Student Loan strategy

[Aznfarmerboi]

Advertisement - Members don't see this ad

............ borrowing from your 401k money to pay off student loan.

This is one of the options that I see less suggested. When used correctly, I think it can be a powerful tool.

Most 401k general loans have interest rates around 4 to 5 percent and that interest is paid into your account. Student loan interest rates varies but standard was 6.8 percent when I graduated.

You win both ways.

1. 6.8 percent interest charged is after tax money so you are guaranteed a 6.8 percent tax free return!

2. If you take out small amounts to pay off higher interest loans (10k for first loan), you are diversifying your 401k portfolio. The return is less (4-5 percent), but no less than investments in bonds. The stock market is at an all time high anyway so its doesn't have much room to go up anyway, and a lot of room to come down.

3. By having money deducted from your paycheck, you are forced to pay off the student loan in x amount of money. If you took out 10k from your 401k, at 4.25 interest, you are looking at a deduction of 390 per paycheck which is not noticeable.

4. It raises your credit score because it reduces your debt. While this also reduces your income, your credit score does not factor in your income.

The catch is if you are fired, you are forced to repay the loan asap. The trick is to take out a loan for the amount that you think you can repay within 90 days.

 

[BMBiology]

4. It raises your credit score because it reduces your debt. While this also reduces your income, your credit score does not factor in your income.

This is not true. The utilization ratio depends on how much you spend vs your credit line. It has nothing to do with the amount of your student loans.

The catch is if you are fired, you are forced to repay the loan asap. The trick is to take out a loan for the amount that you think you can repay within 90 days.

The question is how often can you take a loan from your 401 k. The stock market goes up and down so you can actually lose money. What if you take out a loan and then there's a huge stock market rally? Then you would miss out on the gains. No one knows right? If we did, we wouldn't worry about our student loans.

Taking a loan from your 401 k can be an option but it can also be risky. You can also buy stocks on margin and use the potential gain to pay off your student loans but again, it's also risky.

 

[BMBiology]

I think the only sure way is to cut down your cost. That's something you have control over. Use the saving to pay off your student loans.

 

[Ackj]

Isn't there a big tax penalty for taking money out of a 401k before a certain age?

 

[boriqua]

I don't know **** about 401k's but i'm 100% certain there's a penalty for premature withdrawal

 

[FlavyFlav]

You can't withdrawal early without penalty (excepting hardship), but you are allowed to take out a loan that has to be paid back without penalty (I'm assuming the loan would be tax free?). The only question is how many of these loans are you allowed to take out in a time period, and would the student loan repayment strategy be a better investment than leaving that money in your 401k in order to grow.

 

[Aznfarmerboi]

This is not true. The utilization ratio depends on how much you spend vs your credit line. It has nothing to do with the amount of your student loans.



The question is how often can you take a loan from your 401 k. The stock market goes up and down so you can actually lose money. What if you take out a loan and then there's a huge stock market rally? Then you would miss out on the gains. No one knows right? If we did, we wouldn't worry about our student loans.

Taking a loan from your 401 k can be an option but it can also be risky. You can also buy stocks on margin and use the potential gain to pay off your student loans but again, it's also risky.

Stock markets go up and down. A good 401k is diversified between aggressive funds, and capital preservation funds. Taking out a 401k loan and guaranteeing yourself 10 percent return (6.8 percent plus what you would have to pay in tax) can be a good move....

Nobody can see their 401k gaining another 10 percent in the next year...., so borrowing a small amount (10k out of 100k) will allow you to take capital out of your riskier 401k assets and give you a healthy guarantee return that is better than bonds (3-5 percent).

 

[N974]

The money you use to pay back your loan is not tax free. Also rethink the true costs. Remember YOU are paying yourself the 4%, that is still a cost. You're not making that $ from someone else. Sure it's in your account but its $ you had to take from somewhere else. If it was invested you would MAKE that money in addition to.

Say you pay $70 in interest on your student loan and would have to pay $40 to yourself in interest on the 401k loan. If left alone you would be losing $30 a month if the market returned 4%, the same rate as your 401k loan. You would pay $70, but make $40 in the market, so a net $30 loss.

If you take the 401k loan you "save" $70 in student loan interest, but lose $40 in interest income, so your net cost is the same. If the market returns 5% them you lose money. The only real benefit is there is some additional dollar cost averaging, but that is handicapped since you pulled the money OUT to begin with.

Timing the market is never a good thing. 2 years ago people thought the same thing about the market. Using a 401k loan is a tool, but a pretty poor one. Kind of like a rock can be used as a hammer, effective but really not the best option.

It's an idea, but nowhere near a great one. If diversification is what your claiming to accomplish, there are better ways to do that within your 401k fund choices.

 

[Aznfarmerboi]

The money you use to pay back your loan is not tax free. Also rethink the true costs. Remember YOU are paying yourself the 4%, that is still a cost. You're not making that $ from someone else. Sure it's in your account but its $ you had to take from somewhere else. If it was invested you would MAKE that money in addition to.

Say you pay $70 in interest on your student loan and would have to pay $40 to yourself in interest on the 401k loan. If left alone you would be losing $30 a month if the market returned 4%, the same rate as your 401k loan. You would pay $70, but make $40 in the market, so a net $30 loss.

If you take the 401k loan you "save" $70 in student loan interest, but lose $40 in interest income, so your net cost is the same. If the market returns 5% them you lose money. The only real benefit is there is some additional dollar cost averaging, but that is handicapped since you pulled the money OUT to begin with.

Timing the market is never a good thing. 2 years ago people thought the same thing about the market. Using a 401k loan is a tool, but a pretty poor one. Kind of like a rock can be used as a hammer, effective but really not the best option.

It's an idea, but nowhere near a great one. If diversification is what your claiming to accomplish, there are better ways to do that within your 401k fund choices.

I am confused... you are still making money here. If you are paying 70 dollars in interest, you are paying 70 dollars to the bank. You can be saving 30 dollars in your pocket, and guaranteeing a 4 percent return in your 401k. This is a total of 70 dollars saved.

If the market returns 5 percent, you will still be making money. The 30 dollars that you saved makes up for that return especially since you do not have to pay taxes on your return for that.

It is a powerful tool because it is a win-win. You can also increase your contribution rate so that the 30 dollars you saved goes into your 401k.

Lastly, I don't know if you are a pharmacist or a financial advisor. I know that based on my income, and my employee's match rate.. with an annual return rate of 8 percent over 35 years, I will have about 5 million dollars in my account. That is 5 million dollars that I am forced to withdraw from my account through 5 years after I reach 65. Nobody can predict the future but I am pretty sure that we will be paying more taxes later on 1 million a year withdrawal rate. It is better to have that income money, and invest it.

I actually don't even care about my 401k and only put money into it because of my employee's 5 percent match. Most of us would be better using the money to pay off our student loans with 6.8 interest if not for the match.

 

[koercive]

Another strategy:

Tell parents to refinance some of their equity on their property. Get 3.5% to 4% rate on a 15 year mortgage with excellent credit. Use that money to pay your student loan in full.

Pay back your parents.

Of course not everyone has this option (including me)

 

[BMBiology]

This is a reasonable strategy but keep in mind that it cost money to refinance and if for some reason you can't find a job, then the house is at risk

 

[koercive]

This is a reasonable strategy but keep in mind that it cost money to refinance and if for some reason you can't find a job, then the house is at risk

But you can actually declare bankruptcy on your home! (jk don't screw over your parents)

On a side note, I find it funny that you can declare bankruptcy on gambling debt, asinine credit card purchases, etc.... but not student debt. If they can garnish SS and wages for student debt, I would appreciate 3% interest rates. Modern day indentured servitude

 

[pezdispenser]

That is 5 million dollars that I am forced to withdraw from my account through 5 years after I reach 65. Nobody can predict the future but I am pretty sure that we will be paying more taxes later on 1 million a year withdrawal rate. It is better to have that income money, and invest it.

Why are you withdrawing all of your 401(k) in 5 years after you reach 65? Are you talking about the Required Minimum Distributions? My interpretation was that you have to take RMDs after 70.5 y/o at a rate starting at 3.65% of your balance, but the percentage increases each year. It would be 6.75% at 85 y/o.

Still, 3.65% of 5 mil is $182k. That would probably put you over the limit where you have to pay income tax on your Social Security benefit, so combining SS + 401(k) withdrawals would put you in quite a high tax bracket. That's why I agree with you in that I also don't see much tax benefit from 401(k) and you may have better things to do with the money when you are young like paying off loans and investing.

 

[Aminex]

Isn't there a big tax penalty for taking money out of a 401k before a certain age?

This. My parents keep taking early disbursements because "they have to". I'm not convinced of that but when I do their taxes for them, it's murder. Last year, they took 10K out and I got to see the infamous "double penalty" in action. They paid a 25% tax upfront on the disbursement and once that extra 7,500 got factored into income, it changed their tax bracket. They wound up owing 1,000 so they paid 3,500 to get 7,500 at a total penalty of 47% all said and done.
Folks in the know may have some next-level strategies that I'm unaware of but from where I'm standing, sticking your hand into the 401(k) pot at any time other than the defined period is like sticking it in a beehive. You'll get some honey but your hand will be stung all to *#&@

 

[MindOverMatter]

Instead of posting yet another student loan thread, I decided to randomly bump one to post this question. First a little background:

• I'm currently in the first year of IBR (250k loan, 125k salary, how I got to this miserable state is not the point of the question).

• 
  The government is paying the outstanding interest that my monthly payments don't cover. I'm making no dent in the principal.

• 
  My plan is to get off IBR within the first 3 years that the outstanding interest is paid and jump back into a standard payment plan extended most likely to 15 years.

• 
  I have built up a good cushion this year while on IBR since my payments have been dramatically lowered.

Should I continue on IBR for the full 3 years while saving up money, or just jump right back into the standard payment plan now and begin that payment structure?

I don't really see the point of getting out of IBR now since the outstanding interest is covered by the government and will not be capitalized at the end of the 3 year period. Instead, I could continue to save up money for a home down payment or use it to pay off high interest loans while my current monthly payment is low.

The only reason I can see to change now is to be that much closer to paying it off. While that's obviously a valid reason, I think the idea of saving for a house is more important in the short-term.

What do you think?

 

[Ackj]

Instead of posting yet another student loan thread, I decided to randomly bump one to post this question. First a little background:

• I'm currently in the first year of IBR (250k loan, 125k salary, how I got to this miserable state is not the point of the question).

• 
  The government is paying the outstanding interest that my monthly payments don't cover. I'm making no dent in the principal.

• 
  My plan is to get off IBR within the first 3 years that the outstanding interest is paid and jump back into a standard payment plan extended most likely to 15 years.

• 
  I have built up a good cushion this year while on IBR since my payments have been dramatically lowered.

Should I continue on IBR for the full 3 years while saving up money, or just jump right back into the standard payment plan now and begin that payment structure?

I don't really see the point of getting out of IBR now since the outstanding interest is covered by the government and will not be capitalized at the end of the 3 year period. Instead, I could continue to save up money for a home down payment or use it to pay off high interest loans while my current monthly payment is low.

The only reason I can see to change now is to be that much closer to paying it off. While that's obviously a valid reason, I think the idea of saving for a house is more important in the short-term.

What do you think?

Couldn't you stay on IBR and make extra payments that would affect the principle? That way you still get the benefits of low payments, you can still do some saving, but you can throw some at the principle when you have extra cash. Or do you have so much interest accrued already that you'd take a few years to even get down to principle payments?

 

[BMBiology]

Instead of posting yet another student loan thread, I decided to randomly bump one to post this question. First a little background:

• I'm currently in the first year of IBR (250k loan, 125k salary, how I got to this miserable state is not the point of the question).

• 
  The government is paying the outstanding interest that my monthly payments don't cover. I'm making no dent in the principal.

• 
  My plan is to get off IBR within the first 3 years that the outstanding interest is paid and jump back into a standard payment plan extended most likely to 15 years.

• 
  I have built up a good cushion this year while on IBR since my payments have been dramatically lowered.

Should I continue on IBR for the full 3 years while saving up money, or just jump right back into the standard payment plan now and begin that payment structure?

I don't really see the point of getting out of IBR now since the outstanding interest is covered by the government and will not be capitalized at the end of the 3 year period. Instead, I could continue to save up money for a home down payment or use it to pay off high interest loans while my current monthly payment is low.

The only reason I can see to change now is to be that much closer to paying it off. While that's obviously a valid reason, I think the idea of saving for a house is more important in the short-term.

What do you think?

You can stay on IBR but keep on paying as much as possible toward the principle. If you stayed on IBR, not only will you be paying back all of the principle but you will also be paying a mountain of interest over a 20-25 year period.

 

[68quebec]

http://www.goarmy.com/amedd/health-care/benefits.html

hope this helps 😎

 

[MindOverMatter]

Couldn't you stay on IBR and make extra payments that would affect the principle? That way you still get the benefits of low payments, you can still do some saving, but you can throw some at the principle when you have extra cash. Or do you have so much interest accrued already that you'd take a few years to even get down to principle payments?

Good point. That approach makes even more sense. I do have a lot of interest accrued, but I still don't see a reason to get off IBR when I can direct the extra money specifically at the highest interest loans first.

A quick calculation of my situation shows the following:

IBR first payment: $1353.06
IBR last payment: $2750.50

Fixed monthly payment (15-year plan): $2261.07

Total Amount Paid on IBR: $581,963.62
Total Interest Paid on IBR: $331,963.62

Total Amount Paid on 15-year fixed: $406,992.82
Total Interest Paid on 15-year fixed: $156,992.82

Source: http://www.finaid.org/calculators/scripts/ibr.cgi

So by staying on IBR, I have an extra ~$900/month (this year) to put directly toward my highest interest rate loans (based on what my fixed payment would be on the standard repayment plan). In reality, I will pay even more than that.

Am I missing something here?

 

[BMBiology]

Fixed monthly payment (15-year plan): $2261.07

Total Amount Paid on 15-year fixed: $406,992.82
Total Interest Paid on 15-year fixed: $156,992.82

Honestly? About 40-50% of your take home salary will go toward your student loans for the next 15 years. That's assuming there is no period of unemployment. That's not easy.

You would also need to save 3-6 months of emergency funds. I think it would be financially difficult (and unwise) for you to buy a house (a mortgage may be difficult to get too since so much of your salary is already going toward your student loans).

 

[BMBiology]

IBR first payment: $1353.06
IBR last payment: $2750.50

Total Amount Paid on IBR: $581,963.62
Total Interest Paid on IBR: $331,963.62

This is exactly why I don't like IBR. The interest you will be paying is greater than the original principle (vs. 250 k).

 

[SoylentGreen]

Stay on IBR. It's a no brainer. They pay some of your interest and it allows you to focus on higher-interest loans. The schedules you gave were assuming you make minimum payments. There's no rule that you have to pay only the minimum. I pay $4-5K per month on IBR right now when my minimum payment is under $300, while they pay the interest on the $30K or so that is subsidized.

You just have to have the discipline to follow a budget without actually *having* to follow it.

I will be sad when IBR goes away for me at the end of the year.

 

[All4MyDaughter]

Stay on IBR. It's a no brainer. They pay some of your interest and it allows you to focus on higher-interest loans. The schedules you gave were assuming you make minimum payments. There's no rule that you have to pay only the minimum. I pay $4-5K per month on IBR right now when my minimum payment is under $300, while they pay the interest on the $30K or so that is subsidized.

You just have to have the discipline to follow a budget without actually *having* to follow it.

I will be sad when IBR goes away for me at the end of the year.

After I have to reapply for IBR next year, I'm switching to the extended repayment plan. It will be a lower payment each month than IBR is.

 

[SoylentGreen]

Yes, if you want the lowest possible monthly payment IBR may not be the way to go. Most people should be paying at least 15% of their disposable (above poverty line) income, which is what IBR requires, but there are some scenarios in which it would make sense to go for the lower payment, and I'm sure you have a good reason. But most people would be better off making the higher payment and getting the interest on the subsidized loans taken care of, because they'll end up paying less in the long run.

Even for people who do want the lowest possible payment, recall that your income is calculated based on last year's tax returns. I applied for IBR in 2011, shortly before my loan's grace period ended, and, based on my 2010 tax returns when I was a student, my monthly payment was $0 in 2012. Now it's based on my 2011 tax returns, when I was a student half the year, so it's still considerably less than the monthly payment on the extended plan would be. Only in December, 2.5 years after graduation, will I have to make payments based on a pharmacist's full salary.

Unless you made a lot of money somehow during pharmacy school, this will apply to most people, so they should still do IBR for the first year or two.

 

[All4MyDaughter]

Yes, if you want the lowest possible monthly payment IBR may not be the way to go. Most people should be paying at least 15% of their disposable (above poverty line) income, which is what IBR requires, but there are some scenarios in which it would make sense to go for the lower payment, and I'm sure you have a good reason. But most people would be better off making the higher payment and getting the interest on the subsidized loans taken care of, because they'll end up paying less in the long run.

Even for people who do want the lowest possible payment, recall that your income is calculated based on last year's tax returns. I applied for IBR in 2011, shortly before my loan's grace period ended, and, based on my 2010 tax returns when I was a student, my monthly payment was $0 in 2012. Now it's based on my 2011 tax returns, when I was a student half the year, so it's still considerably less than the monthly payment on the extended plan would be. Only in December, 2.5 years after graduation, will I have to make payments based on a pharmacist's full salary.

Unless you made a lot of money somehow during pharmacy school, this will apply to most people, so they should still do IBR for the first year or two.

Right. My first year of IBR was based on 2010 tax returns, when I was a student, and my current payment is based on my 2011 tax returns (end of school/beginning of residency). If I have to recertify with my 2012 tax returns, the payment will go up considerably because we made so much money last year. But I think I might avoid that, because my loans were recently transferred to a new servicer, and they gave me an automatic re-certification that's good until 8/2014. So I can apply with my 2013 taxes, and they will be lower than 2012. For now, I'm just going to keep paying my nice small payment and putting away extra money to make bigger payments when I can. That approach has worked so far for me.