I've seen strong advice on this subreddit to aggressively pay off medium- to high-interest loans, including in the flowchart. This makes total sense for high-interest loans (e.g., credit cards), but I want to talk about moderate-interest loans >4%, most notably student loans, especially among graduates with a few decades of earning potential ahead of themselves.
On one hand, by paying off loans early, you are effectively guaranteeing a return equal to the loan interest rate. This is nothing to scoff at, guaranteed 4+% interest seems like a pretty solid investment.
On the other hand, savings in tax-advantaged accounts, most notably 401(k)s and IRAs, allow you to save money without paying taxes on those savings, effectively allowing you to save more for less. However, while the market returns 6-10% on average in the long term, it is also subject to potential losses. I always assumed the loss potential was the reasoning for recommending early loan payoff.
To investigate this, I've run some numbers for my situation, and I was surprise to find that retirement savings first was far more advantageous with respect to net worth, even just 5 years down the road under very modest expected market returns. In the long run, the tax-advantaged approach is far far superior.
Our situation: My wife and I are ~30yrs old. We have over six figures of student-loan debt from medical school (the national average is 190k at graduation for an M.D.) at an average of 5.5%. After budgeting, we have approximately $6k/mo pre-tax (or $4.5k after tax) that we can use to pay off loans and/or save for retirement. If we pay off the loans aggressively, we can get them paid off in several years. However, if we max out our 401(k)s, and put the rest to student loans (still over required monthly payment), it will take a bit longer to pay off the loans, but we'll have more in retirement. By my calculations (I've run the numbers in excel under many different scenarios), after 35 years, the difference is over $1M in some cases in favor of retirement savings first! This appears to be mostly a function of being able to contribute nearly $100k more to tax-advantaged accounts over our lifetimes, which over 35 years compounds substantially.
Assuming my analysis is valid and there is nothing I'm missing, why is aggressive loan payoff favored so highly here? Is it generally sound advice, but not for higher-income earners? If so, at what point(s) should folks be starting to consider deviating from the flowchart?
tl;dr: What is the reasoning behind advocating aggressive loan payoff vs. retirement savings?
Submitted April 20, 2019 at 10:31PM by bcw006 http://bit.ly/2vhegKE
