Q. I am about to receive a $100,000 bonus for work I did several years ago. I need help deciding what to do with the money. I am 31 years old, single, female and a lawyer. My salary is $70,000. I usually get about a $12,000 bonus. I have a private student loan in the amount of $76,000 with a variable rate currently at 4.2 percent. I also have a $10,500 variable rate private loan currently at 6.7 percent.
What should I do?
I’m tempted to pay off a lot of the variable rate student loans even though they are at such low interest rates— just to make them go away. I’ve heard that if a debt costs less than 6 percent interest, you should invest the money and just pay the minimum on the debt. Does that logic apply to variable rate loans if the rate goes up?
I want to max out my Roth IRA for 2009 (assuming my bonus comes in before April) and 2010. And I want to put some money in savings - I was thinking $12,000, but not sure. And should I put it in CDs so I can access it when/if I need it? I work for my stepfather, so I don’t foresee being laid off. That’s also why I don't plan on having a super big rainy day fund - I would rather pay off the loans that are hanging over my head. —L.D., by email
A. That $144,500 is a lot of student debt. It will limit your personal choices as long as you carry it. While the temptation may be to let inflation whittle it away, the prospect of paying $1,000 a month for another 20 years is pretty grim.
Worse, the principal must be repaid with after-tax dollars. So it could cost more if you delay. Since you pay the 15.3 percent employment tax and also pay income taxes at 25 percent, you need to earn about $1.67 to pay off a dollar of debt. Worse, since your income appears to disqualify you from taking the interest as a deduction, you have to earn $1.67 to pay back a dollar of interest as well.
That’s not debt you want to carry.
You can cut the repayment period to about 15 years by adding about $150 a month. It will take a bit over $500 a month of extra payment to bring the payback down to 10 years. Using that bonus cash, of course, will give you a big start.
Begin with the high-rate, 6.7 percent variable note. Pay that off first. Then pay as much as you can on your $76,000 variable note at 4.2 percent. That will reduce your vulnerability to rising interest rates in the future.
Q. I have the opportunity to convert my IRAs to Roth IRAs this year. I will have to start withdrawing funds in 2011 when I turn 70 1/2. I have the cash to convert some, but not all. The Roth IRAs do not require yearly withdrawals. It seems I should do the conversion and take the hit now, and thus have fewer requirements for withdrawals in the future. I would not convert so much as to make me "cash poor." —K.B., by email
A. For many people there is no advantage for converting. Basically, they can pay taxes now, or pay taxes later. It won’t make a big difference to their standard of living either way.
If converting will allow you to have virtually all of your financial assets in a Roth and not have much in a conventional IRA, you may be able to escape the possible taxation of Social Security benefits.
Why? Because Roth withdrawals are not counted in the income computation that makes Social Security benefits taxable. This is a complicated calculation, so I’d suggest visiting with a good tax accountant.