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Larger Student Loan to Fund IRA?


"I plan to start graduate school and work full time over the next two years. I will have to take out student loans to pay tuition costs. I've opened an IRA account but haven't put any money into it yet. Should I hold off on putting money into an IRA until student loans are paid off? Currently, I do not have any debt."

What a great question, Veronica!  Before I dive into your question, it may be beneficial to rephrase it.  Basically, what you are asking is whether you should borrow money to fund your IRA because in essence that is what you will be doing.  If you didn’t make a contribution to the IRA, that money would be put towards school and your loan would be smaller by that amount.

By rephrasing it this way, I think you will better be able to address the first part of this decision which is the emotional part of debt and investing.  Some people are strictly opposed to having debt of any sort while others view debt as a way to grow wealth.  I am not an advocate or opponent of either approach; my job is to first and foremost ascertain how the individual feels about the matter.  By the way you worded the question, I am going to assume you that you are comfortable with taking out a loan to fund your IRA from an emotional perspective.  Now to your question from a financial perspective, is it a good idea.

I am going to assume two things about you.  The first is that you are young and the second is that your highest income earning years are in your future compared to what you expect to make over the next two years.  If both of these are true, then it probably makes the most sense to contribute as much as you can to a Roth IRA this year ($5500 if under 50).  Again assuming that you are young, it probably makes the most sense to invest this money in stock mutual funds.  We would expect that these mutual funds will grow at a rate faster than what you are paying as an interest rate for your student loans and this growth will be compounded over the course of 30-40 years.  This, coupled with the fact that you will not have to pay any taxes on this growth if used for retirement, suggest that a Roth IRA would be a very good idea in your situation from a financial perspective.

This discussion would not be complete without also mentioning two other points.  The first being that some of the interest paid on your student loans may also be tax deductible.  This would add further validation for pursuing the Roth contributions.

The second is that you can always reverse this decision and withdraw the money you contributed to your Roth IRA without penalty or taxes.  By this I mean that, if necessary, you could withdraw $5500 at any point in the future for whatever emergency should arise.  You cannot go back in time, however, and make a deposit to a Roth after the deadline has passed.

I hope this is helpful and thank you for your question.