Just because you might owe hundreds of thousands of dollars for your education does not mean you should forgo your other financial goals. One of the biggest mistakes I see is someone funneling a lot of their take home pay into repaying their student loans. It is unlikely those people will live financially satisfying lives. Just when one debt is paid there will likely be another incurred in the form of a mortgage. And do not forget the cost of education for children. Even if you do not funnel most of your take home pay into repaying your student loans, it is crucial to not forgo saving for your other goals such as buying a home or retiring. Here are three smart steps to begin building a sound financial plan for those of you who have meaningful student loans.
Step 1: The first step is to figure out how you are going to repay your student loans. Many young professionals that I meet with are very inquisitive about the right way to pay their loans back. There are many income-based repayment (IBR) programs like Pay as You Earn (PAYE) that allow one to pay a maximum of 10% of discretionary income. Fun Fact: the government’s definition of discretionary income is income – 150% of poverty level with the poverty level being $24,030 in CA if you are married. There are many different IBR options in addition to the standard 10 year repayment schedule. For those that decide that an IBR solution is best, just remember to save for your eventual tax liability. If you work in the private sector, then the loan amount that is forgiven will be considered income in the form of a 1099, which will likely be a very sizable amount.
Step 2: The next step is to budget. Start with figuring out how much you have to spend each month. Then figure out what your average monthly expenses are. Be honest with yourself. This can be a very enlightening experience but a necessary one. With what is leftover you will want to put towards accounts that are going to get you to your financial goals such as buying a home or retirement. If you are participating in an IBR program then do not forget to set aside money on a monthly basis to cover the tax liability your forgiven debt will incur.
Step 3: Save for retirement! It might seem like retirement is far off in the future but it is imperative to start saving immediately. If you are still in residency or just making substantially less income then you soon will, look into your qualifications for a Roth IRA. A Roth IRA allows you to make after-tax contributions to a retirement account. As long as you wait until age 59.5, your withdrawals are tax-free. It’s unlikely you will qualify for long. There is a beautiful thing about paying taxes when your tax bracket is low and then taking the money out 30+ years later tax-free. Furthermore, if you have access to an employer sponsored plan at work you will want to start using that as well. Do not make the mistake of forgoing these plans if a match is not offered. With these plans you can make pre-tax contributions that lower your adjusted-gross income, which is the number used to determine your IBR.
By Zachary Bainter
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.
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