I'm a graduating medical student, and have ~$220,000 in student loans. The majority of this (~$180,000) is in federal student loans at 6.8%, with the rest being at a lower rate (4-5%). I also have ~$20,000 in a Roth IRA which I've been contributing to for about 15 years. Should I close out the Roth IRA to pay down my student loans? I'm starting residency in a few months which pays ~$55,000/yr, and after cost of living I won't be able to contribute much over the minimum payments to my loans until after residency.
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1To add a bit more, I'll almost certainly be above the income limit to contribute to a Roth after I graduate from residency. That makes me even less sure what to do with the account - close it now, stop contributing but keep it around, try to contribute a little bit now at the expense of my student loans?– Austin PMay 4, 2014 at 15:22
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2 Answers
I would not suggest closing out your Roth IRA --
Couple of reasons for that -
1) Since you've been contributing to it for 15 years, your investments have probably grown, seen dividends, etc. If you close it out, you will owe taxes and be slapped with a 10% penalty on the growth (money you didn't contribute). That's quite a waste of hard earned money.
2) While your income may exceed the contribution limit of a Roth, you could do what's called a 'backdoor' Roth - which is really just converting your after tax contributions into an IRA into a Roth IRA.
3) Given the length of your contributions your Roth IRA is seasoned (5 years) This allows you to use up to 10k for your house if you chose. (Usually not an option people use)
Other than that, consider paying off the student loans with the highest interest first.
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2+1 for the well-thought out answer. 6.8% is tough. Would you borrow at 6.8% to invest today? I think withdrawing just the deposits, no tax, no penalty, is a good compromise. May 4, 2014 at 15:40
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6.8% is pretty tough and withdrawing just the contributions would be a good compromise. The decision would be dependent on the individual person. Historically the market will return 7% on average. Austin also has enough debt where the student loan interest deduction max is still there if he pays it down faster ($2,500 of interest). The only other consideration is by not withdrawing the contributions he does have a last resort emergency fund.– AbrahamMay 4, 2014 at 15:49
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10%, actually, which supports your leaning towards staying the course, and the thought that keeping it for emergency purposes is not popular, but one I agree with. May 4, 2014 at 15:52
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1I was under the impression that the Roth could also be used to pay for education without incurring the 10% penalty -- am I misunderstanding that, or does that not apply when I'm using it to retrospectively pay off educational loans?– Austin PMay 4, 2014 at 16:20
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Usually doesn't include repayment of student loans. You could withdraw it tax-free/ penalty free for the actual educational expense (tuition, room and board, books, etc.)– AbrahamMay 4, 2014 at 16:29
The key thing to consider in a question like this is, What return am I getting on my investment versus what interest am I paying on the loan? If the investment returns more than what you're paying on the loan, than it makes sense to keep the investment and pay off the loan with other income. If the investment returns less, than it makes sense to cash it out to pay off the loan.
One complicating factor is taxes. In the case of an IRA, you're not paying taxes on the profits. You do pay a tax penalty for an early withdrawal. Those are both factors that tend to make keeping the money in the IRA more desirable.
And of course, if the choice is between keeping your investment and defaulting on the loan, you probably want to close out the investment.
I don't know what return you're getting on your IRA, but it's probably more than 6.8%. I'd have to check but I think my retirement funds got over 20% last year. If you're not getting 6.8%, you might want to investigate switching to another investment fund.
I'm sure there's a lot I don't know about your situation, but I'd think that keeping the IRA would be a better plan. If you can't add to it for some time well you get these debts paid off, well, that's how it is.
