefit from that deduction.
Plus when you consider inflation, and that the interest on a loan is front loaded, the tax savings will occur when purchasing power is higher, one has the the flexibility to use that purchasing power as needed, put more towards the principal, or invest it in something with a high return. And when the extra costs of the loan do occur, it will 15 years down the line when the real costs are likely 30% lower.
I completely understand both the psychological benefits of paying off debt and the financial benefits and flexibility more cash flow without the debt expenses. It just seems weird when it gets taken to an extreme that has no flexibility, requires one to severely restrict their cash flow by increasing expenses and increasing tax liability , when the cash flow more restricted, and when value of that cash is greater. And furthermore it also limits the ability to build wealth that gives one more flexibility and makes that future cash flow when debt free less necessary.
Posted on 11/9/18 at 8:16 am to Tigerfan56
Personally, I would put have at least $2-4K in a savings or money market account as a baby emergency fund.
Then I'd knock out the credit card debt immediately, that shite will weigh you down.
Then fully the emergency fund with 3-6 months of expenses.
Then throw $1500+ whatever your monthly credit card payment was at the student loans. At the same time, put $500 into a Roth. (Annual Contribution limit increases to $6000 per person in 2019)
Your car payment is not a big deal right now. But once you're done knocking out the student loans, fully fund the Roth for your spouse and then knock the car out too.
Once the car is knocked out, you have an extra $1000 + (way more actually because you have no payments on debt) in your budget every month. I'd set aside whatever your car payment was every month for a new car fund. (I do this, I put $450/month in a taxable account with American funds, C-shares, no front load. You don't have to put it in mutual funds, especially if you're gonna be buying a car soon. Just do a money market if you want.) Buying a new car is more fun when you can just write a check, trust me.
That's what I would do.
Then I'd knock out the credit card debt immediately, that shite will weigh you down.
Then fully the emergency fund with 3-6 months of expenses.
Then throw $1500+ whatever your monthly credit card payment was at the student loans. At the same time, put $500 into a Roth. (Annual Contribution limit increases to $6000 per person in 2019)
Your car payment is not a big deal right now. But once you're done knocking out the student loans, fully fund the Roth for your spouse and then knock the car out too.
Once the car is knocked out, you have an extra $1000 + (way more actually because you have no payments on debt) in your budget every month. I'd set aside whatever your car payment was every month for a new car fund. (I do this, I put $450/month in a taxable account with American funds, C-shares, no front load. You don't have to put it in mutual funds, especially if you're gonna be buying a car soon. Just do a money market if you want.) Buying a new car is more fun when you can just write a check, trust me.
That's what I would do.
Posted on 11/9/18 at 12:47 pm to Tigerfan56
Follow the Ramsey plan and get rid of your debt before bumping up retirement savings.
You are guaranteed a 4-7% return on your student loan payments. If I could guarantee a steady 4-7% return on an investment with no decrease almost everyone here would get in on it.
You are guaranteed a 4-7% return on your student loan payments. If I could guarantee a steady 4-7% return on an investment with no decrease almost everyone here would get in on it.
This post was edited on 11/9/18 at 12:53 pm
Posted on 11/9/18 at 2:13 pm to Tigerfan56
Tell you what, pay off all debt and see how that feels. If it sucks, please go back and borrow to previous levels. Sometimes its more than what may optimize in the long run. Debt free here for over ten years and there's no looking back. [Proverbs 22:7] "The rich rules over the poor, And the borrower is servant to the lender."
Posted on 11/9/18 at 2:48 pm to weagle99
quote:
You are guaranteed a 4-7% return on your student loan payments. If I could guarantee a steady 4-7% return on an investment with no decrease almost everyone here would get in on it.
The fault in your logic is its not compounding like retirement savings
Posted on 11/9/18 at 3:58 pm to Mingo Was His NameO
quote:
The fault in your logic is its not compounding like retirement savings
Wait, are you suggesting that interest on debt doesn't compound?
Posted on 11/9/18 at 4:07 pm to Vols&Shaft83
Simply no not all debt.
His student loans is more than likely compounded interest while his car note is more than likely simple interest. this is even more reason to not speed up the payment on your 2% car loan.
Student loans may make more sense to pay off now depending on what you can or can not get back interest wise on your taxes.
His student loans is more than likely compounded interest while his car note is more than likely simple interest. this is even more reason to not speed up the payment on your 2% car loan.
Student loans may make more sense to pay off now depending on what you can or can not get back interest wise on your taxes.
This post was edited on 11/9/18 at 4:08 pm
Posted on 11/10/18 at 7:08 am to Mingo Was His NameO
quote:
The fault in your logic is its not compounding like retirement savings
Sure, but your retirement savings can have a negative return. 4-7% on the loan is guaranteed.
This post was edited on 11/10/18 at 7:14 am
Posted on 11/10/18 at 7:30 am to HYDRebs
quote:
Simply no not all debt.
His student loans is more than likely compounded interest while his car note is more than likely simple interest. this is even more reason to not speed up the payment on your 2% car loan.
Student loans may make more sense to pay off now depending on what you can or can not get back interest wise on your taxes
Which is pretty much why I suggested paying off the credit cards and student loans first.
Even if the 2% car note is compounding, 2% is not gonna grow very much in 2-3 years
Posted on 11/10/18 at 7:52 am to weagle99
quote:
Sure, but your retirement savings can have a negative return. 4-7% on the loan is guaranteed.
He's 28 years old, if his retirement has negative returns when he taps into it we're all fricked.
Posted on 11/11/18 at 7:32 am to Mingo Was His NameO
I had a disability occur out of the blue and my insurance only covered 60% of my income. The type of medical issue I had, the insurance only covered two years. I have two kids and wish I had paid off more of my debt when I had a chance. I ended up having to use retirement funds for daily living expenses until I finally recovered. Just something to think about...it happens every day even though most 20 year olds think they’re invincible.
Posted on 11/12/18 at 6:48 pm to weagle99
quote:But that’s not really accurate since student loan interest is tax deductible, which based in his information, means roughly he’ll only pay $72 dollars for every $100 dollars of interest, and for a 5.5% loan, his effective interest rate is more likely 4%. And paying $2000 early will save him maybe $4100 total, over the course of a 6 year loan.
Sure, but your retirement savings can have a negative return. 4-7% on the loan is guaranteed.
Most importantly, putting all $2,000 toward retirement savings means he won’t have a year to put into his Roth, that’s $12,000 he can’t make up. Considering he is only 28 and assuming he wants to retire in 32 years, not investing that 12,000 would result an opportunity cost (loss of principal and gains) of the following annualized returns at retirement:
6% return—$77,441 less
7% return—$104,583 less
8% return—$140,845 less
9% return—$189,160 less
10% return—$253,365 less
And considering he will still have at least $1,000 extra to put towards his the debt each month, he can easily maximize the benefits of both the Roth and paying off debt earlier, especially if he puts it towards the higher interest debt first.
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