Funding Roth IRA while taking out loans: Yay or nay?

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lurker2013

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MS1 here. I suspect I should liquidate my funds, but I wanted to double check.

No undergrad debt. 30k grad school debt (mix of perkins, sub stafford and 6.8% unsub stafford). Borrowing 100% for medical school (~70k/yr) (mix of perkins, sub stafford, 6.8% unsub stafford, and 8.5% grad plus).

I have ~8k in a brokerage account, and I do not have any kind of retirement account. Should I open and max out a Roth IRA this year, or should I take the 8k and pay down loans/borrow less? When I look at historical trends, I could expect a 10% return in the market and funds put in a roth could grow tax-free. But my grad plus loan is kind of daunting. So what is the smarter financial move?

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The point may be moot. Did you work this year? You can't contribute to a Roth IRA more than you earned.

However, to answer your question (which is essentially asking if you should buy on margin with an 8.5% interest rate,) my personal opinion is that it isn't worth it. That's assuming you use the $$$ to take out LESS of an 8.5% interest loan.
 
The point may be moot. Did you work this year? You can't contribute to a Roth IRA more than you earned.

However, to answer your question (which is essentially asking if you should buy on margin with an 8.5% interest rate,) my personal opinion is that it isn't worth it. That's assuming you use the $$$ to take out LESS of an 8.5% interest loan.

Concur. The mathematical backup for other finance geeks is that 8.5% is essentially a guaranteed rate for debt that you'd incur, whereas the 10% rate of return on the stock market has a lot of risk involved, aka a high standard deviation on this rate of return. In practical terms, the risk means that if you averaged 10% per year but the market tanked a year before you retired, you're in bad shape.

The more appropriate rates to compare would be your "guaranteed" debt rate of 8.5% versus a "guaranteed return" rate which may be the rate if you invest in government debt, or maybe a diversified corporate bond fund. The return on those investments would be far below 8.5%, ergo I'd concur with Sol that the best financial option would be to take out less 8.5% loans and use the funds to pay for school.

per the "risk return" paradigm, there will always be investments that "promise" high returns, think junk bonds or startup firms. But the higher the return promised, the higher the implied risk that you are accepting.
 
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Agree with the last two posters. If you look at compound interest, the amount of lost income you have by not putting $5k/ year into an IRA for 5 years at the beginning of your career is devastating... but this is the price of med school. Your salary as a physician should help you catch up with your working friends who have (hopefully) been maxing contributions since graduation.
 
lurker2013,

Before you do anything, you may want to familiarize yourself with roth ira taxation and withdrawal rules.

http://www.rothirarules.net/roth-ira-tax.htm
http://www.rothirarules.net/roth-IRA-Rollover.htm
http://www.rothirarules.net/roth-ira-withdrawal.htm

Good Luck!;)

MS1 here. I suspect I should liquidate my funds, but I wanted to double check.

No undergrad debt. 30k grad school debt (mix of perkins, sub stafford and 6.8% unsub stafford). Borrowing 100% for medical school (~70k/yr) (mix of perkins, sub stafford, 6.8% unsub stafford, and 8.5% grad plus).

I have ~8k in a brokerage account, and I do not have any kind of retirement account. Should I open and max out a Roth IRA this year, or should I take the 8k and pay down loans/borrow less? When I look at historical trends, I could expect a 10% return in the market and funds put in a roth could grow tax-free. But my grad plus loan is kind of daunting. So what is the smarter financial move?
 
I'm in a similar position minus the grad school debt. Right now i'm accumulating debt at the alarming (really, especially considering the rates you can get a mortgage for these days) rate of $42,700/year at 6.8%. Having loans at 8.5% certainly changes the scenario, but the fact is with a roth IRA you CAN'T play catch up when your income increases. The good thing about a Roth is that the interest accrues tax-free (all the better given a longer time frame), but the kicker is the income cap (i.e. say bye-bye to being able to contribute at all when you are an attending) and the contribution cap (currently at $5k/year). So while previous posters have pointed out the important, however unfortunate, fact that our student loans are at relatively high guaranteed rates of 6.8%/8.5%, you also cannot count on the ability to play catch-up with Roths in the future. Savings, yes, but Roth IRA savings, no.

As for me, I'm going to continue to max out my Roth contributions (wife is working, so I am eligible), while accumulating debt with the hope that I can pay off my interest before it is recapitalized at the end of 4th year. Even if I can't pay off the interest before it gets recapitalized, I hope to continue to contribute to the Roth through residency while making at least the interest payment (probably over $1,000/mo...ouch!) on my student loans.
 
I am a firm believer in the Roth IRA. Every intern should open one up and fund it to the max through each year of their residency.
 
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