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Question for the Money Doctors

Question submitted on Oct 16, 2011.

Question

My wife and I have the same old, "should we invest our money, or pay down debit?" We''ve looked into this quite a bit, but feel that our situation is a little different than others. For starters, we''re both healthcare professionals who make a roughly $145,000 a year combined pre-tax. Most of the time we read about people who have this question, but do not have the same earning potential and we were wondering if that changes the picture at all? For starters, we have approximately $28,000 (@ 6.5% interest) in student loans left, plus $13,000 (@ 4% interest) on a car loan, and $137,000 (@ 4.5% interest) in a home mortgage. Also, we each were granted student loan forgiveness through our employer upon hire and we will have to pay taxes on a total of $14,000 a year (that is forgiven by our employer each year of work) for the next 6 years. We''re both 27 years old, and each get a 3.5% salary match from our employer in addition to placing 9% of our salary into a 457 plan. We have very reasonable hobbies, bills, and etc. We have the extra cash at hand every paycheck to either a)pay down debit (which we''ve been doing), b) increase our 457 plan to the $16,500 max, c) start a IRA of some sort, or d) any random concoction of the previous. Do you have any advice for individuals who would like to pay off debit, limit taxable income, and prepare for a very enjoyable retirement? Thanks for your help, I''m a big fan!

Answer

I would recommend trying to payoff the student loan. That carries the highest interest rate and is non-deductible. Think of it as making a guaranteed 6.5% interest - and where can you get that kind of interest these days?
Your car loan and home mortgage seem reasonable and well within your means to satisfy those obligations. Also, since the interest on your home mortgage is tax deductible, your effective post tax interest rate is about 3.4% (assuming you are in the 25% tax bracket), so this is pretty cheap money.
I would also recommend that you start a Roth IRA, based on your current income, it appears that both you and your wife can contribute the maximum of $5K per year. A Roth isn''t tax deductible, however, when you retire, any withdraws from a Roth are tax free. In addition, you can withdraw your contributions (but not earnings) at anytime both tax and penalty free.
Finally, you haven''t mentioned if your employer also offers a 401(k) or 403(b) in addition to the 457 plan. I would recommend investing in those vehicles before the 457. Reason is that contributions into a 457 that is offered by a non-profit employer (non-government) is not held in trust and is subject to creditor claims, also, these funds usually are not transferrable to an IRA should you decide to leave your employer.
Although your risk of loss with the 457 plan is small, it is still a risk and should be considered. If this is the only deferred tax vehicle that your employer offers, then I would continue to make tax deferred contributions after your Roth contributions.


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