Rules of financing / planning for retirement

Quote from Cougarstang : I hadn't thought of that, nor had I considered state taxes. Could you provide an example with round numbers?

I'm in a pretty high tax bracket, but my effective rate is about 14 percent.

Depending on your situation, yours may be a lot lower than your marginal rate (kids, mortgage, etc).

Quote from vaultaddict : I'm in a pretty high tax bracket, but my effective rate is about 14 percent. Depending on your situation, yours may be a lot lower than your marginal rate (kids, mortgage, etc).

Ah yes. I understand the effective tax rate. I was referring to calculating the "effective" rate on your student loan. Perhaps I should give a simplified scenario:

Suppose your effective tax rate is 20%. Also suppose you have a student loan with a balance of $1000 at 3.5% and you also have $1000 to invest. On January 1st you're deciding whether to pay it off in full for a guaranteed "return" of 3.5% (by avoiding $35 in interest). Or you can invest it in a vehicle that will likely give you a return of 3%, which gives you $30 in interest (for simplicity, let's assume this rate already factors taxes on interest for next year).

At first glance, you should pay off the loan since you would be saving more than you're earning. However, that $35 would normally be deducted off your taxable income and is taxed at an effective rate of 20%. That is, you would lose the $7 tax savings if you don't pay student loan interest and claim it as a deduction. So even though you've avoided paying your creditor $35 in interest by paying it off on January 1st, if you invested $1000 and only earned $30 in interest, you would owed $35 to your creditor, but saved an additional $7 in taxes, making it as if you made $2.

So in the "don't pay the loan off" scenario we're really looking at 3.5 - (3.5*0.2) = 2.8% overall loss of your own money, which can be viewed as an effective rate of student loan. With the above figures. Yet if you can invest your money elsewhere and beat 2.8%, it would be worth it to pay only the minimum amount on your student loan. With the above figures, this is equivalent to losing $0 if you pay off the loan in full on Jan 1, or losing $28 then earning $30 if you don't pay but invest your money.

So I think this is what my original question was referring to. When Serus said "I don't agree on paying off a mortgage or student loan if interest is below 3% after tax deductions", he was referring to the 2.8% figure in my example above, not the 3.5% figure, right?

My apologies for the lengthy, convoluted order of thoughts. It's been a long day.

Quote from Cougarstang : Ah yes. I understand the effective tax rate. I was referring to calculating the "effective" rate on your student loan. Perhaps I should give a simplified scenario: Suppose your effective tax rate is 20%. Also suppose you have a student loan with a balance of $1000 at 3.5% and you also have $1000 to invest. On January 1st you're deciding whether to pay it off in full for a guaranteed "return" of 3.5% (by avoiding $35 in interest). Or you can invest it in a vehicle that will likely give you a return of 3%, which gives you $30 in interest (for simplicity, let's assume this rate already factors taxes on interest for next year). At first glance, you should pay off the loan since you would be saving more than you're earning. However, that $35 would normally be deducted off your taxable income and is taxed at an effective rate of 20%. That is, you would lose the $7 tax savings if you don't pay student loan interest and claim it as a deduction. So even though you've avoided paying your creditor $35 in interest by paying it off on January 1st, if you invested $1000 and only earned $30 in interest, you would owed $35 to your creditor, but saved an additional $7 in taxes, making it as if you made $2. So in the "don't pay the loan off" scenario we're really looking at 3.5 - (3.5*0.2) = 2.8% overall loss of your own money, which can be viewed as an effective rate of student loan. With the above figures. Yet if you can invest your money elsewhere and beat 2.8%, it would be worth it to pay only the minimum amount on your student loan. With the above figures, this is equivalent to losing $0 if you pay off the loan in full on Jan 1, or losing $28 then earning $30 if you don't pay but invest your money. So I think this is what my original question was referring to. When Serus said "I don't agree on paying off a mortgage or student loan if interest is below 3% after tax deductions", he was referring to the 2.8% figure in my example above, not the 3.5% figure, right? My apologies for the lengthy, convoluted order of thoughts. It's been a long day.

Yes.

But really, if you're putting this much effort in to it, you're gonna be winning like crazy no matter the decision you make here.

Quote from vaultaddict : Yes. But really, if you're putting this much effort in to it, you're gonna be wining like crazy no matter the decision you make here.

? What's wrong with putting a small amount of effort into understanding a solid strategy for student loan repayment with disposable income?

Quote from Cougarstang : ? What's wrong with putting a small amount of effort into understanding a solid strategy for student loan repayment with disposable income?

I'm certainly not being critical.

I was applauding your effort.

And I meant to type winning.

Looks like you thought I meant whining.

Quote from vaultaddict : And I meant to type winning. Looks like you thought I meant whining.

Haha! I did think you wrote whining

Thanks again

Quote from Altron1000 : Thanks Serus. I am currently single and have a decent job. I live frugally and was able to save a lot each year. You are correct, when i said debt, i mean bad debt. Finished all the student loan already and recently bought a house.For mortgage, i do intended to pay it off over 15 years. I have already saved up an emergency fund and have been able to max Roth, max 401k and still have a little bit of funds left over aver all living expenses and occasional entertainment. Was just wondering what should be my next step. Probably life insurance??

No life insurance needed since you're single, unless someone else is dependent on your income. As stated, disability insurance may be beneficial, but it depends on your career and your employer may already provide some (mine gives 50% salary for LTD, and 26 weeks of 50% for STD).

Something I have been considering lately. My wife and I are planning for retirement around age 50. Only about 20 years from now. We are on pace, and we only intend on a partial retirement - we can't "not" work. We have to do something, so retirement would be more of a home business or charitable work without a need to work full time or make a lot of money.

Anyhow, in order to do that, we don't want to put all of our funds into a 401k, since those can't be accessed until almost 60 without paying a penalty.

It's something to consider if you plan on retiring early. The ROTH is still great since you can withdraw the principle at any time without penalty, so keep doing that. I would consider only putting enough into the 401k to drop into a lower tax bracket or to get the company match, and then go into a taxable retirement account.

Alternatively you could keep maxing both and contributing to a normal taxed account.