Sell mutual funds to pay student loans?

[Protege28]

I have approximately $150,000 in mutual funds inherited from childhood that I am now regretting I did not use to pay for my medical school tuition.  I am currently in residency making payments on $200,000 of student loans at 6.8%.  My financial advisor advised me during medical school not to use the mutual funds to pay the tuition as I was making 12% on my mutual funds at the time.  That is no longer the case and my primary goal is to pay off student loans.

I will be starting a one year fellowship in August and thus 2016 will be my last "low" income year prior to a physician salary.   Therefore, 2016 is my last year year which I will have a relative low income that I am assuming will minimize my tax burden.

If the market rebounds before the end of 2016, I would like to sell off mutual funds to pay off student loans.

Is this a reasonable idea?

Am I going to take a huge tax penalty for doing this?

Any ideas on how I can minimize my tax burden if I do cash in?

Any help is appreciated.

[Zaphod]

No, dont do it. You have a ginormous head start, just leave them be. Refinance when you can, and crush them when you can. Yes you would take a large penalty. Your money will either go to rebuilding what you had or paying down the loans so you might as well just keep them there.

[The White Coat Investor]

I disagree with Zaphod on this one. Taking a chance on earning more than 6.8% in mutual funds after taxes and expenses seems foolish to me. I'd take the 6.8% guaranteed after-tax, after-expense investment. If you don't want to hold those mutual funds until death, now may be the best time in your entire life to liquidate them. If you are in the 15% ordinary income bracket, then you are in the 0% capital gains bracket. That's a great time to liquidate them.

Another consideration if you choose to continue to invest (and you ought to fire that advisor for not pointing this out) if you have a 401(k) or 403(b) (especially the Roth version, but even the tax deferred version which you can probably convert this Fall or at a minimum next Fall) available to you, you can essentially move some of the money in there (deferring salary while living off savings) and of course can do a personal and spousal Roth for 2015 and 2016. No reason to have money in taxable when it could be in tax-protected.

[jhwkr542]

One other thing to consider: do you have a job lined up? Will it qualify for pslf? If so, that would push me to pay as little towards loans as possible and then be done with them in 5 years.

[LBKCLU]

Why not apply to refinance your loans now and see what interest rate you qualify for? If you can reduce the interest rate significantly, you may be able to keep the mutual funds and potentially earn more and maintain your liquidity.

The mutual funds can then be used as your emergency fund until you purchase a home and need it for a downpayment.

[MichaelB]

I agree with WCI- sell the mutual funds, pay down the loans, and get a new adviser ASAP. Just make sure you know your tax liability before you pay the loans so you hold out enough to cover taxes.

Also, if you don't have an emergency fund, I would hold out some of this money for that as well.

[Zaphod]

It of course depends, and agree someone should have been telling you to convert it to a Roth all these years. Will the monthly payment overly burden you in the future? Will you be able to refinance to better terms once employed?

Its erroneous to think about it short term. Lets just look at the total cost of the loan, since it has a known price that is not a mystery of any sort and you can find out what it is given any repayment plan. So, lets just choose a bad one, 20 year level.

20 year level repayment loan cost; $366,402, paid off in 20 years.

There is also of course a cost to selling the investments you already have, opportunity cost. So lets handicap the investments return and see where they'd be in 20, 30, and 50 years since of course there is no set limit on how long it can be invested. We will ignore any dividends and reinvestments for simplicities sake.

20 years @ 4%, $328,668, @6% $481,070.

30 years @ 4% $486,509.

50 years @ 4% $1,066,000, @5% its $1,720,199.

However, even with very low and likely attainable rates you can see the power of compounding vs. simple interest, and this ignores the possibility of refinancing to lower rates and better term that would dramatically tilt it to investing over even a shorter time frame.

Feel free to pay down those loans, nothing wrong with that. The only thing thats an issue is using an inappropriate method of comparison to justify one move over the other. You cant look at it as what the market is doing over one year vs. your loan rate, you have to take into consideration the full cost of the loan (which is known) and the opportunity cost as opposed to simply letting that money grow, or how much growth did you miss out on over your career until retirement with the decision to pay that off asap.

[jfoxcpacfp]

I'm quite suspicious that your advisor just didn't want to lose the account - tricky to persuade you into thinking "he/she" could continue to "achieve" 12% returns, especially when the market was rebounding from the last bear market. You do not have a ginormous head start when your debt exceeds your assets.

You'll never pay taxes at a lower rate than you will now, but you need to do some serious tax planning. Makes me sick that we didn't have the forum in 2015 so you could have spread the gain between 2 years, possibly paying 0% in LTCGs. You'll have 0% on part of the gains and 15% on the rest - really, really timely for you to get this done.

Agree with WCI that you should have been moving max contributions to a Roth IRA ever since you have been earning income. Shame on the advisor.

[Zaphod]

How does he not have a head start on saving for retirement? The assets/liabilities balance is totally fungible and net worth is agnostic as to the how. If he pays the loans down then the retirement account has to be rebuilt (losing or gaining depending on timing, and losing due to inflation), if he doesnt then the loans have to be paid down. Either way you get to zero and then positive eventually, one just costs more in the long run. One or the other has to be preferentially addressed, otherwise we wouldnt be talking about it.

[jfoxcpacfp]

Zaphod wrote:

How does he not have a head start on saving for retirement? The assets/liabilities balance is totally fungible and net worth is agnostic as to the how. If he pays the loans down then the retirement account has to be rebuilt (losing or gaining depending on timing, and losing due to inflation), if he doesnt then the loans have to be paid down. Either way you get to zero and then positive eventually, one just costs more in the long run. One or the other has to be preferentially addressed, otherwise we wouldnt be talking about it.

Click to expand...

He has as big a head start on saving for retirement as someone who walked into my office with nothing saved but "only" $50k in debt at 6.8%. Both are in the same situation. An account valued today at $150k is what it is.

I know what return he'll get by paying down a 6.8% loan. I have no idea what return he (or his glorious advisor) will get on his investments.

[AlexxT]

If OP decides to hold onto some of the mutual funds, he should also look into which funds he owns.  They may be high-expense, low performing funds.

As for what OP should do:  I think either choice would make sense.

I would ordinarily recommend paying down loans rather than investing with that money.  I even paid off my 3% mortgage recently.  However, OP already has the mutual funds, which makes the decision a little different.

He can either refinance the loan down to 3.5% or so, or use IBR/PAYE/REPAYE which would also effectively bring down his loan cost to 3% or less, not to mention the possibility of PSLF.  So, given all those parameters, I would lean towards selling the funds in the low income years and getting as much as possible into Roths. Once he has a job lined up, if it's not PSLF eligible, he can decide if he wants to pay off the loans immediately with the mutual fund money or do it over a couple of years with his income.

I think there's a psychological advantage to keeping the funds and using the loan payback as a form of forced savings.  On paper, keeping the funds earning an average of  7-10% is better than the guaranteed 2-4% he gets from paying back the loans.  Remember, we're looking at a 30-50 year time horizon.

WCI: you still have a 2.75% (?)  mortgage you're not paying off.  OP will have a loan at 3.5% with refinancing, maybe 3% or less given the effective rate of the IBR/REPAYE plans.  Looks like a similar situation to me.

NOTE: It's not April 15th yet.  He can still get money into an IRA for last year if he hasn't done so.