Question: My wife and I have taught in Alabama public schools for the past 2 years and have made (forced) contributions to the state retirement system in that time frame. Together, we've got around $8,000 invested in the state retirement system. Realizing the limited income prospects for career teachers, we both applied and were accepted to a top 25 law school on full-tuition scholarship. However, we're still going to have something like $35,000 a year in living expenses that we'll foot through loans.
We have almost $50,000 in stocks, money-market funds and savings accounts, but we're saving that to put a down payment on a home. (As an aside: Should we be doing that or should we withdraw a portion so that we won't have to take out as much in student loans?)
My question to you is this: For my retirement account, I have the option of either a) taking a lump-sum payment of the $8,000, minus 20 percent in federal income tax, or b) rolling it over into a 401(k), IRA, or similar long-term savings plan. Should I take the money and run, or should I start building a retirement nest egg while I'm financing the rest of my life with borrowed money? Alex, Montgomery, AL
Answer: I would roll the money over into an IRA. Let the retirement savings continue to compound, tax-deferred. I wouldn't lose the advantage of time.
On your second question -- whether to tap into the savings you've set aside for a down payment on a home to reduce how much you borrow for your education -- here's one way to think it through. From a purely financial point of view, it sometimes pays to use OPM -- Other People's Money -- even when you don't have to borrow. The reason is that you maintain a measure of financial flexibility.
You and your wife are investing in a law school education. It will open up new career opportunities. But you don't know what the job market will be like in 3 years when you graduate. You might have an idea of the kind of law you'll pursue, but you could change your mind as you learn more about the law. You may even decide the better job prospects are in another city or state.
The advantage of keeping your savings and borrowing with student loans is that you'll know the answer to these questions around graduation time. At that point, you and your wife might decide the smart thing to do is use the bulk of the savings to eliminate as much the debt as possible. You could decide the debt is manageable and that buying a home is still a realistic option. You might want to use some of the savings to fund a move to another state and all the costs that come with a new job and a new town. You'll have the freedom to make the choice that works for you, and you'll have a lot more information than you do now.
That's one strategy. It's an approach that could work for you because you have a nice margin of safety with your savings. However, the strategy isn't for everyone. I've known plenty of folks for whom it works out well on paper but emotionally it involves too much borrowed money. That's fine. In that case, I would use the savings to cut down on how much you need to borrow.
One last point: At the moment, you and your wife are making a huge investment in your careers. I wouldn't take the risk of another investment -- a home -- until you have a clearer idea what the return on investment will be from your law education.
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