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Retirement vs. student loans

Chris Farrell Mar 26, 2009

Question: Hi Chris, my question relates to two subjects: a student-loan for graduate studies and funding my retirement. I am 27 years-old and am planning to enroll in a graduate program (MBA) in the fall of 2010. The total cost of this education is in the vicinity of $100,000. By the fall of 2010, my savings should amount to at least $25,000. So, I will have to obtain financing for the majority of my education costs.

Since I will require a loan for such a large percentage of my educational costs, should I immediately cease contributing to my retirement accounts and, instead, add that money to my savings? Currently, I am contributing 5% of my pre-tax income to my 401k through my employer. Moreover, I am making regular contributions to a Roth IRA so as to achieve a total contribution of $5,000 by the end of the year. Please let me know what I should do. I worry about taking on such a large student loan. But also, I worry about the long-term consequences of not regularly contributing enough to my retirement.

Here’s some information about me that you may find useful when crafting your reply. I am currently employed and am quite confident that my income ($70,000/year) will remain steady for the remainder of 2009. My savings currently amounts to $25,000 and my credit score is 770. I do not have any debt. Thanks Chris. I love the show and it’s really helped me in so many ways. Cheers. Mark, Los Angeles, CA

Answer: Thanks for your note. You’re making a big investment in your job and career by getting an MBA. You’ve done the research, and the rate of return on that investment measured in terms of job options, total compensation and career satisfaction will more than pay for the money you borrow. In a sense, your standard of living in retirement will largely be influenced by how much your investment in an MBA pays off over time.

Price matters, and the less you go into debt to get your MBA the more financial and job flexibility you’ll enjoy at graduation. That’s why I think your instinct to reduce contributions into retirement savings and, instead, put the money into a bank or credit union savings account, certificate of deposit, or some sort of very safe parking place for money is sound.

Here’s another thought: Stop contributions into the 401(k), but continue to fund the Roth-IRA up to the $5,000 limit (and that’s how much you are setting aside in total anyway). A Roth is a unique retirement savings vehicle. It’s a retirement plan and a parking place for emergency savings. The reason is that by law you can withdraw contributions without any tax bite or early withdrawal penalty. You can’t tap the earnings without taking a big hit, however. You leave the earnings alone.

You keep your financial options open by funding the Roth. If you decide the smart strategy is to borrow less you can withdraw your contributions from the Roth and just leave the earnings in the account. If it turns out you’re borrowing less than you anticipate, well, you leave the Roth alone and let the money compound over time.

Since a Roth is funded with after-tax dollars will give up some income tax advantages with this tactic.

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