Saving for Student Loan Tax Bomb--Good or Bad Idea? Forum

[Tiago Splitter]

Go to a cheap online broker that doesn't charge account fees. Open a Roth IRA and a traditional IRA. If you're married, put your 5500 in the traditional and then immediately move it to the Roth. Don't have to do anything more than that as long as you don't have other IRAs.

Your GF can do the same thing when you get married but she can keep her Roth just exactly the way it is now.

[AVBucks4239]

Go to a cheap online broker that doesn't charge account fees. Open a Roth IRA and a traditional IRA. If you're married, put your 5500 in the traditional and then immediately move it to the Roth. Don't have to do anything more than that as long as you don't have other IRAs.

Your GF can do the same thing when you get married but she can keep her Roth just exactly the way it is now.

Is this even legal?

[Tiago Splitter]

I mean everybody has been doing it since 2010.

[AVBucks4239]

Also: contemplating contributing an enormous amount to my 401(k). Thinking that I'm going to do the 6% I was already going to contribute, plus whatever percentage $5,500 ends up being, then adding a little more. My 52 (when I have to pay the tax bomb) I'll have somewhere around $750,000 in there.

I know the early tax penalties suck, but I could pull $150k, suck up the tax and early withdrawal penalty, and take care of my tax liability with the $90-$100,000 left over.

[LadyProspero]

Really don't want to sound like a noob, but could someone please explain to me exactly what the "tax bomb" is? I've seen it referred to over and over again in different threads but haven't been able to really pin down exactly what it is/how it happens etc.

If you go on IBR/PAYE and pay that for 20/25 years, then the forgiven loan amount is considered income in that 20th/25th year. So you have to pay tax on that.

Ah got it, thanks for the clarification!

And it's due all at once. So if you have $100k being forgiven and your marginal tax rate is 35%, you'd be on the hook for $35k the year after your loan is forgiven. It'd be sensible for Congress to make some sort of payment plan for that but it's the Congress.

Ouch. Definitely a tax bomb then, ha. I agree, you'd think after needing IBR/PAYE they wouldn't expect you to pony up $35k in a lump sum.

[AVBucks4239]

I mean everybody has been doing it since 2010.

What are the odds the government goes back to pre-2010 regulations?

[Tiago Splitter]

I mean everybody has been doing it since 2010.

What are the odds the government goes back to pre-2010 regulations?

Hard to say. We all thought they'd go right back in 2011 so by now it doesn't seem all that likely. But if they do ever change any money you get into the Roth in the meantime will be left alone.

To your 401(k) point, keep in mind that you often can't get money out of a 401(k) for a purpose like this, so don't put all your eggs in that basket. Also many plans allow you to defer salary into the 401(k) on a Roth or pre-tax basis, so if you have that choice you'll probably want to go with Roth. The income limitations on contributions don't apply to 401(k) plans so you won't need to use any tricks there.

[AVBucks4239]

Hard to say. We all thought they'd go right back in 2011 so by now it doesn't seem all that likely. But if they do ever change any money you get into the Roth in the meantime will be left alone.

To your 401(k) point, keep in mind that you often can't get money out of a 401(k) for a purpose like this, so don't put all your eggs in that basket. Also many plans allow you to defer salary into the 401(k) on a Roth or pre-tax basis, so if you have that choice you'll probably want to go with Roth. The income limitations on contributions don't apply to 401(k) plans so you won't need to use any tricks there.

Christ this is complicated.

I'm just thinking about it, and your last point resonates with me most: the 401(k) thing seems to be the safest way to go. Roth and Traditional IRAs seem to have an absolute shit-ton of tax implications, brackets, and tricks that I just don't want to deal with.

I know there's significant penalties for withdrawing 401(k) money, but here's the math as I've calculated it:

Contribute 17.5%

After 25 years, 401(k) is worth $730,000.

Pull $150,000 for "immediate financial hardship." Pay 30% income tax and 10% withdrawal penalty.

Pay tax bomb.

Continue investing same high percentage (probably the max at this point).

Assuming I'm making $100,000 by then, 401(k) still ends up being worth over $1.8 million at 65.

[AVBucks4239]

Of course, the Traditional --> Roth set up might be best in the short term, but I'm not really sure I can count on the stability of the Roth and Traditional's tax implications like I can with a 401(k).

[Tiago Splitter]

I really don't think it's as complicated as I'm probably making it out to be. If you do the 401k move it's possible your plan will not simply allow you to pull 150k for an immediate hardship.

FWIW the traditional IRA and the 401k have essentially identical tax implications. For the most part you aren't gaining anything by putting money in a 401k instead of an IRA.

[AVBucks4239]

I really don't think it's as complicated as I'm probably making it out to be. If you do the 401k move it's possible your plan will not simply allow you to pull 150k for an immediate hardship.

FWIW the traditional IRA and the 401k have essentially identical tax implications. For the most part you aren't gaining anything by putting money in a 401k instead of an IRA.

I think things got complicated with the "married filed separately" discussion.

I'm going to sleep on it for a few days and think about the Traditional --> Roth setup you recommended. I'm still not even sure how that's legal but I'll consider it.

[AVBucks4239]

I haven't billed anything for like two hours now because I'm reading everything I can get my hands on. Oh well.

I think I might go with just opening a Traditional IRA. Seems like the simplest and least risky thing to make sure I'm secure at retirement.

Value of Traditional IRA at 52 (tax bomb year): $372,000

Pull $122,000, pay 10% penalty plus 39.8% (maximum tax bracket) income tax, pay tax bomb.

Contribute max until 65.

Value at retirement: $742,000. Add to that my 401k (projected $1.4-1.6M) and social security (if it's still around) and I'll be okay.

[fats provolone]

in 25 years we'll be boomers bro. we can just tax young people

[AVBucks4239]

in 25 years we'll be boomers bro. we can just tax young people

AND MAKE THEM PAY FOR OUR COLLEGE!

[LadyProspero]

in 25 years we'll be boomers bro. we can just tax young people

AND MAKE THEM PAY FOR OUR COLLEGE!

This.