Though a college education can open the doors to a world of career opportunities, there's a downside to pursuing that degree: debt. A good 43 million Americans now owe a collective $1.3 trillion in loans, with the average 2015 graduate owing a ridiculous $35,000. But while student loans are bad enough on their own, here's another sucker punch for you: The more debt you graduate with, the less money you're likely to save for retirement.
According to a new Morningstar report, each $1 of student debt you accumulate will decrease your retirement savings by $0.35. Furthermore, the research found that this calculation applies no matter how much money you make or how old you are.
What this means is that if you rack up $35,000 in student debt, that loan could set you back $12,250 in retirement savings. Assuming your retirement lasts 20 years, losing out on that sum means having $600 less each year, or $50 less each month. And while $50 a month may not seem like a lot, when you're living on a fixed income, every little bit helps.
Don't let student debt trump retirement
If you're among the many who graduated college deep in debt, there's a simple way to avoid sabotaging your retirement savings. All you need to do is prioritize retirement over repaying your loans.
Of course, you should never default on a loan payment for the purpose of stashing aside some extra retirement cash. But assuming you're able to repay your loans on schedule, any extra money you get your hands on should be earmarked for retirement. The reason? The best way to grow a substantial nest egg is to invest wisely and take advantage of compounding, which essentially means earning interest on your investments and then reinvesting that interest to further your gains. The sooner you start saving and investing, the better, which is why you're better off putting that extra cash into a retirement account as opposed to paying down your debt.
Let's say you receive a $5,000 performance bonus your first year on the job, at which point you're 22 years old. If you invest that money for retirement and manage to generate an average annual 8% return (which is actually below the stock market's average), by the time you reach 65, you'll have grown that $5,000 to roughly $137,000. Over the course of a 20-year retirement, that's an extra $6,850 a year, or $570 a month -- talk about a game-changer.
Now let's see what would happen if you were to use that money to make a dent in your student loan balance. Assuming you have 10 years to repay $35,000 at 5% interest, you're looking at a monthly payment of $371 and a total of $9,500 in interest payments over the life of the loan. If you apply a $5,000 lump sum payment to your loan during that first year, you'll save $2,500 in total interest, which is no doubt a good thing. But which would you rather do? Save $2,500 in the near term, or amass an extra $137,000 in the long term? The answer is pretty clear.
Another good reason to save
There's an additional benefit to using extra income to save for retirement rather than pay down college debt. If your company offers a matching program, putting that money into a 401(k) could result in even more cash in your pocket. Let's say your employer will match 3% of whatever amount you contribute. If you put your $5,000 bonus into your 401(k), you'll get an extra $150 in free money. But wait -- it gets better. If that extra $150 earns an average annual return of 8% as well, by the time you're 65, you'll have an additional $4,100 to pad your retirement savings.
When you're staring down a massive pile of student debt, it's natural to want to wipe it out as quickly as possible. But while paying off your loans might make the most sense from a psychological point of view, it may not be your best move financially. If you budget wisely, you can repay those pesky loans without derailing your retirement savings in the process.
