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Why I Didn’t Pay Down My Student Loans During Grad School

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Today’s post is a personal story on why I didn’t pay down my student loans during grad school, though I had the opportunity to. There are several factors you should consider when you make the decision of whether to pay down student loan debt during grad school. In my particular situation, based on both the math of the situation and my personal disposition, it made more sense to contribute money to other financial goals during grad school.

When I graduated from undergrad, I had $17k of student loan debt, $16k subsidized and $1k unsubsidized. I chose to defer my student loans during my postbac fellowship and PhD, and I didn’t pay down my student loans in that period. Although my stipend afforded me the flexibility to make progress on my loans if I wanted to, I had higher financial priorities than making payments on debt that was effectively at 0% interest.

I didn't pay down my student loans during grad school

My Debt Was Not Pressing

I’ll make a slight edit to my statement that I didn’t pay down my student loans in grad school: I kept my $16k of subsidized student loans throughout my training period, but I paid off the $1k unsubsidized loan during the 6-month grace period following my graduation from undergrad. I didn’t like the fact that it was accruing interest, unlike my subsidized loans, so I paid it off as soon as I could.

Because the rest of my loans were subsidized, not only did I not have to make payments during their deferment, they were not accruing interest. I was effectively borrowing money at 0% interest. While in some cases it would still make sense to prepare to pay down or off the loans when they came out of deferment, in my case I had higher financial priorities.

I Had Higher Financial Priorities

I can divide my seven-year training period into three sections: my postbac fellowship, my first two years in grad school, and my last four years in grad school (after I got married). My financial priorities were different in each of these periods, but in all of them paying down my student loan debt was a low one.

Postbac Fellowship

Right after I finished undergrad, I helped my parents pay down their parent plus loans from my undergrad degree, which were accruing interest. I gave them $500/month throughout the year, which at first was a rent-equivalent because I was living with them, but even when I moved out I continued to send them the money.

I also contributed $200/month to my Roth IRA (10% of my gross income) because I had started learning about personal finance and found that to be commonly given advice.

After contributing to my Roth IRA, sending my parents the loan repayment money, and paying for my living expenses, my stipend was exhausted. Thankfully, I was released from the relational obligation of sending my parents money shortly after I started grad school.

First Two Years of Grad School

Starting grad school brought a new kind of debt into my life: an auto loan. I still had the attitude that any loan that was accruing interest was one worth paying down first, so I decided to send $200/month to that loan to pay it off in two years. I was still contributing 10% of my gross income to my IRA, and I also started tithing. After fulfilling those monthly obligations and paying for my living expenses, I didn’t have a lot of discretionary money remaining, and I didn’t even consider using it to pay down my student loans.

Last Four Years of Grad School

My husband, Kyle, (also a grad student) and I got married after my second year in grad school, and combining our finances meant a complete reset of our financial status and priorities.

Kyle had been living an effortlessly frugal lifestyle (unlike me – my frugality took a lot of effort!) and also had only started contributing to his Roth IRA a year before we got married, so he actually had a good amount of cash sitting around. After paying for our portion of our wedding expenses, we found that we were left with about $17k. We created a $1k emergency fund and set $16k aside as my student loan payoff money. Our top financial priorities became maxing out our Roth IRAs every year (which we didn’t quite manage to do, but we slowly incremented our saving percentage up to 17% by the end of grad school) and building up the balances in our targeted savings accounts.

We could have paid off my student loans with Kyle’s savings when we combined our finances, but instead we decided to experiment with investing.

I Wanted to Experiment with Investing

Kyle and I were already investing for the long term in our retirement accounts, but we were curious about mid-term investing.

It’s pretty hard to pin down precise advise for how to invest for a goal 3-5 years away. Many financial people will tell you to keep your money completely in cash, while others will say bonds are best, and still others perhaps a conservative mix of stocks and bonds.

Our goal was to grow our student loan payoff money during the remaining time they were in deferment, but still have a fairly good chance of not losing any of the principal. Our plan was to pay off my loans right when they came out of deferment. We were averse to paying any interest on debt, yet wanted to take some risk with the money for the chance at growing it modestly.

After wasting about a year waffling over our choices, we ultimately decided to keep part of the payoff money in a CD, put part into mutual funds that were a conservative mix of stock and bonds, and put part into all-stock mutual funds/ETFs. We treated this as an experiment, the goal of which was to learn more about mid-term investing and also about ourselves as investors.

As this period of mid-term investing (2011-2014) coincided with the post-Recession bull market, our investments did earn a decent positive return, so we retained both the $16k student loan payoff principle and made about $4,500.

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Hindsight: Would I Make those Same Decisions Again?

The math of why I didn’t pay down my student loans during grad school is stark. The $1k unsubsidized loan was at a fairly high interest rate, so I would definitely pay it off ASAP again. It’s also pretty hard to argue with the 0% interest rate on the subsidized loans making them a low priority.

My personal disposition toward debt changed over my training period. I started off fairly insensitive to interest rates. Interest accruing on my debt bothered me – so the subsidized loans didn’t register as a priority – but I wasn’t bothered in proportion to the rate itself. Now, I am much more careful to consider how the interest rate on any debt compares with 1) the long-term average rate of inflation in the US and 2) the possible rate of return I’m likely to get on investments. So I would still choose to not pay down my subsidized student loans during grad school, but I would pay more attention to the interest rate they would reset to when they exited deferment.

If I had it all to do over again, I would still pay off my unsubsidized student loan and keep my subsidized student loans throughout grad school, preferring to prioritize long-term investing.

With the hindsight of knowing about the continued bull market and low interest rate environment, it would have turned out better for our net worth if we had aggressively invested most of the payoff money, keeping somewhat safer only the money needed to pay off my highest interest rate (6.8%) subsidized loan immediately upon graduation. (The rest of my subsidized student loans, being at variable interest rates, have stayed at about 2-3%, which to us is low enough to keep around.) But as no one can predict the future and at the time we expected to pay off the loans right after graduation, I think it was a fine decision to hedge our bets and invest conservatively in the time period that we did.

But this decision was right for us only because we were willing to invest and not too concerned about the student loans. Other people are disposed to be much more risk-averse, so for them the right decision could be to pay off their student loans during grad school, even if the loans are subsidized or at a low unsubsidized interest rate.

Where does paying off subsidized student loans rank on your list of financial priorities? Are you paying down your student loans during grad school, and if not what goals are you working on?

How Graduate Students Are Financially Distinct from Young Professionals

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Two young adults graduate with the same major from the same college in the same year. One of them gets a job and the other enters a funded graduate program. Their financial lives have just diverged, despite their similar professional starting points, and it’s not because the graduate student lacks an income.

graduate students are financially distinct

 

Here are the top ways graduate students are financially distinct from their young professional former peers.

Limited Income, Unlimited Training

Graduate students are among the best and the brightest college graduates, but that isn’t reflected in their stipends/salaries.

The value proposition of graduate school is that the student will be provided with training, and therefore the stipend is only intended to cover living expenses (more or less) to keep the student from undertaking outside work. (Of course, some students undertake unfunded PhDs or lose their funding at some point.) So the grad student’s income is suppressed, and there is little opportunity to increase it without engaging in a side hustle. This is very different from a regular job, where there is a chance for promotion or at least opportunity to take a different job with a better salary without derailing your career trajectory.

by Jorge Cham

A compounding factor in this situation is the uncertainty of the length of the training period. It’s unusual for a PhD in the U.S. to take less than five years, and apparently the average is 8.2 years. This is such an issue that asking a PhD student when she’s going to graduate is viewed as a faux pas. It takes an unusually driven graduate student and motivated advisor to accurately set the end date for the graduate degree more than a year in advance, let alone at the start of grad school. And even the end of graduate school doesn’t mean the student will get a big income boost, as 65% of PhDs will continue their training as postdocs.

These factors together mean that a grad student has a low salary for an uncertainly long amount of time: at minimum half a decade, and for many a decade or more.

Not a Full Employee

The exact nature of the relationship between the university and the graduate student is being reinterpreted at many universities around the US due to the recent National Labor Relations Board ruling that allows the unionization of graduate student assistants at private universities.

Graduate students are certainly “students” in the eyes of the university, and graduate assistants are also considered “employees” secondarily. The benefits offered to graduate students therefore often straddle these two statuses; they receive some or all of the benefits that undergraduate students do, but virtually always less than other classes of employees like faculty and staff.

Commonly, graduate students take part in the student health insurance plan, and the premium might be partially or completely paid as one of their benefits. Beyond that, benefits vary widely by university, school, and program. Some graduate students may have defined vacation policies while others’ are left to the discretion of advisors; some get dental and vision insurance alongside health insurance; some receive subsidies for housing or childcare; some receive a free or subsidized gym membership; very few even have access to a 403(b).

Common financial advice to young professionals to take full advantage of employer benefits by contributing to a 401(k) at least to the full match amount and maximizing the value of life, disability, health, dental, and vision insurance benefits therefore does not apply to graduate students. Conversely, graduate students may access to student benefits that are very unusual outside of universities, and it’s very important in those cases that the students are aware of all their benefits.

Fellowships Do Not Provide Taxable Compensation

While grad students receiving stipends have an income, they don’t all have “taxable compensation” or “earned income.” Graduate students (and postdocs) whose salaries are paid by fellowships are not being compensated/earning their income. (Their income is still taxable, however.) They are not employees, but neither are they self-employed. Therefore, they are not eligible for tax benefits that are tied to having compensation or earned income, such as IRA contributions and the earned income tax credit. Having an income that is not reported on a W-2 also may throw a wrench into the process of taking out a mortgage. This situation is very hard to wrap your mind around when you first hear about it because it is so different from what (self-)employed people experience.

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Low Taxes

The silver lining to having a low income is that you don’t have to pay much in the way of income taxes. Nearly all graduate students whose only income is their stipend will fall into the 15% marginal tax bracket or lower. Therefore, tax reduction strategies that might be recommended to young professionals are not as beneficial for graduate students. For example, contributing to a Roth IRA is a great idea for a graduate student with taxable compensation, while a young professional with a higher income might benefit more from using a traditional IRA or 401(k).

The unexpected bonus to being in the 15% tax bracket or lower is that the current federal tax rate on long-term capital gains and qualified dividends is 0%. Therefore, even graduate students who are saving for retirement outside of tax-advantaged retirement accounts can minimize the tax bite on their investments.

Finally, graduate students do not have to pay FICA tax, either because they have a student exemption or because they aren’t receiving compensation. Young professionals can’t easily avoid that 7.65% tax bite.

Access to Student Loans

Lastly, graduate students have the option to take out student loans. If the student experiences an income drop or a personal emergency, they could take out a student loan to cover it, whereas a non-student would more likely turn to credit cards or personal loans. While using a student loan in these circumstances might be advantageous in some ways (for example, the interest rate is almost certainly lower than the interest rate on a credit card), student loans are more uniquely dangerous than other kinds of debt because they cannot be discharged in bankruptcy. A graduate student, because of this access, therefore needs enhanced information and counseling when looking to take out a new loan.

In what ways are graduate students financially different from their age-mates who have real jobs?

Perfect Use of a Credit Card

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Graduate students have a pretty good handle on financial literacy topics like credit cards. In fact, 85% of graduate students have a credit card (Council of Graduate Schools’ Financial Education). But it’s one thing to understand how credit cards work and another to actually practice perfect credit card usage.

When I signed up for my first credit card after college, I thought of it as a form of an emergency fund. While I never ended up carrying a balance, on a couple occasions I used it to push paying for an expense from one month to the next. I thought I was being responsible by choosing a credit card with a relatively low interest rate (only 10%!) in case I did ever carry a balance.

With a lot more financial savvy and years of experience under my belt now, I can appreciate both the benefits and dangers of credit cards. If you follow the rules of perfect usage, credit cards can serve you well and benefit your life in small ways. But if you deviate from perfect usage, credit cards can bite – and it could be a tiny nip or a scarring chomp. The downside potential is definitely larger than the upside potential, so you must toe the line carefully!

Further reading: Don’t Buy into the Pro- or Anti-Credit Card Hype

Here’s how to use a credit card perfectly so it never bites you.

Have a credit card

It is a good idea to have a credit card as (when used perfectly) it will benefit your credit report and score. If you have never had any debt, opening a credit card will generate a credit report and score for you. (Make sure your first credit card is one you can keep open indefinitely, as it will establish the beginning of your credit history.) If you already have a credit score due to installment debt, such as student loans or a car loan, adding a revolving debt like a credit card will increase your score.

Further reading: Reader Request: Credit Scores and Credit Reports; “I Want a Credit Card, But I’m Scared”

The main reason to have a high credit score is to obtain favorable terms when you take out new debt, such as a mortgage. (The time to be concerned about maximizing your credit score is when you’re approaching taking out new debt, but other than that it’s not a big concern.) Some landlords also check credit scores, so a good score can be beneficial to a renter.

Further reading: 7 Ways to Improve Your Credit Score

If you have ever failed to make payments on a debt or have carried a credit card balance, don’t use a credit card. Give yourself time (at least a year) to ingrain good financial habits using only a debit card before returning to credit.

Never pay interest or fees

Your credit card should never cost you any money. Perfect use of a credit card means that you never carry a balance or pay any kind of fee (with one possible exception).

Pay off the entire balance by the due date

To avoid ever paying interest on your credit card, you must pay off the balance in full by the due date.

42% of graduate students with credit cards carry a balance on their credit cards, and 9% only make the minimum payment (Council of Graduate Schools’ Financial Education)! These students are paying a ridiculously high interest rate (15% on average) on this debt, which in many cases could be avoided entirely by better money management practices. With credit card debt, compound interest works against you with amazing ferocity.

Make it an unbreakable rule to always pay off your entire credit card balance before the due date; it’s a slippery slope from allowing a balance to carry over in one month to being saddled with thousands or tens of thousands of dollars in credit card debt that just keeps growing. The average American household with credit card debt has a balance of $16,425. Having this rule in place will force you to get creative about ways to cut your spending or earn extra money before the deadline.

A great way to make sure that you never miss a payment and incur a late fee or interest charges is to set up your card to auto-pay the entire balance before the due date. Just make sure that you always have enough money in your checking account to cover your credit card bill or you risk getting slapped with a fee by your bank instead.

Don’t Spend Ahead of Your Income

To use your credit card(s) perfectly, though, you have to go a step further. It’s not quite enough to pay off your credit cards when they are due. If you get sloppy with this practice, your spending can actually get ahead of your earning by 1-2 months, which can really put you in a bind if an emergency occurs.

To use a credit card perfectly, treat it like a debit card: only spend money that you already have in the bank, not money you expect to receive before the bill is due. That means that you will earn money, then get paid, then spend the money. To keep your credit card bill in sync with your budget, pay it off in full at the end of every month/budgeting period. You could even pay it off a couple times each month to keep your utilization ratio low.

Further reading: Living on Time with Your Credit Cards

Gain Benefits and Rewards… But Don’t Go Crazy

All the points above are about avoiding the downsides of credit cards, but now we get to the fun part – the upsides!

Credit cards are safer than debit cards for fraud protection, and they also often confer benefits in the small print like rental car insurance.

Further reading: Credit Card vs. Debit Card: Which Is Safer Online?; Renting a Car? Know Whether Your Card Adds Insurance

But the really big draw is the rewards. When you have a good credit score, you will be eligible for all kinds of rewards credit cards. These rewards come in the form of a signup bonus (usually after meeting a minimum spending requirement), ongoing rewards based on your spending, or both. Credit card rewards are actually one of the top ways my husband and I ‘saved’ money while we were in grad school, even though we rarely spent enough to meet minimum spending requirements.

Signing up for credit cards for the bonuses and strategically using certain cards for certain purchases to rack up points is a great way to score some free money or free travel. But you can’t get so caught up in the bonuses that you overspend or deviate from perfect use.

Credit card companies use rewards to prey on your psychology. The rewards make spending feel even better than it normally does, so you’re more likely to spend lots of money on their particular card. In that way, the company gets the transaction fees from the merchant plus a greater chance that you will overspend, not be able to pay off your balance, and end up paying interest.

Further reading: Think about It: Why Would the Credit Card Company Give You Cash Back?

If you want to go after credit card rewards, great. Just put in place strict boundaries such as a budget to constrain your spending, the habit of paying off your card every month, and autopay. If you juggle multiple cards at once, consider signing up for account aggregating software like Mint or You Need a Budget to help you keep track.

I said earlier that you should never pay a fee for a credit card. The one exception is a fee for a rewards credit card when you are dead certain that you will gain more in rewards than you are paying in an annual fee. If you’re at all unsure about the ROI of the fee, don’t get the card. A credit card with a fee should also not be the first credit card you open (or probably your first rewards card, either) as you should feel free to close it whenever paying the fee no longer makes sense. If that is your oldest credit card, your credit might take a small hit upon its closure.

If you’re going to use a credit card, use it perfectly. Credit card fees and interest are too detrimental to your financial health to play around with! Just treat your credit card like a debit card and you’ll be fine.

Are You Ready to Invest Your Grad Student Stipend?

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Having been sufficiently convinced that it is a great idea to start investing during graduate school, you’re eager to get your money working for you. But as beneficial as investing is for the long-term growth of your personal net worth, you must make sure that your finances are sufficiently prepared in the here and now. Once you can answer “Yes!” to the five questions below, you’re ready to invest your grad student stipend.

invest your grad student stipend

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Do you have excess cash flow/cash savings available to invest?

Right off the bat, of course, you have to have some money to invest. It doesn’t have to be a lot of money by any means, but you must have either some cash flow available every month or savings that you are willing to devote to investing. If you are going to invest your grad student stipend on a regular basis, write your investing goal into your budget and pay yourself first through an automated transfer. Investing a lump sum of cash savings at one time is a fine approach as well, though you must make sure that you still have enough cash on hand (more on that in question 3).

Do you have zero high-interest rate debt?

Even if you’re super gung-ho about investing and highly optimistic about your prospective long-term rate of return, it’s not the best idea to put money into investments while you have high interest rate debt. When you pay down debt, you receive a guaranteed “rate of return” on your payment that is equal to the interest rate of the debt. On the other hand, investing comes with a degree of risk and you are not guaranteed any specific return, especially in the short term. Given an interest rate on debt equal to or slightly less than the expected long-term rate of return on your investments, mathematically it makes more sense to pay down the debt.

Generally speaking, you should pay credit card debt down immediately and with gusto (even 0% introductory offers) before beginning to invest. Any car or personal loans that have a very low interest rate and subsidized student loans can take a back seat to investing if you like, though it’s also a great option to pay them off before beginning to invest if they weigh on your mind. Unsubsidized student loans can fall into either category. The interest rate tipping point above which you should pay off debt and below which you should invest is up to you and will be related to the long-term rate of return you expect on your investments.

Do you have sufficient short-term reserves?

It’s important to have some cash savings available to you before you begin to invest your grad student stipend. Even though that money will not earn much of a return sitting in a checking, savings, or money market account, it serves as a safety net. You don’t want to have to go into debt or pull out the money you already invested if a short-term problem pops up. It’s much better to have cash available to smooth out any rough patches.

There are two forms of short-term reserves that you should build to a sufficient level before you begin to invest: an emergency fund and cash for short-term spending. Every grad student should have at minimum a $1,000 emergency fund and perhaps even a larger one before moving on to any other financial goals. The other type of cash to keep available to use is money to use for irregular expenses, which are expenses that occur once or a few times per year that are difficult for you to cash flow.

If you’re incredibly eager about investing, you can build these two types of cash funds to a fairly low funding level – perhaps just $1,000 in your emergency fund and $1,000 for short-term spending. But as you grow your investment accounts, consider continuing to build your cash reserves as well.

Do you have an investing goal?

Before you begin to invest your grad student stipend, you have to be very clear about what you are investing for. The most common investing goal for grad students is for retirement. It’s rather counter-intuitive, but you should actually start investing for your longest-term goal first. Some grad students may also create a mid-term goal for about 5 years out. The time horizon of your goal will determine your asset allocation (the level of risk you want to take for the amount of return you want to get). You should invest as aggressively as you are comfortable with for your retirement/long-term investments, but somewhat more conservatively for your mid-term investments.

For the specific goal of investing for retirement, you will need to decide whether to invest inside a tax-advantaged retirement account like an Individual Retirement Arrangement (IRA). If you decide to use an IRA, you will have the choice between a Roth IRA and a traditional IRA. In my experience, virtually all grad students choose the Roth IRA.

Do you know where and in what you will invest?

Your final decision before beginning to invest your grad student stipend is what brokerage firm to invest through and what specific investments to put your money in. When you are deciding on a brokerage firm, look at their selection of investments, cost, reputation, and minimum balances. Passively investing in broad index funds is the most effective and time-efficient approach. You can learn all you need to about passive investing in as little as an hour or two, so don’t let yourself get bogged down in analysis paralysis. Getting started investing with a good but imperfect strategy is better than waiting around to develop a perfect strategy.

Once you have five ‘Yes’ answers to the questions above, don’t delay your first contribution to your investment account! You are well prepared to take the next step with your finances.

If your answer to one or more of these questions was ‘No,’ don’t despair. Put the energy and excitement you have toward investing into turning your ‘No’ into a ‘Yes.’ This might take as little as a couple hours of contemplation for the last two questions or as much as months or years of refining your budget and diverting your cash flow for the first three questions. But if you apply yourself diligently, you’ll be ready to start investing before you know it.

Are there any additional steps you with you had or hadn’t taken before starting to invest your stipend? What steps are you working on before you begin investing your stipend?

Why Pay Down Your Student Loans in Grad School?

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While you’re in graduate school, you have the option of deferring payments on the student loans you have previously taken out. This is a very standard procedure that your lender should have no trouble helping you with once you make the request. Deferment means that you are not required to make payments on your student loans. You are allowed to defer student loans when you are enrolled at least half-time in graduate school.

That’s where many graduate students stop thinking about their student loans. “I don’t have to pay? Awesome!” But just because you defer your student loans does not mean that you should ignore them. Even in deferment, you have the option of making payments of any size you choose on your student loans. Depending on the rest of your financial landscape and the interest rate of the loans, it can be a good idea to pay down your loans while you are in graduate school.

When your student loans enter deferment, you don’t have to make payments but the loans still accrue interest at their given rate. In the case of federal subsidized student loans (which are now only available to undergraduates), the federal government pays the interest for you, so your loans don’t grow any larger. In the case of federal unsubsidized and private student loans, the accrued interest adds to your balance due. When your loans exit deferment, the interest capitalizes, which means it becomes part of the principal due, making your accruing interest and minimum payments even higher.

Interest rate is crucial

The higher the interest rate on your unsubsidized loans, the faster the loan balance will grow during the deferment period. Let’s look at a few examples. Direct unsubsidized loans for undergraduates are offered at 4.45% and direct unsubsidized loans for graduate students are offered at 6% (as of June 2017). Private student loans might be offered anywhere from 3 to 12%.

This table illustrates how much your loan balance would grow at the given interest rate if you made no payments (deferred) for five years.

You can see how much the interest rate itself affects the balance after five years. And remember, interest will continue to accumulate throughout the entire life of the loan! Not making payments just allows the problem to grow larger.

If your student loans are currently deferred, you have a decision to make: Should you make payments on your student loans even though you don’t have to, and what amount should you pay? There are different answers depending on your exact situation.

You can’t pay – period

Some graduate students have no choice here; they are simply unable to make any payments on their student loans. This might be because they are taking out more student loans or consumer debt during graduate school or because their stipend only just covers their bare-bones living expenses. This is a situation in which deferment is sorely needed. The best course forward is to finish graduate school in a timely manner, get a well-paying job, and start repayment when the deferment ends.

You might be able to pay, but you’re reluctant to free up the cash flow

Many graduate students who receive stipends technically have the ability to make payments toward their student loans if they want to, but they either don’t recognize their ability or are unmotivated to make the sacrifice to their lifestyles. When you’re not compelled to put money toward your future, it’s easy to let your lifestyle inflate to your income level.

When you’re dealing with compound interest, like with debt repayment or investing, the question comes down to how much you value an amount of money now vs. a larger amount later. How much larger an amount depends on the interest rate. Yes, it would be a sacrifice to cut $100/month from your budget, for example, to make a regular payment on your debt, and it would almost certainly be easier to sacrifice $100/month out of your larger post-grad school income. But remember that we’re not comparing $100 now to $100 later – more like $100 now with $120 or $140 or $160 later.

What the tipping point is between those two options is up to each individual to decide based on his risk tolerance, post-graduation income prospects, and lifestyle desires.

You have available cash flow, but you’re not sure if it should go toward the loans

Other graduate students have already identified some amount of cash flow each month that they want to put toward their financial goals, but they’re not sure if their loans should be their top priority. Maybe they feel they could also use some additional cash savings on hand or are excited about investing.

As long as the student has a satisfactory emergency fund and/or cash for short-term spending and no higher-interest rate debt, putting the cash flow toward either the debt repayment or long-term investing is a good choice. Which one comes out on top should be determined based on two primary factors: the math and your personal disposition.

The math: Compare the interest rate on your debt with the average annual rate of return you expect on your investments. If your interest rate is much lower than your expected average annual rate of return, that’s a big argument in favor of investing over debt repayment. If your interest rate is comparable to or higher than your expected average annual rate of return, that favors debt repayment.

Personal disposition: How you feel about this investing vs. debt repayment decision matters, too. If you can’t sleep at night for thinking about your looming debt, just work on paying it down. If the math doesn’t sway you strongly to one side and you are super excited about starting to invest, go ahead and do that (but keep in mind that losing money is a distinct possibility).

Remember that subsidized loans are effectively at a 0% interest rate, so repaying those loans would only be a top priority for someone who really hates their debt.

Payment strategies

If you have decided to repay your student loans to some degree during grad school, you have some options on how to do so.

The first is that deferral decision that we assumed at the beginning. Even if you don’t feel you have to defer because you can easily afford the minimum payment, deferring still may be advantageous for two reasons: 1) If something ever came up that prevented you from making your required payment, your credit score would take a hit. 2) With no minimum payment required across all your loans, you can choose to pay down one loan at a time.

Second, assuming your loans are deferred, you can make regular payments or save up for some time and make larger, lump-sum payments. It might be easier to make fewer payments over the course of a year, but if your loans are unsubsidized you would lose a little bit of money to interest accumulation. Talk with your lender to see how willing they are to accept payments of variable amount and at irregular times. For subsidized loans, you wouldn’t be penalized for building up your payoff money in your own coffers up through the entire deferment period as long as you paid the sum before the loans exit deferment.

Third, within your set of student loans, you may have multiple different interest rates, perhaps including both subsidized and unsubsidized loans. If you have decided to commit a certain amount of money to loan payment, you should put the whole payment toward the unsubsidized loan with the highest interest rate (the debt avalanche method).

Pay just the interest

One option that I haven’t yet mentioned is the common suggestion to pay off only the accruing interest during the deferment period so that the loan balance you have upon exiting deferment is exactly the same as the loan balance that you had upon entering deferment. While it is a fine idea to pay some amount toward the loans during deferment, I don’t see a compelling reason why that number should exactly equal the amount of interest accruing. If you have the ability to make interest-only payments, why stop there? You should pay as much as your budget allows.

I do think it’s a good idea to defer your student loans while you are in graduate school. And on top of that, to the greatest extent you are willing you should put your money toward increasing your net worth. Both debt repayment and investing fulfill that goal well, and which one you choose will depend primarily on the math and your personal disposition. The higher the interest rate on your student loan debt, the more compelling the argument for paying it down while you are in grad school.

Why the Roth IRA Is the Ideal Long-Term Savings Vehicle for a Grad Student

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You’re a graduate student with the means and desire to save for your future. What is the best way to do so? If you have taxable compensation, the Roth IRA is an awesome choice. IRAs confer long-term tax advantages so your money grows at its maximum possible rate. The Roth version of an IRA is very well-suited for people who currently have a lower income than they expect to have in retirement. And if you decide that your goal is not saving for retirement after all, you can still access your money!

Further reading: Even Grad Students Should Have a Roth IRA


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Tax Advantage of the IRA

If you keep your investments in a taxable account, whenever a taxable event occurs (like you sell an investment or receive a dividend) you will have to pay tax. Year after year, those taxes erode the gains in your account. In any given year, this may seem like a nibble, but when you consider that you will stay invested for decades, taxes become quite a big bite.

As a simplified example, compare the account balances of two people who invest $5,000 per year at a 10% rate of return over 40 years. The person whose account is not subject to tax ends with $2,434,259.06. The person who pays a 20% tax on the gains yearly ends with $1,398,905.20, 43% less!

The way to keep from paying tax on the gains in your account is to use a tax-advantaged retirement account. This deal does presume that you will not access your money until retirement (exceptions are below). There are many types of tax-advantaged retirement accounts out there, but they all depend on your workplace offering them to you or you being self-employed. Virtually no universities extend their 403(b) benefits to graduate students. Luckily, there is one tax-advantaged retirement account that is independent of your workplace or self-employment income, which is the IRA (Individual Retirement Arrangement).

The IRA is a wonderful vehicle to invest through. As it is independent, you can open this type of account at just about any brokerage firm and can put just about any type of investment inside of it. The world is your oyster when it comes to investment choice inside an IRA. In 2021, you can contribute up to $6,000 per year to an IRA.

You do need “taxable compensation” to contribute to an IRA. Starting in 2020, non-W-2 fellowship income is considered “compensation” for the purpose of contributing to an IRA. As long as your grad student stipend is taxable (it is for US citizens and residents, but may not be for non-residents covered by a tax treaty), it can be contributed to an IRA.

Further reading: Fellowship Income Is Now Eligible to Be Contributed to an IRA

Pay Tax Now, Not Later with the Roth

Tax-advantaged accounts currently come in two flavors: traditional and Roth. The main difference between the two is when you pay income tax on your money. While your money is inside the IRA, it grows tax-free, as discussed above. But you also get a tax break upon either contribution to or withdrawal from the account.

With a traditional IRA, you take an income tax deduction on the money you contribute to the account and pay ordinary income tax on the distributions you take in retirement. With a Roth IRA, you pay your full income tax on the money you contribute and do not pay income tax on the distributions.

When choosing between the traditional and Roth, the idea is to pay tax when you will be in a lower tax bracket. The typical graduate student has a low income during graduate school but expects a higher income later in life and in retirement. Therefore, the Roth option is the more popular for graduate students.

The Roth promises that you will pay tax on your IRA contribution now at your marginal income tax rate (likely 15% or lower) and never pay tax on that money again, no matter how much your investments grow!

Flexibility for Non-Retirement Goals

I’m an advocate of clearly defining your goals and choosing investments appropriate to your time horizon. For this reason, I think that you should only contribute to an IRA if you intend to use the money in retirement. But the Roth IRA rules allow for some flexibility. If the idea of absolutely not being able to use your investments for anything other than retirement is preventing you from starting to invest, you should know that you can access much of the money in your Roth IRA early should you change your mind about your goal.

Usually, when you pull money out of an IRA early, the distribution is subject to a 10% penalty. However, there are big exception categories for the Roth IRA. You can remove the contributions you made to your Roth IRA at any time without penalty. When it comes to your earnings, your distribution becomes qualified and therefore not penalized if you use it for the purchase of a first home (up to $10,000) or for higher education expenses.

So if you want to invest for the long-term but the idea of absolutely not being able to touch your money until retirement puts you off, rest easy that the Roth IRA is a great option for you. If your financial goals change in the next few years, you do have the ability to use the money in your Roth IRA for something other than retirement.

Between the tax-advantaged status, the option to pay tax now at a low rate and never again, and its flexibility to be used for multiple goals, the Roth IRA is just about a perfect retirement investing vehicle for graduate students! The only thing I would change about it is for the contribution limit to be higher. But grad students with taxable compensation have very good reasons to contribute to a Roth IRA