IRA/Student Loan Dilemma

[DigitalFrenchie]

Hey all, I'm looking for some advice in the dilemma I have.

My mother passed away a little while back and I was left with a traditional IRA valued at $90,000. I also have private student loan debt at about $80,000. We didn't make a sound FinAid decision at the time or explored our alternatives, but we didn't know any better and whats done is done...I just want the best outcome. I have been making the monthly payments on this loan via my yearly distribution from the IRA, taking out the years payments in one shot. The rates are low now, about 4%, but solely due the down economy. I'm sure they will balloon back to their high of just under 8% soon enough. The payments will jump to just over $500 in January. Up until now they have been about $250 on a "graduated payment plan".

Question: Do I close the IRA and use the proceeds to bring down the loan to a more manageable amount of $30k, which I could afford on my salary? (This includes the Fed and NY state taxes I know I will have to dish out.) I can't see me taking out $6k a year from the IRA solely to make the minimum payments as being a better alternative...but then again if I knew for sure, I wouldn't be here posting.

It makes me sick to think I have to do this because I know my mom worked hard to save this, but I know she would not want this debt lingering over me, either. I just need some guidance on this situation, as it has been eating at me for some time.

I appreciate any input and advice, thank you.

[TheStreetCeo]

It's hard to say unless we have abetter idea of your financial picture. For example do you have other income in the home, what other debt do you have if any at all? What retirement do you have saved up? stuff like that would help a lot. Without it, you'll get a lot of no don't do it answers.

[DigitalFrenchie]

It's hard to say unless we have abetter idea of your financial picture. For example do you have other income in the home, what other debt do you have if any at all? What retirement do you have saved up? stuff like that would help a lot. Without it, you'll get a lot of no don't do it answers.

No problem!

Well, I'm 23 years old and I work for a local government here and I make a decent income with gradual raises each year, with a top-out of a little over $90,000 in about 3.5 more years, though I make a little over half that at the moment. I also have a 50% pension I will collect after 20 years (18 to go). A portion of my income goes into funding that pension, while I contribute 4% to my own retirement accounts-2% 457 plan, 2% Roth. I plan on increasing that as my income rises. I'm single so it's just my income. I used the life insurance I received to cover all living expenses from the time my mother passed to the time I was able to get on my feet 2 years ago. I used the remainder as a down payment to purchase a coop here in NY and I have seen significant tax savings as a result. Besides my mortgage and the previously mentioned student loan, I have no debt as I only keep my credit card for emergencies. My credit is in the 700's. I have about $2,000 in savings I'm building up as an emergency account. I fund this through some side jobs here and there since I do not have much wiggle room with my current income, but I understand the importance of having such an account. Should I do what I mentioned in my question, the remaining loan balance would be covered by the additional $250 (give or take, after taxes) raise I would receive this January.

Thanks for a quick reply.

-Morgan

[TheStreetCeo]

Morgan, I think you are in a good situation based on the info I have. I would say that with your increase in income in three years why make a permanent decision by using the IRA money for what seems like a temporary problem? At 23 years old with 90k in an IRA you could potentially be in a great situation while continuing to fund it. You already are in a great position to have a rare start to a great retirement fund. If you use the money you will be closing the book on a lot of money. Remember, you aren't losing 80k to payoff your student loans you are losing the value of 80k in 30 years when you decide to retire. Google compound interest calculator and look at the first site. There you will see that you are losing $477,545 if you use that money to pay off your low interest student loan. 80k x 30 years a t6% interest with no additional payments = $477,545.

I would wait it out, keep your 90k, and make your payments. When your income increases use that oney to pay down your debt and keep your living expenses the same.

[jIM_Ohio]

what is your income now?
what is the IRA balance now?
how much are the required yearly IRA distributions?
what tax bracket are you in?
what is the balance on all student loans?
what is the interest rate on those loans?
what is the IRA invested in, and what have been past returns?

[jpg7n16]

what is your income now? a little over $45k
what is the IRA balance now? a little less than 90k
how much are the required yearly IRA distributions?
what tax bracket are you in?
what is the balance on all student loans? about 80k
what is the interest rate on those loans?
what is the IRA invested in, and what have been past returns?

The answers in blue were found in the posts above.

Using the charts at 2010 Tax Rate Schedules: Marginal Ordinary Income Tax Brackets for Year 2010

If claims standard deduction and 1 personal exemption, is borderline between 25% and 15% - likely barely into the 15% with the retirement deferrals, and interest deductions. But it is best to treat any withdrawals as being included in the 25% bracket. (As virtually any meaningful withdrawal would quickly push income back over the 34k hurdle)

Interest rate on the loans is a good question. IRA asset allocation is a good question. But past returns has no impact on the decision today.

[jIM_Ohio]

The answers in blue were found in the posts above.

Using the charts at 2010 Tax Rate Schedules: Marginal Ordinary Income Tax Brackets for Year 2010

If claims standard deduction and 1 personal exemption, is borderline between 25% and 15% - likely barely into the 15% with the retirement deferrals, and interest deductions. But it is best to treat any withdrawals as being included in the 25% bracket. (As virtually any meaningful withdrawal would quickly push income back over the 34k hurdle)

Interest rate on the loans is a good question. IRA asset allocation is a good question. But past returns has no impact on the decision today.

I was looking for current balances and more specific posts- started with 90k, but some withdraws were made.

80k of debt, but somehow if IRA were cashed out, that debt only sits at 30k, so the IRA balance is much less than 90, and the student loans have not been paid down as much as IRA has dropped. I sense there is more to this than info posted, so waiting on more info. I could not tell from wording if the 4% "return" was on the IRA or on the student loans (could be interpreted a couple of ways based on wording of post).

Past returns on IRA might be impacting the decision OP is "forcing" himself (herself?) to make now based on a year like 2008 which probably dropped any equity based IRA balance in half. I sense there is more info than posted, so asking for more info and trying to figure out mindset of the OP.

So I want more specific (current) information.

[DigitalFrenchie]

Morgan, I think you are in a good situation based on the info I have. I would say that with your increase in income in three years why make a permanent decision by using the IRA money for what seems like a temporary problem? At 23 years old with 90k in an IRA you could potentially be in a great situation while continuing to fund it. You already are in a great position to have a rare start to a great retirement fund. If you use the money you will be closing the book on a lot of money. Remember, you aren't losing 80k to payoff your student loans you are losing the value of 80k in 30 years when you decide to retire. Google compound interest calculator and look at the first site. There you will see that you are losing $477,545 if you use that money to pay off your low interest student loan. 80k x 30 years a t6% interest with no additional payments = $477,545.

I would wait it out, keep your 90k, and make your payments. When your income increases use that oney to pay down your debt and keep your living expenses the same.

I see how that makes sense, and playing with the numbers I really see it. It just stings to have to take out $6k a year just for those payments! Once I hit that top pay, I feel I should be able to allocate enough for the payments, so long as my living situation doesn't change for the worst or some unexpected high-expenses come up. I long for the day I can let this account sit pretty without having to worry about depleting it. Thank you for your advice

PS- I love your site.

I was looking for current balances and more specific posts- started with 90k, but some withdraws were made.

80k of debt, but somehow if IRA were cashed out, that debt only sits at 30k, so the IRA balance is much less than 90, and the student loans have not been paid down as much as IRA has dropped. I sense there is more to this than info posted, so waiting on more info. I could not tell from wording if the 4% "return" was on the IRA or on the student loans (could be interpreted a couple of ways based on wording of post).

Past returns on IRA might be impacting the decision OP is "forcing" himself (herself?) to make now based on a year like 2008 which probably dropped any equity based IRA balance in half. I sense there is more info than posted, so asking for more info and trying to figure out mindset of the OP.

So I want more specific (current) information.

I apologize if I seemed vague, I didn't realize the confusion in my wording.

The balance of the IRA as I write this post is $89k and change. In the scenario, I assumed I would be paying quite a bit of taxes on the fed and state level which is how I came up with an estimate of paying the loan down to only $30k. The interest rate on the loan is currently hovering around 4%, but at its peak it hovered around 8%. The account was inherited at a higher value, but economy+distributions have brought it much lower. Since I inherited the account, the yearly returns have been between 5%-10%.

what is your income now? $45k, closer to $50k with overtime.
what is the IRA balance now? $89k
how much are the required yearly IRA distributions? $3,200
what tax bracket are you in? 25%
what is the balance on all student loans? $80k
what is the interest rate on those loans? currently 4%
what is the IRA invested in, and what have been past returns? Past returns have been around 5%-10%. I have admittedly not been very hands on with the account, and I am unsure as to the exact asset allocation. On my last meeting with my adviser however, I know it was set-up at "medium risk" with a focus on the long-term.

[TheStreetCeo]

[QUOTE=DigitalFrenchie;264329]I see how that makes sense, and playing with the numbers I really see it. It just stings to have to take out $6k a year just for those payments!QUOTE]

No question about it. It's difficult to make those payments knowing you could pay it all off with the IRA money. At your young age I would expect you to think that way, Lord knows I did. Your 65 year old self with the knowledge of a lifetime will thank you over and over for helping you to do whatever you want in retirement. If you use it, your 65 year old self with a lifetime of knoweldge may not be so nice.

Thanks for the nice comment on my blog, I have fun with it. It's a fun hobby.

[jIM_Ohio]

I apologize if I seemed vague, I didn't realize the confusion in my wording.

The balance of the IRA as I write this post is $89k and change. In the scenario, I assumed I would be paying quite a bit of taxes on the fed and state level which is how I came up with an estimate of paying the loan down to only $30k. The interest rate on the loan is currently hovering around 4%, but at its peak it hovered around 8%. The account was inherited at a higher value, but economy+distributions have brought it much lower. Since I inherited the account, the yearly returns have been between 5%-10%.

what is your income now? $45k, closer to $50k with overtime.
what is the IRA balance now? $89k
how much are the required yearly IRA distributions? $3,200
what tax bracket are you in? 25%
what is the balance on all student loans? $80k
what is the interest rate on those loans? currently 4%
what is the IRA invested in, and what have been past returns? Past returns have been around 5%-10%. I have admittedly not been very hands on with the account, and I am unsure as to the exact asset allocation. On my last meeting with my adviser however, I know it was set-up at "medium risk" with a focus on the long-term.

Are you able to make payments on the student loans without touching the IRA?
I am sketchy on the withdraw rules for inherited IRAs... are you REQUIRED to take distributions?

Here are my three schools of thought

1) You are required to take distributions. In this case I would invest the IRA in something close to cash (like a fund which is 80% bonds or cash) and take out the minimum amount required. I would either reinvest the money, add it to a savings account, or pay down the debt (or a mix of the 3). With loans at 4%, you can generally get a 5-6% return taking on some risk in stocks and other similar types of investments.

2) You are NOT required to take money out, but need the money to pay bills. In this situation I would re-examine your budget, keep money invested in something which is at least 80% bonds and cash inside the IRA, and take out what you need, while trying to find a way to fix you long term problem (not enough income or too much expenses)

3) You are NOT required to take money out, and do NOT need the money to pay bills. In this case I would leave money sit in the IRA, invested in something which has "no more" then 20% bonds and cash (meaning 80%+ equities) assuming you are comfortable with that level of risk. Basically use this money to kickstart your retirement savings.

Couple of other questions:

1) Was any of the education expense incurred in 2010? 2009? Who filed the tax return in 2009? in 2010?
2) Do you have a retirement portfolio?
3) How are you with handling your finances (budget, investments and taxes)?