Paying Interest vs Roth IRA?

[MDhasbeen]

Hello folks,

I'm a resident at present making an avg resident salary. I'm trying to weigh the pros and cons of paying off $3K of my student loans for a tax break in 2009 vs putting that much money into a Roth IRA which I heard we're not elligible for once we're making physician salaries. If it helps, my student loans are consolidated at a rate of 3.375% and I'm guessing my salary in psych will be in the $150k range once I'm actually working. Any thoughts appreciated and thank you in advance!

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[TMP-SMX]

Moved to Finance and Investment

 

[Sol Rosenberg]

Do you think you can earn more than 3.375% (actually less, because you will not pay taxes on the earnings) on the $$$? If so, go for the Roth. Otherwise, pay off the loan.

If it were me, I would put it in the Roth. 3.375% is essentially free money.

 

[MDhasbeen]

You'll have to excuse my ignorance, but in what ways would you recommend I earn more than 3.375% to make up the difference? Investments? CD? I guess I keep thinking I'll get taxed out of whatever difference I can make up, but everyone swears not to bother paying the loan interest back. At this point, I'm most desiring of a hefty tax credit for the year since I've already put down quite a lot for career-related expenses, and I'd really rather not have to settle for the standard credit.

 

[Sol Rosenberg]

You don't pay tax on the earnings in a Roth IRA. You will pay tax on your income that you contribute to the Roth IRA, but that is no different from what you would be using to pay back your loans -- both are after-tax $$$, so the discussion of taxes is irrelevant for your situation.

Long-term, you should be able to earn greater than 3.375% in any multitude of investments. Rule of thumb on the S&P 500 (index fund) is something like 10% per year on average (though definitely not recently!)

If you want a tax credit for this year (not sure why since you are still in a low tax bracket, so I would rather pay the lower tax rate on those $$$ now) you should look into contributing to a traditional IRA.

Though I haven't checked, I expect that CDs pay exactly diddly right now.

 

[The White Coat Investor]

Do whatever it takes to max out a Roth. You won't have that option again. You're not paying squat in taxes now, so get that after-tax money into a Roth.

 

[xanthines]

I agree that the Roth is best way to go, as I have one myself. However, I'd like to bring up another point. Apparently a lot of people are concerned that Obama, Congress, whoever will change their minds and tax you (again, essentially) on your retirement withdrawals, Roth or not.

Anyone want to weigh in on how secure the tax advantage of the Roth's are? Could Congress one day decide to tap into the retirement funds? Would it be legal? Do enough people have Roth IRA's to persuade against this idea if it ever comes up?

Inquiring minds want to know...

-X

 

[Sol Rosenberg]

I agree that the Roth is best way to go, as I have one myself. However, I'd like to bring up another point. Apparently a lot of people are concerned that Obama, Congress, whoever will change their minds and tax you (again, essentially) on your retirement withdrawals, Roth or not.

Anyone want to weigh in on how secure the tax advantage of the Roth's are? Could Congress one day decide to tap into the retirement funds? Would it be legal? Do enough people have Roth IRA's to persuade against this idea if it ever comes up?

Inquiring minds want to know...

-X

The bottom line is that Congress can do anything it wants -- no plan is safe: Tax rates can be increased such that you will take it in the shorts when you withdrawal from your tax-deferred plan, or they can blunt the benefits of Roth's by making the earnings not-as tax free.

Personally, I think the former is more likely than the latter, but in terms of $$$, there are WAY more total $$$ tied up in tax-deferred plans, so the voices lobbying for their benefits to be preserved would be WAY louder. However, my personal opinion/guess would be that, even in the worst case, any taxes on the Roth plans would only be applied to the earnings, nothing as egregious as double-taxing the contributions as you suggested. This would essentially turn them into tax-deferred plans.

However, again, the total number of $$$ in Roth plans isn't huge right now (though it might be after next year) so I would expect them to stay off the RADAR.

Just my opinion.....

 

[Terpskins99]

Hello folks,

I'm a resident at present making an avg resident salary. I'm trying to weigh the pros and cons of paying off $3K of my student loans for a tax break in 2009 vs putting that much money into a Roth IRA which I heard we're not elligible for once we're making physician salaries. If it helps, my student loans are consolidated at a rate of 3.375% and I'm guessing my salary in psych will be in the $150k range once I'm actually working. Any thoughts appreciated and thank you in advance!

I'm not sure about how much of a benefit you receive through your tax break, but from a pure investment perspective a Roth IRA is without a doubt the best option out there for residents.

Concerning the so-called income limits... interestingly enough, those limits will not exist for 2010 (one of the nice tax breaks George Bush left us). Whether or not it will remain the same for 2011 and beyond is anybody's guess. I assume the socialist/communist... er.. I mean democrats are going to attempt to replace the income limits asap. But I suspect Obama will consider keeping it around as it will leave more money available for the government to spend in the immediate future.

 

[DOctorJay]

Based on that 3.75% interest rate I'm going to assume that the OP is a resident a little farther along in training. I have a few loans at 2.75 and a few at 6.8 and 6.5. I'm accruing interest of course and am thinking about paying it down or sending monthly contributions so I can avoid the hit of capitalized interest before I go into repayment (I would really love to avoid paying interest on interest). Do you guys think it's still a good idea to put the cash into the Roth for now or should I be knocking out the accrued interest?

 

[xanthines]

I'm not sure how that page helps, since the rates are kind of out of date (despite being written in Feb '09). Savings accounts at 3.6% don't really exist anymore. Also, that link doesn't address the somewhat unique position of residents/physicians who have student debt larger than many mortgages. Despite the practically "free" money, it's hard to make payments on a resident's salary. It becomes less free when you go into forbearance and the interest capitalizes. Ouch!

As for the OP. My opinion is that the money should towards a Roth IRA as well. Might as well save for retirement now and let it start earning money (much like the way your student loan interest "earn" more money after being capitalized). Also, next year the salary cap on Roth's are going to be gone:

http://www.rothira.com/

Of course, Congress could go ahead limit them again...

 

[zeloc]

Will the interest capitalize? If so, I'm not convinced that a Roth IRA would be better than paying interest on interest in the future, in fact, I think that paying off the interest would come first. But if it won't capitalize, then definitely the Roth IRA.

 

[Sol Rosenberg]

Will the interest capitalize? If so, I'm not convinced that a Roth IRA would be better than paying interest on interest in the future, in fact, I think that paying off the interest would come first. But if it won't capitalize, then definitely the Roth IRA.

Do you mean compound? Even then, since your earnings compound as well, it simply comes down to how much you think you can earn on your savings (i.e. Roth IRA.) If you can earn more than 3.375% per year the Roth is a better deal. Though a bit tougher in these times, in general, I would suggest that a chimp throwing darts can do better than 3.375% per year.

 

[VILO]

Yeah, you want to get the after tax money into a Roth before you are put in a higher tax bracket.

 

[zeloc]

Do you mean compound? Even then, since your earnings compound as well, it simply comes down to how much you think you can earn on your savings (i.e. Roth IRA.) If you can earn more than 3.375% per year the Roth is a better deal. Though a bit tougher in these times, in general, I would suggest that a chimp throwing darts can do better than 3.375% per year.

After a certain amount of time, unpaid interest becomes part of the principal, which is called capitalization, not compounding. But I see what you're saying, it would still make more sense to put it in a Roth IRA if the % is more than the interest on the loans.

MDhasbeen, how did you get 3.375% on your loans? You must have consolidated before they made a flat rate of 6-7% on all the student loans.

 

[Sol Rosenberg]

After a certain amount of time, unpaid interest becomes part of the principal, which is called capitalization, not compounding. But I see what you're saying, it would still make more sense to put it in a Roth IRA if the % is more than the interest on the loans.

MDhasbeen, how did you get 3.375% on your loans? You must have consolidated before they made a flat rate of 6-7% on all the student loans.

Yeah, I actually know what capitalized interest is, but it's not a fair comparison with compound interest because the account with compounded interest will always earn/cost more. Put another way, even if the interest rate on the savings account (or ROTH IRA, or whatever) was a bit LOWER than that of a loan with CAPITALIZED interest, you could still come out ahead by putting money into the savings account, rather than paying off the loan.

 

[Lonestar]

put your money in a roth IRA. This is a no brainer.

As far as which stocks to pick, pick the most stable ones you know and give one of the highest dividends.

I will start you off: Try VZ (Verizon) and Altria (i.e. Phillip Morris). Both of these companies pay a 6% dividend per year regardless of what happens to its stock price.

Think about it. Dividend paying stocks are the way to go. OR you could put your money in a S&P 500 index mutual fund. Either way, you will come out ahead.

 

[dsherida]

Would you guys mind chiming in on my situation? I graduate in May and my loans are at 6.8%. My plan was to pay around $500 a month towards the interest while I put them in Mandatory Forebearance (we can't defer anymore). Would I be better off to put that into a Roth IRA (~5-6k/yr) throughout residency or pay down the interest...

Correct me if I am wrong, but I could withdraw that $$$ I put in the Roth if I needed it for some reason before retirement tax free correct? Just wondering if I should tuck some away in a savings acct as well for emergency type funds?

Thanks for your thoughts, I really appreciate it!

 

[Sol Rosenberg]

Would you guys mind chiming in on my situation? I graduate in May and my loans are at 6.8%. My plan was to pay around $500 a month towards the interest while I put them in Mandatory Forebearance (we can't defer anymore). Would I be better off to put that into a Roth IRA (~5-6k/yr) throughout residency or pay down the interest...

Correct me if I am wrong, but I could withdraw that $$$ I put in the Roth if I needed it for some reason before retirement tax free correct? Just wondering if I should tuck some away in a savings acct as well for emergency type funds?

Thanks for your thoughts, I really appreciate it!

Statistically, I think you're in even-money territory here. I wouldn't assume that you will do better than 6.8% per year (unlike the OP who was at ~3.5% or something like that) in a Roth, though it is definitely possible. So, my opinion is to do whatever feels best to you. I don't think you are talking a big difference in the bottom line either way. But, that's just my opinion.

 

[bjackrian]

Also, if you can afford $500/month, you should consider interest based repayment. They take 15% of your adjusted gross income less the poverty line for your family size and use that as your payment. Any outstanding balance is forgiven after 25 years (for everyone) or 10 years (for 10 years of work for a non-profit or government agency). Obama proposed decreasing the payment to 10% and changing the loan forgiveness to 20 years for everyone as part of the state of the union.

 

[Old_Mil]

Hello folks,

I'm a resident at present making an avg resident salary. I'm trying to weigh the pros and cons of paying off $3K of my student loans for a tax break in 2009 vs putting that much money into a Roth IRA which I heard we're not elligible for once we're making physician salaries. If it helps, my student loans are consolidated at a rate of 3.375% and I'm guessing my salary in psych will be in the $150k range once I'm actually working. Any thoughts appreciated and thank you in advance!

If your loans are consolidated at 3.375% *FIXED* I'd consider the roth. Otherwise, if the rates are variable, pay down those loans as fast as you can. Our nation and its currency does not exist in a vacuum. One of the side effects of the out of control government spending going on now is that it is going to become more expensive for the government to borrow money. This will ultimately force the federal reserve to raise interest rates despite its stated desire to keep them low. If it does not, the hyperinflation that will occur in our economy because of a cratering dollar will be scary to see.