Pay Off Student Loans Or Save for Retirement?
One of the biggest barriers to saving for retirement for younger potential investors, is student loans. In the US, student loan debt has nearly reached 1.5 trillion dollars with recent graduates having an average of nearly $40,000 in student debt. Paying off student loans is a reality for many people in the workforce which inevitably brings up the decision of “should I pay off student loans or save for retirement”. This is a challenging decision for many people so this article is aimed at bring some clarity about the tradeoffs of each approach.
Facts About Student Loans
Here are some of the things you should be aware of when it comes to student loans:
- The average student loan payment is $351 a month (source)
- Interest rates typically range from 3-7% for student loans.
- You still have to pay your student loans even if you don’t complete your education.
- It is nearly impossible to declare bankruptcy on your student loans
- There are multiple repayment options including: deferment, income based payments and more
- You can write off the interest from your student loans on your taxes
For the most part, student loans cannot be canceled, forgiven or discharged. In short, once you have them, you are kind of stuck with them. That said, there are a number of strategies depending on your income that can be applied to offset some of the burden.
Because student loan repayment is a reality for most people earlier in their career, it begs the question of whether repaying student loans or saving for retirement should be your priority.
Retirement or Repayment
When you graduate from college and get your first job the excitement is often hampered by your student loan payments coming due. It is tempting to focus on the debt you are trying to repay instead of focusing on the future. When it comes to investing, the more time you can let your account grow the better. The other thing to factor is the interest rate on your debt vs. the growth rate on your retirement account.
On average the interest rate for student loan debt is relatively low (around 4-5%). Most retirement plans grow between (8-10%). You can think of paying off debt as a low risk investment of 4-5% ROI that doesn’t compound over time. Saving for retirement on the other hand will yield a higher amount. Because of the wonders of compounding interest, the earlier you start saving for retirement, the more your money will grow. If you haven’t played around with the Investment Calculator, plug in some sample numbers and see how much that money will grow over time.
In addition to paying off debt being a lower yield investment, you can’t take out a loan for retirement like you can for a college education and can’t “catch up” by investing more after you have repaid your loans. For that reason, you should prioritize the growth of your retirement account over repaying your student loans.
Strategies For Deal With Student Debt
When you decide to prioritize saving for retirement, there were undoubtedly be some hurdles to overcome. You may not have a lot left over after you pay your bills to save so here are a few tips. First, pay off the highest interest debt first. When you take a look at your student loans, you will likely have a combination of multiple different loans that each have a different interest rate. By paying off the higher interest loans first you maximize the delta over time between your investment growth and the interest you are paying.
Second, try and get a lower interest rate. There are many companies that offer student debt consolidation. Lowering your interest rate will also lower your monthly payment for you loans freeing up money to invest. If your average interest rate is lower than 5% that you probably won’t benefit much from loan consolidation, but it is worth looking into.
Third, you can “slow play” your loan payment. You can do this by extending the term of the loan. Taking a longer loan term is only a good option if you are really serious about maximizing your investment. When you lengthen the term of your loan, it lowers your monthly payments which can free up money for investing. However, it also increases the total amount of money that you pay in interest over time, so if you aren’t planning on investing the money you save on your payments, its not worth doing this.
There area few other strategies to consider when it comes to paying off your student loans. Income based payments are based off of your discretionary income and depend on your income level (obviously) and other factors like family size. When you start your career you typically have less disposable income than later in your career, yet its the most critical time to be saving for retirement. Finding ways to minimize your student loan payments in favor of investing (for retirement) especially early on is typically a good idea.
How to Save and Pay of Debt
It is really difficult to “catch up” when it comes to retirement saving (as we have already discussed). It is so important to get started saving for retirement as soon as you start your career. That said, it can be a challenge to save when you are paying off your student loans and have other life expenses. Here are a few tips to help you put more money away for your retirement:
One of the first places to start when figuring out how to pay off your student loans and still save for retirement is to reduce your monthly expenses. As painful as it may be, getting an extra room mate, or even living at home (if that is an option) are great ways to reduce your living expenses. Cost of living should definitely be a factor in where you decide to live after college. Having a higher cost of living can cut into the amount you are able to save so make that decision wisely.
Many employers offer a 401k match as one of their benefits. One of the best things you can do is to “max the match”. Saving in a retirement account decreases your taxable income and maximizes the benefit your are receiving from your company. The average salary is $44,148 and the average employer matches a 401 by 2.9%. If you “max the match” you’d be able to double your savings from $1280 / year to $3560 / year.
Another way you can save more while paying off debt is to try and save more every year. Every time you get a raise, try and save at least some of the extra money you get each month. Sometimes that is as simple as adjusting your 401k contribution. The “rule of thumb” is that ideally you would be saving 15% of your income for retirement. While this may not be attainable, you can always work towards it.
Over time, as you have made progress paying off your student loan, you eventually will pay it off. One of the best things you can do is to “snowball” the payment you were making towards your debt and instead of spending more each money, invest that money.
Regardless of your situation, the best thing you can do for your retirement growth is to start early. In order to do this, it can take some strategy, but in the long term it is well worth it to prioritize your retirement investment early on. One of our goals for Investment Calculator is to provide resources and tools to help you do that. Good luck and happy investing.