Federal Income Tax Student Loan Interest Deduction

As a follow up for my last post that shows I should be maxing out my tax deferred retirement right I do have some money left over to pay back a little of the student loan. It turns out you can deduct up to $2500 in student loan interest payments from your taxes if your income is below $65,000. As it happens my income will be below that for the next 3 years so I'll be saving a little bit more on my taxes.

Paying Back Student Loans vs. Saving for Retirement

I have a substantial amount of student loans. $182k of it is fixed 3.5% for life which I am able to defer for 3 years and plan on dragging out the payments as long as possible. Another $56k is variable private loans currently at around 8% which I can defer for 3 years.

Currently my income allows me to either save for retirement via 401(k)/Roth IRA or pay back big chunks of the private 8% student loan. My job is such that my income should rise substantially in 3 years such that at that time I will be able to pay back the private student loan and max out my 401(k)/IRA at the same time. Here's the math:

Tax Savings of Maxing out IRA Right now:

• 3 years x $20,000(401(k)+IRA)) = $60,000 in tax deferred money.
• $60,000 x 30 years @ 5% inflation adjusted return = $259,317
• Tax savings on capital gains tax = ($259,317-$60,000) x 15% capital gains tax rate = $29,897.
  
  

Total Student loan interest for three years if defering:

• $56,000 x 3 years @ 8% interest = $70,543 - $56,000 = $14,543 in interest.

Total Student Loan Interest if paying back $18,000 per year:

• Year 1: $56,000 - $18,000 = $38,000 x 8% interest = $41,040 ($3,040 in interest)
  
• Year 2: $41,040 - $18,000 = $23,040 x 8% interest = $24,883 ($1,843 in interest)
  
• Year 3: $24,883 - $18,000 = $6,883 x 8% interest = $7,433 ($550 in interest)
• Total interest = $3,040 + $1,843 + $7,433 = $5,433

Interest saved on student loans by paying back right now = $14,543 - $5,433 = $9,110

Let's see: $29,897 saved in capital gains tax in 30 years by investing right now vs $9,110 saved in student loans by paying back my loans right now. I will be maxing out my 401(k)/Roth IRA starting right now.