Excuse me if I'm repeating myself.
But the longer I write this column, the more I find common themes and issues among the questions readers pose to me. Favorite topics include retirement plan rules, Social Security, student loans and other forms of debt.
That tells me there are some issues I can never discuss enough and is the reason the questions and answers below may sound familiar if you read this column on a regular basis.
Q: I am a 26-year-old female. I was laid off by my current employer. My 403(b) is still at the company and I am in the process of turning it over to a mutual fund at my bank. My question before I do this is: Will it benefit me to take the $7,000 I have saved in the retirement fund and pay a student loan that I have currently in repayment? I am trying to get the loans put on hold due to unemployment but it has been taking some time and I can no longer afford the monthly payments.
- A.C., Trumbull, Conn.
A: The short answer is no, A.C. Pulling the money from your retirement savings to pay down the student loan will not benefit you. In fact, it will cost you more than you could imagine.
The reason is the taxes and penalties you would pay on the $7,000 withdrawal from the 403(b) plan are likely to exceed the savings on interest charges you would realize by paying down the loan. By my calculation, that $7,000 withdrawal would likely cost $2,100 in taxes and penalties.
That $2,100 figure assumes you are in the 15 percent federal tax bracket and the 5 percent Connecticut state tax bracket and that you would be paying to the IRS a 10 percent early withdrawal penalty.
And you would need to come up with that $2,100 when you file next year's tax return if you elected to have no taxes withheld from the payment. If you're still unemployed next April, where is that money going to come from?
One other thing to keep in mind: The eventual savings on interest charges stemming from early repayment of the student loan are unlikely to be as great as you think. Student-loan interest is deductible up until you reach higher income levels.
That means a 6.8 percent rate loan (the current rate for unsubsidized Stafford loans) may be costing you just 5.78 percent, again assuming you are in the 15 percent federal tax bracket.
Finally, there is an opportunity cost to yanking out the $7,000 you've accumulated in retirement savings. The greatest advantage a young investor like you has is time, which turbo charges the power of compounding. Once lost, that time – and the potential earnings – can never be regained.
Now that I've told you what not to do, let me suggest a different course of action.
First, I would persist with your efforts to obtain a deferment on payments while you remain unemployed. Keep calling your student-loan lender until you get a satisfactory answer. Don't let them off the hook easily.
While you await an answer, squeeze your budget as much as possible to make payments.
If you decide it's absolutely necessary to draw from your retirement savings, then transfer the 403(b) to a rollover IRA and then withdraw only the amount needed to make a particular month's payment. Better to pay taxes and penalties on a $200 early withdrawal rather than the full $7,000.