On the Money is a monthly advice column. If you’re looking for advice on spending, saving or investing — or any complicated emotions that may come up when you’re getting ready to make a big financial decision — you canSubmit your question in this form. Here, we answer two questions asked by Vox readers, which have been edited and condensed.
I am debating whether to pay off a personal loan with a savings account or keep saving and keep paying off the loan. I have no debt other than a personal loan of $25K. I am 42 years old, have two jobs in Hawaii and it is depressing. My thought is to pay it off and start with no savings. Please help.
Dear Personal Loan,
I contacted you to get some more information about your finances, including your loan interest rate, and here are the numbers to consider:
- Personal Loan Interest: 5.75%
- Monthly minimum payment: $738
- Monthly income from both jobs: $1,500
- Monthly Discretionary Income: $200
The original balance on your 60-month loan was $35,000 when you took it out in August 2023. In one year, you’ve brought the balance down to $24,800, which you’ve accomplished by paying back discretionary purchases and putting more money towards your debt. . Good job, especially on a tight budget like yours.
I also learned that you have $5,000 in your savings account and are thinking of withdrawing $20,000 from your life insurance mutual fund. This leaves you with no money in your savings account and no money in your life insurance account — but no debt.
Is the trade worth it?
From my point of view, you have successfully paid off 30 percent of your personal loan in one year. If you stick it out for the next two or three years, you can pay off the personal loan in full. Yes, that means a few more years of careful budgeting and limited discretionary shopping. This means putting more than half of your monthly income towards your debt.
If you take the other option — paying off debt with savings and life insurance — your first priority after paying off your personal loan will be to replenish your savings account. If you save every penny that goes toward personal loan payments, you should take care of $5,000 in about six months.
The problem is that you won’t have much of an emergency fund if something happens to you during those six months. Your budget doesn’t leave you with extra cash at the end of the month, and all you want to do is turn an unexpected expense into an unexpected debt.
Yes, there are situations where a family member can help, or you can get a 0 percent APR credit card to cover the cost and pay it off before the regular interest rate kicks in. That said, I want you to avoid dipping into saving to pay off your debt if possible.
On the other hand there is the possibility of life insurance. If you have a permanent life policy that allows you to withdraw the cash value without penalty, you have to make a case for paying off $20,000 of your loan immediately and paying off the rest of your personal loan from your carefully budgeted income. You’ll save a lot of money in interest this way, and you’ll get to keep your $5,000 emergency fund.
Which means the real question is whether you need the money in your life insurance policy. Do you have dependents who could benefit from the $20,000 if something happens to you? The budget you showed me doesn’t include expenses related to a partner or kids, but I don’t want to guess.
Another question is why you took a personal loan in the first place. The answer may be personal, but it’s worth considering. In 2023, you borrowed $30,000, and I’d hate to find you in a situation where you have to take out another five-figure loan a year from now.
That’s why I’d still recommend paying off the debt the way you’re doing. At 5.75 percent APR and $800 monthly payments, you’ll pay off your loan in two years and 10 months. It will cost you $2,112.11 in interest, which may seem like more than you want to pay, but during that time your $5,000 in savings could accrue as much as $625 in interest (if you have a high-yield savings account with a 4.25 percent APY, for example) and Your life insurance mutual fund can earn 6 percent returns.
You can decide what is best for you, but at least you understand your options.
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Do you have personal finance questions? Submit them here.
Is it wise to hold a variety of mutual funds, such as a work-provided 401(k)/403(b) and an individual IRA, as well as one or two additional investment accounts? Or is it more efficient to have just one account, like a work-provided 403(b)?
dear prudence,
Employer-sponsored retirement plans are great. I always recommend signing up for them, especially if you get a company match. These plans allow you to save pre-tax dollars, allowing you to put more of your earnings directly into your retirement fund while simultaneously reducing your tax burden. Yes, you will pay tax on your withdrawals later, but many people are in lower tax brackets by then. More importantly, many employers automatically match your 401(k) or 403(b) contributions up to a certain percentage. As financial advisors like to say, this is “free money”.
That said, these types of investment accounts shouldn’t be what you consider “efficient.” 401(k) accounts, which are designed to help private sector workers save for their own retirement, and 403(b) accounts, which are often available to nonprofit employees, teachers, and those who work for the government, help you set Can set aside money for the future — but in many cases, the types of investments you can make through employer-sponsored accounts are relatively limited. You’re not only tied to the investment provider associated with your employer’s plan, but you can only choose from a small number of investment options.
If I remember correctly, the last time I had a 403(b) I didn’t even get to pick my investments. The onboarding program asks me to select my risk level – low, medium or high – and then creates a portfolio for me.
Which is all well and good, and I still recommend signing up for such things, but chances are you’re going to be investing in funds that may offer lower returns and higher expense ratios than what you’d get if you opened up. Create your own portfolio after comparing your own IRA and the options available at various top brokerages.
You certainly can’t do anything about returns — even if you choose the wildly popular total-market funds that people recommend on investment forums — but you can do something about expense ratios. Basically, investment providers determine in advance how much it is going to cost you to manage the fund; They provide that number in the form of an expense ratio and you can compare the expense ratio before investing.
A lower expense ratio is generally better, since you get to keep more of the money you invest.
However, employer-sponsored retirement plan providers don’t really have an incentive to keep expense ratios low because they know you have no other choice. If your employer’s 403(b) is with a specific provider, you can’t just switch your 403(b) investments to another provider, so you’re stuck paying whatever the provider decides to charge.
That doesn’t mean investing in an employer-sponsored account is a waste of money. Employer-sponsored accounts are great, especially for people who might not otherwise be motivated to save for retirement. It’s just that nirvana hint everything Employer-sponsored retirement accounts may not be the most efficient use of your money.
I can’t give you investment advice because I’m not an investment advisor, but I can suggest that you contribute as much as you need to your 403(b) to get the tax break and company match, and put the rest of your retirement savings into an IRA that you can control Traditional IRAs allow you to contribute pre-tax dollars and reduce your taxable income in your prime earning years, and Roth IRAs allow you to contribute after-tax dollars and withdraw your contributions (but not your return) early if you need to. . Since IRAs max out at a certain dollar amount each year, you may also want to consider opening a brokerage account that isn’t tied to retirement and continue your investment journey that way.
It will take a little extra time to compare all the possibilities and make the best choice for your financial situation, but it can be worth it.
