401(k) while saving for grad school?

September 14, 2011 6:27 AM

Given that I hope to go to grad school in the next two years, should I fund a 401(k) before then?

I have a feeling I'll get berated with "fund the 401(k)!" but I just want some reassurance:

I am a year out of college. I plan to go to graduate/professional school in two years, so hopefully fall 2013 and probably work right up until then; I may take two months off before then, but not much more than that. Currently, I can sock away about $600-$1000/month in savings -- I'm working to stabilize this, hopefully toward the higher figure! -- which I have diverted to a online "high-yield" savings account* (in quotation marks because the interest rate is at a measly 1%).

I am not currently funding a 401(k) because my current thought is that I will need to pay for grad school expenses in two years. It's most likely I will be doing a pricey program, so not a funded PhD or anything like that, and I will most certainly have to take out student loans to fund the tuition.

My current rationale is that I should be able to save somewhere between $25K and $30K over this three-year period between college and grad school. I would apply all of this, excepting a small emergency fund, toward grad school costs (housing, books, personal expense, etc.) in order to lower the amount of student loans and the corresponding interest, especially now that it looks like unsubsidized loans for grad students are out.

After grad school, I definitely plan to fund a 401(k) at my future employer to the max. My question is, is my current strategy short-sighted? Is it better to fund a 401(k) fully now but then incur more student debt when I go to graduate school?

*I'm hesitant to put this money into CDs for almost exactly the same reason as the 401(k), namely that I'm thinking I will need this liquidity sooner than I will be able to access the 401(k) money.

posted by andrewesque to Work & Money (19 answers total)

You don't get to fund a 401(k) unless you have a job that allows it, and I'm not seeing where your question says that? Instead, you could fund a Roth IRA, and then, when the time comes, take the money out when you need it. (My understanding is that you can take out the money you put into a roth without penalty, because you put it in post-tax. You cannot, however, take out any earnings without penalty until other conditions have been met).
posted by dpx.mfx at 6:35 AM on September 14, 2011

I think we need some additional information to answer the question.

Are you presently employed at an employer that offers a 401k program?
If so - absolutely.
If not - fund a Roth IRA

Are you planning on going to grad school in a STEM field?
If so you can get full funding through tuition remission and a graduate research assistant salary.

It is always good to fund your retirement at a young age. Even if it is only $100 a month which is what I could afford while unemployed several year back. You have time on your hands. Put in what you can - anything.
posted by BuffaloChickenWing at 6:38 AM on September 14, 2011

Response by poster: Duh, I forgot to include that. I'm gainfully employed with an employer that offers a 401(k) program, will match up to half of 6% although I have to check on the vesting schedule.
posted by andrewesque at 6:39 AM on September 14, 2011

Response by poster: @BuffaloChickenWing: It will probably be law school, so not a STEM discipline!
posted by andrewesque at 6:40 AM on September 14, 2011

if there is a match, get the match, the match is free money.

whether you fund retirement or law school after that is up to you and, I think, depends largely on what you want to do with a law degree/how much debt stresses you out, etc. You can get loans to cover school but then you have to pay them back. If it were me, I'd fund the 401K to get the match, put the rest in a Roth up to the max, and then put the rest into a money market fund. You may also want to look into whether your plan offers a Roth 401(k), which a lot do now, and see if that provides you move options.


Also: IIAL. Make sure you know what you're getting into there!
posted by dpx.mfx at 6:46 AM on September 14, 2011

Best answer: Check on the details about a Roth, I'm pretty sure you have to leave the money in for 5 years until you can withdraw without penalty. That said, they are *great*, and probably a better option than a regular 401K unless you have a employer that matches funds. The nicest thing about Roths is their flexibility -- for example, you can withdraw to buy your first house without penalty. Plus, you'd have savings that can't be calculated into your student loans eligibility determination.

To to my mind, it would be much better to overfund retirement now, as in the future you'll have to put more towards paying student loans. Given the miracle of compound interest, you're likely to come out far ahead in the end.
posted by susanvance at 6:52 AM on September 14, 2011

I would fund a Roth IRA, and not max out to your employer's matching because I suspect you will not reach the time frame for vesting which is often 5 years at the employer.

I am not a lawyer -
Regarding your law degree - there would be some lawyers right now that would discourage you from entering the field given the large amount of layoffs going on in the industry. I would have some frank conversations with mentors in the area you hope to practice to gain insight on what is going on in the field.

Are you absolutely sure you must attend school full time? Perhaps you can work part time while attending school?
posted by BuffaloChickenWing at 6:54 AM on September 14, 2011 [1 favorite]

If you're saving for grad school, you should consider putting the money into a 529 plan. They are generally federal tax-deferred, distributions for qualified educational expenses are fed-tax-free, and many states offer deductions for contributions.
posted by melissasaurus at 7:03 AM on September 14, 2011

Best answer: You should get professional advice, but I probably wouldn't. You're looking at an incredibly narrow time horizon, and shouldn't put much money in anything besides cash or high-grade bonds (which yield about 0 right now). Note: not bond funds, actual bonds with maturity in the range when you'll be spending the money. The risk that money in anything else becomes trapped over 5 years is pretty significant. The tax-advantaged plans wouldn't really be getting you anything but paperwork, since there will be so little in the way of earnings. Aside from Roth (which is almost never a bad idea), they will require you to pay taxes when you're in law school and have no income (you'll have to borrow from elsewhere - paying taxes isn't, as far as I know, a qualified expense). If you can swing those deferred taxes with some after-tax savings, you might end up with a non-trivial tax savings (you'll be in a low bracket then, and are probably higher now). Of course if you get free money from a match you should get some free money, but make sure you know how borrowing from a 401(k) works.
posted by a robot made out of meat at 7:11 AM on September 14, 2011

Best answer: there would be some lawyers right now that would discourage you from entering the field given the large amount of layoffs going on in the industry.

I would be one of them, though it's moved from active layoffs to simply anemic hiring. If you're already gainfully employed, gainfully to the point that you've got matching contributions for your retirement account, why go to law school? Odds are good not only that you'll need the liquidity before you retire, but that you'll actually wind up making less money, after student loans are taken into account, than you are now.

The average starting law grad salary in 2010 was $84,111, but the median was $63,000. But even that doesn't really reflect the fact that the majority of new law grads make between $40k-60k and will be lucky to hit six figures by the time they retire. If you're already making that... why bother? You'll completely give up three years of income for the prospect of making about what you are now, only you'll have student loans on top of it.

It's just a bad financial decision, period. You're saving $500-1,000 a month. I'm a practicing attorney starting my third year of practice, and I can't do that.

Are you absolutely sure you must attend school full time? Perhaps you can work part time while attending school?

If you must go to law school, go full time. Attending part-time says some combination of "I'm not completely committed to the legal profession" or "I couldn't get into a good law school." Neither of which is good. If you want anything like a shot at getting an okay job after law school, don't go part time.

All of that aside, the thing with the 401(k) is that it isn't just savings, it's savings-you-can't-really-get-at-for-decades. It's one thing to have some money in a non-liquid asset like a house or securities. Those are a pain to sell, and you can sometimes take a hit if you have to sell them in a hurry. But the 401(k) has that plus tax penalties for doing anything with the money before age 65.*

But let's just run the numbers here, shall we? You're talking about putting, what, $30k aside? Optimistically? Which might earn you a grand or two over three years, or might actually lose value, depending on what the market does. Either looks equally likely at this point. On the other hand, you could use that money to take out $30k less in student loans, which are going to cost you something like 5-6% interest. For decades. Which will easily exceed whatever match your employer might give you in the short term.

This is a no-brainer.

*Plus the very real risk that Congress will change its mind about the tax benefits of 401(k) accounts as they desperately claw around looking for revenue.
posted by valkyryn at 7:14 AM on September 14, 2011 [1 favorite]

Response by poster: I don't want to thread-sit, but let's assume for the purposes of the thread that full-time law school is a fixed variable. (It's not actually fixed in reality, but whether or not to go is a separate question from this financial one and I'd like to focus on the retirement savings/grad school finances question here.)

Thanks so much for all the answers so far! Just to preliminarily follow up, can someone explain the difference between a 401(k) and a Roth, and particularly the Roth in a little bit more detail? I have a fairly good understanding of a 401(k) but am only vaguely acquainted with Roths and IRAs.
posted by andrewesque at 7:14 AM on September 14, 2011

Here's a good basic article about the different types of retirement accounts.
posted by susanvance at 7:25 AM on September 14, 2011

Best answer: can someone explain the difference between a 401(k) and a Roth

401(k) = tied to and sponsored by your employer, you put money in from your paycheck before taxes are deducted, employer may match some of it. You pay taxes when you take the money out.

Roth = not tied to an employer, won't have a matching contribution. You put in after-tax money, so when you withdraw you don't have to pay taxes on that amount.

I think the important points for your question are in the details of the 401(k). Find out the vesting schedule for your employer's 401(k). If you can meet it, then definitely contribute at least enough to get the full match. That's free money. If you can't, then it's less useful.

I'm surprised by all the people telling you to fund a retirement plan instead of saving for grad school. I finished a professional grad school program last year (i.e. no grants or assistantships or whatever science and liberal arts people get to help pay for things), and the rates on my government student loans are 6-8%. So far I haven't been able to find any way to "refinance" these loans -- consolidation just takes the weighted average of my interest rates, so I can't even pay down the higher-interest loans first if I go that route. Gross. Anyway, if you think you can beat those rates by investing, then I guess it makes more sense to keep your money in a retirement account. But if you're not confident that you can earn more than those rates by investing, then I think it makes more sense to save your pennies to fund grad school as much as possible without loans.

Also, I know from experience how tough it is to live on the cheap when you've got a well-paying job, even with the prospect of grad school looming. But the more you can live like a student now, the better off you're going to be in the future.
posted by vytae at 7:34 AM on September 14, 2011 [1 favorite]

Since 401(k) contributions are pre-tax, the hit on your paycheck may be smaller than you think. I don't understand why people are suggesting a Roth IRA when the question you are actually asking is whether you should set aside money for retirement now, or defer in favor of saving money for graduate school.

(Personally, when I was in that situation I lived frugally and did both: maxed my 401(k) contribution, and saved a chunk of my paycheck for graduate school. In my situation, contributing the maximum to my 401(k) versus not contributing at all made what I considered to be a very small difference to my paycheck, so I opted to contribute to the 401(k)).
posted by needled at 8:03 AM on September 14, 2011

Response by poster: Quick question about vesting that just occurred to me (I'm at the aforementioned employer, so will read these in more detail later): if the language of my plan says:

When am I vested?

You are always 100% vested in your own contributions to the 401(k) Savings Plan, as well as any earnings on them. You are 100% vested in the Company's matching contributions and any earnings after three years of continuous employment.

This mean that if I leave before 3 years (say 2 years, 11 months) I lose all of the company-matched contribution; but if I leave at 3 years exactly, then I will get to keep all the money vested?

(And as a side question, if I do decide to fund the 401(k), what happens to the money while I am in grad school? Since I won't be with any full-time employer during that time period.)
posted by andrewesque at 9:02 AM on September 14, 2011

Just so you know, law school is not grad school. So in the future, if you're asking for financial advice having to do with law school, I recommend not calling it grad school. They are very different situations.
posted by John Cohen at 9:33 AM on September 14, 2011

Best answer: Yes, you will lose the company-matched contribution if you leave before three years and will keep it after three years. (At my organization, I believe it starts the pay period after your anniversary date, so if you are timing it close, do pay attention to that.)

Re: your side question, you can roll over the 401(k) to an IRA when you leave the company, regardless of whether it is for law school or being fired or getting a new full time job.

This 401(k) is your 401(k) with your current employer, it is not andrewesque's 401(k) for his entire working life. When you work at Acme Inc, you have a 401(k) with Acme Inc; if you switched to Widgets-R-Us, then you would get a Widgets-R-Us 401(k) plan. But the shares you buy with your contributions are always yours.
posted by teragram at 9:40 AM on September 14, 2011

Response by poster: Thank you very all for the helpful answers! A lot of information to chew on.

Based on what I've read here, I think what seems prudent here is to fund my 401(k) at 6% to get the vesting money, since I will be able to hit the three-year mark before starting school again (my "anniversary" is at the start of July, so I have leeway to get to the mark). I'll do this for at least a couple of months and assess how I feel about my finances/savings.

(and @JohnCohen: I'll keep this in mind in the future! Part of the reason I wasn't so careful is because I'm also somewhat considering getting a master's degree instead of the law degree, which would also be unfunded and a large tuition burden, so it's a similar situation anyway.)
posted by andrewesque at 11:29 AM on September 14, 2011

Also be aware that you might be, say, 60% vested in your employers' matching after xx months. Check with HR and find out if it's all or nothing, or if it vests over time. My last employer vested immediately, but the one before that vested over time.
posted by clone boulevard at 9:42 PM on September 14, 2011