I work full-time and will also be taking nine hours graduate school classes (at night) beginning next week. I’m about to apply for some student loans, and am wondering what the ramifications of taking out excess loans to, say, fund my IRA and/or HSA (Health Savings Account), both of which are tax deductions.
Considering the combination of the tax deduction with the potential upside, (investment wise), it seems like this makes sense, especially knowing the student loan interest will not be high. . .
AFAIK, they still won’t let you take out excessive loans. My loans are capped at just under 20K per year. Although what you do with the remainder that isn’t used by the school is your business I think.
Interest from student loans being tax-deductible is not what a lot of people think it is.
The interest you pay is not directly refunded to you dollar for dollar. That is to say if you paid $1000 in interst on your student loan in 2005, you would not receive $1000 back on your tax refund or pay $1000 less than what you owe.
What it does do is reduce your adjusted income. So, if you made $35,000 at your job in 2005, rather than taxing you on an income of $35,000 they will tax you on an income of $34,000.
Depending on how much you earned in a year versus how much student loan interest you paid, the amount you save in taxes may be very little.
Right, I understand how student loan interest works as a tax deduction (by reducing your taxable income).
What I’m considering doing (and I’m looking for somebody to tell me this is an unwise decision) is to take out more stafford student loans than I need to pay for books and tuition, solely for the purpose of putting the loan money into tax-deferred accounts, such as an Individual Retirement Account (IRA) and/or my Health Savings Account (HSA).
I’m thinking that the combination of putting the money in tax-deferred accounts along with the ability to invest the dollars into index/mutual funds in either/both accounts will not only be a good idea in the short-run, but the long-run as well. Otherwise, I will not fund either account for tax year 2005.
I don’t know the math right off hand but if your thinking is that borrowing say $50,000 on a low interst Stafford loan and putting it into a tax deffered IRA will net you more money in the long run versus what you will pay in interest over the years minus the benefits of a reduced taxable income I don’t think you will come out ahead.
I don’t think that earning say 8% annually on your IRA will compensate you for the cost of the loan in the long run.
Oh, sorry, I didn’t mean to fund new account… I meant in order to make just an annual contribution, of say $2000 to each account – contributions which I otherwise wouldn’t make.
So my tuition for one year grad school is $5000. I take out $9000 student loan, however, paying $5000 towards tuition and the other half as contributions to the IRA and HSA. My taxable income reduces by $4000, as I put the $2000 away in the IRA to invest as I choose and the $2000 into the HSA for the same reason (or more importantly, for potential medical cost reasons).
Investing in index funds with borrowed money is NEVER a good short-term strategy. It is theoretically sound long-term, but not short-term.
Index funds are fixed to the market’s performance, and while that performance is historically quite positive, it is not historically consistent over the course of two or three years.
Short horizon, look for a mutual fund tied to treasury notes, etc.
Right, but these are not short-term investments. I’m not going to be liquidating them (perhaps the HSA if I have to, but I probably won’t “invest” those dollars until I have a higher balance anyway). They are retirement accounts. I won’t be taking the money out for 30+ years, assuming I’m alive or don’t go bankrupt. I am familiar with index funds, as about 60% of my current IRA is already made up of Nasdaq and S&P Index Funds…
Sorry, my reaction about “not good short term” was based on the fact that you mentioned the short term as well as long.
And about the retirement accounts, this is not legal advice, but consult an attorney before assuming that your retirement accounts are available to creditors in case of bankruptcy.
I suspect that IRAs and 401Ks are partially or wholly shielded even in bankruptcy.
Yes, long-term in terms of the tax-sheltered retirement accounts and short-term in terms of the immediate tax-deductibility. The downside is the mid-range timeframe in which the student loans are paid back after I’m done with school. Since I’m still working full-time, and hope to continue to do so, I’m less concerned with the notion of paying off the student loans, but I"m not sure if that’s a reasonable way to look at things, given the other factors (assuming the standard risks, etc).
How would it not? Student loan rates aren’t usually as high as 8% and your retirement account will accumulate compound interest before you even need to start paying them back. You get a slight tax advantage as well. That might be good for a couple of hundred dollars.
Personally, it sounds like a pretty good idea to me and I am not ignorant in these matters. We would have to know further details though, especially the interest rate of the loan to run the numbers.
Student loans, the kind that have low interest rates and payment deferred until after you graduate, are a form of need-based financial aid. You have to demonstrate financial need to get them. Your school has a standard calculation of tuition plus living expenses, let’s say that’s $9000, per your example. They will only lend you the full $9000 under those favorable terms if you have that much need. If you only have $5000 in need, they will only lend you $5000 under the favorable terms. Loans under less favorable terms are available for students who expect higher expenses, but those are regular loans. The general rule that it is not a good idea to borrow money to make this kind of investment applies.
What you might be able to do is get your student loans to cover tuition, pay for living expenses from your job, and fund IRA/HSA with additional earnings from your job.
FYI, a Roth IRA requires that you have a certain amount of wages in a year to fund a Roth account, and only up to the amount you earned can be put in. In other words, they won’t let you not work and fund it from savings. Other accounts may have similar restrictions, I’m just not familiar with them.
I will say though, that if you manage to, through whatever means, fund your retirement fund nicely while you are in the years that most people are in college, you will have compound interest working on your side.
Find a decent retirement savings calculator online.
Plug in saving 15% beginning when you’re 20. Look at the result.
Then plug in saving 20% beginning when you’re 35.
You wanna’ start saving for retirement the moment you’re done with your final year of pre-employment education. Wait ten years and you double the effort needed to retire safely.
You’re smart enough to ask this question, so you’re ahead of the curve 99% of Americans are on. Congratulations!
One practical downside is that you can be audited, either by the IRS or by your financial aid agency or by your uni’s financial aid office. I’ve had to go through the last two audits, and I’d rather be dragged across barbed wire.
My MiL suggested that I use my loan proceeds to buy a CD to cover the next term’s tuition. My neighbor, who works for the state student-assistance agency, told me not to do it. If you show significant increases in investment assets, particularly the kind that are tax-deductible, they’re gonna wanna know where the money came from. If it came from student loans, you can be disqualified from federal (and state) financial aid. Loan proceeds are to fund tuition, fees, and other educational or living expenses period, and my neighbor told me horror stories of people who used them to fund other things. They weren’t pretty.
Using student loan proceeds to fund your IRA and HSA is a bad idea. Any tax advantage is small compared to the possible hassle of being audited and possibly disqualified. It’s not worth it.
Speaking as someone with two graduate degrees and $116,000 in student loan debt, I can say with a great deal of certainty: Not in graduate school. You can borrow up to the maximum set by the college per term whether you need it or not. Now, you’d have to qualify for financial aid in the first place, but on the promissory note you sign when you agree to your aid package is a line where you can write in “borrow maximum” and they hand it over. They assume that you’ll just really regret it later if you don’t actually need all that money.
bobkitty, you may want to look into whether your loans are subsidized or not. As this link explains in more detail, additional amounts of unsubsidized loans are available, but do not have the favorable terms. The reason they assume you will really regret it is because interest is accruing on the unsubsidized portion.
I spoke to a financial planner this morning, and he says that you cannot borrow money to fund contributions to IRAs or HSAs. Contributions have to come from earned income.
So because I work full-time and could fund those accounts with earned income, how is it determined what the true source of the contribution is? I don’t want to feel like I’m “getting away with something” here, but you know what I’m saying? Let’s say that today I put $4000 away into those accounts for tax year 2005, and then took out the extra loan money to do what I wish. . .certainly it’s not a tax violation to fund accounts the same year you have student loans? Or maybe that’s what you’re saying!