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Should I Pay Off Student Loans or Save for Retirement?

By Maurie Backman – Updated Feb 4, 2020 at 1:10PM

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Both are noble goals -- but which should take priority?

Woman sitting at desk holding her hands up as if confused

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These days, it's not uncommon to graduate college saddled with debt, especially given the fact that tuition costs seem to go nowhere but up from year to year. Now you probably know that the longer you carry student debt, the more interest you inevitably wind up paying on it. As such, many college graduates are motivated to knock out their student loans early, even if it means letting other financial goals, like retirement savings, fall by the wayside.

That said, there comes a point when neglecting your IRA or 401(k) for too long can have serious repercussions. So what should you do: Pay down your student debt, or fund your nest egg? Obviously, try to do both as best as you can. But, the answer really depends on one key question: what's your student loan interest rate?

The benefit of paying off student loans ahead of schedule

Paying off student loans early has its benefits. Imagine you're looking at $30,000 in student loans at 8% interest, and that you're supposed to pay them off over a 10-year timeframe. If you were to add $200 to your monthly loan payments from the start, you'd be out of debt in about five years rather than 10. You'd also save yourself about $6,500 in interest in the process.

That $6,500 could then come in handy in helping you achieve other financial goals. It could go into the bank for emergencies, serve as part of a down payment for a home, or even go into your retirement plan as a lump sum (though keep in mind that if you're under 50 and are saving in an IRA, you can only contribute up to $6,000 per year at present). Remember, you can always work on knocking out your student debt sooner, thereby saving yourself some interest, and then ramp up your retirement plan contributions once that debt is behind you.

There's also the peace of mind factor to consider when deciding whether to first pay off your student loans or save for retirement. While it's true that having the foundation for a robust nest egg might help you sleep better at night, let's face it: Not having student loan payments hanging over your head will likely do more for your sanity.

Furthermore, if you fall behind on your student loans (say, because you fall on hard financial times or encounter a string of unplanned bills that eat up all of your income for a period), you risk damaging your credit and having your wages garnished so that your lenders can be made whole. On the other hand, if you fail to save for retirement for a number of months, no one's going to come after you for that money, and your credit score won't take a beating in the process.

And that's a good argument for getting out of student debt before saving for retirement. Having those loans out of the picture could help you avoid unfavorable financial consequences that might hurt you in the long run.

What does your student loan interest rate look like?

If you're trying to figure out whether you should pay off your student loans or use your extra money to build a nest egg for retirement, one factor you should really consider is the interest rate you're paying on your student loans. If you took out federal loans, your rate is capped at a preset amount, and generally a reasonable one at that.

For example, federal Direct Subsidized Loans given out after July 1, 2018 and before July 1, 2019 have a fixed interest rate of 5.05%. Perkins Loans, meanwhile, have a fixed interest rate of 5%, regardless of when they were given out. Your savings associated with paying off that type of loan early will therefore be somewhat limited, whereas you have the potential to invest your retirement savings at a much higher rate than what your loans are charging you.

If you borrowed privately, however, then the interest you're paying on that debt could mimic that of what a credit card might charge. If that's the case, it might actually pay to allocate more of your extra money to your student debt, and make smaller contributions to your IRA or 401(k).

Another thing to keep in mind is if you borrowed privately for college, you may be looking at a variable-rate loan. This means that your interest rate has the potential to rise over time, which means you may want to pay off your loans early -- before that happens.

Furthermore, while you'll ideally generate some sort of return on your retirement savings by investing that money wisely, a specific return is by no means guaranteed. The 7% return used in the example above, for instance, is a reasonable assumption based on the stock market's historical performance, but it's certainly not a given. On the other hand, if you pay off your student loans early, you're guaranteed to shave money off of your total interest costs, and that concept certainly has a nice ring to it.

If you are going to focus more of your money on paying off your student loans at present and then plan to catch up on retirement savings once they're done with, just make sure to contribute enough of your earnings to your 401(k) to snag your full employer match. If you don't, you'll be giving up free money on top of the potential growth mentioned above, and that, frankly, is a real waste.

The benefit of saving for retirement early on

You might assume that Social Security will suffice in covering your senior living expenses, but in reality, it will only provide about half the income you need to live comfortably in most cases -- hence the need for savings of your own. And the more time you give your retirement savings to grow, the more you get to take advantage of compounding. Compounding is the concept of earning interest on interest, and it's what could allow you to turn a series of modest contributions to an IRA or 401(k) into a large sum over time.

Imagine that you're able to sock away $300 a month for retirement over a 40-year period at an average annual 7% return (that's a couple of percentage points below the stock market's average). Even though you'll only end up putting in $144,000 of your own money, you'll wind up with about $719,000, and that $575,000 gain will be a product of compounding over time.

Now let's say you're only able to save that $300 a month over a 30-year window, because you spend those first 10 years paying off your student debt. At that point, you'll wind up with just $340,000 in your IRA or 401(k), and a gain of just $232,000. Granted, that's still impressive, but you can't argue the difference at hand.

Therefore, if you're dealing with a relatively low student loan interest rate, paying a smaller loan amount each month and using your extra cash to fund your nest egg can really pay off in the long run. Remember, if you're carrying loans with an interest rate in the ballpark of 5%, the additional gains you'll see in your IRA or 401(k) will far surpass the amount of interest you'll save by paying down your loans ahead of schedule.

That said, always make sure you're keeping up with your monthly student loan payments and aren't falling behind. You shouldn't neglect your loans in order to pad your nest egg, even though prioritizing your IRA or 401(k) often makes sense.

Remember, too, that when you fund a traditional IRA or 401(k), that money goes in on a pre-tax basis, thereby saving you additional money up front. Granted, student loan interest is also tax-deductible, but if, for example, you put $8,000 into a 401(k) over the course of a year, and your tax rate is 24%, that's $1,920 in tax savings right off the bat. And then you could, in theory, take that saved money and apply it to your student loans.

Striking a balance

Of course, saving for retirement and paying down student debt don't have to be mutually exclusive. If you have extra money to work with on a regular basis, you could use some of it to contribute to your retirement plan, and the rest to pay into your student loans so that they go away sooner. In fact, if you're really eager to achieve both goals simultaneously, you can take steps to boost your income to make that happen, whether it's picking up extra shifts at work or getting yourself a side hustle to supplement your earnings from your main job.

Slashing expenses in your budget will similarly work to give you more cash to work with, so think about cutting back here and there, whether it means canceling cable, cooking at home instead of dining out or ordering takeout, or curbing your rideshare habit. If you're able to free up enough extra money, you might manage to fund a retirement plan in a meaningful fashion while also chipping away at your student debt so that it's gone sooner.

Paying off student debt and saving for retirement are both critical financial goals to work on. Though it's okay to prioritize one over the other, ultimately, it's important to strike a balance between the two.


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