An increasing number of people are graduating from college with student loans to pay back. Some 44.7 million student borrowers have an average of $37,584 in student loans each, and 65% of students graduated with student loan debt in 2020. As a result, an entire generation is entering the workforce with a difficult question: Should they save for retirement or pay off student loans?
Both saving for retirement and paying off student loans are critical to advancing one's financial future. And the good news is that graduates don't have to choose one or the other. While the right answer may look a bit different for everyone, it is possible to balance retirement savings with debt payoff.
For most people, student loans represent the largest financial burden they'll face in their early adult years. And it's one that affects your life and your finances in myriad ways.
First, making student-loan payments each month reduces the amount you have to put toward other expenses and future financial goals. Depending on the amount of debt you have, this could represent a sizable portion of your monthly budget.
Student-loan debt also affects your credit. It may be more challenging to qualify for loans and credit cards with significant debt on your credit report. And missing just one student-loan payment can cause you to have bad credit.
It's also important to remember that there are few other ways out of student-loan debt besides paying them off. Federal student loans have no statute of limitations and can't generally be discharged during bankruptcy. The government can garnish your wages and tax returns. And most borrowers aren't eligible for the handful of loan-forgiveness programs available.
Paying off student loans is a more expensive process for some than others. Federal undergraduate loans tend to come with lower interest rates. But for graduate students or those who had to take out private loans, rates can be quite steep. Those borrowers may find that a lot of their money is going to interest each month instead of paying down their balance. It becomes even more important to prioritize those loans.
You may have read up until this point and determined that you should pay your loans off as quickly as possible, forgoing saving for retirement until they're gone. And while some personal-finance experts do recommend that, it's not quite that simple.
Retirement is likely to be a lot more expensive than your student loans, and investing requires having significant time in the market for compound interest to work its magic. If you wait until your student loans are gone to start saving, then you'll have to save a lot more per month to catch up.
You can find a balance so that you can prioritize both student-loan payoff and retirement savings in your budget. Here are a few questions to ask yourself to get started:
There are plenty of benefits to paying your student loans off early — and they aren't just financial benefits, though that's certainly a big piece of it.
The earlier you pay off your student loans, the less you pay in interest. And depending on the rate on your student loans, that could be a significant chunk. The interest rate on private student loans can exceed 10%, making them quite costly. Even just a few percent on a large balance adds up over time.
When you remove student loans as a line item in your budget, you free up more money for other financial goals, including retirement. You can also reallocate that money toward a house down payment, medical procedures, children and many of life's other expenses.
And it's not just the increased cash flow that will help you reach other goals. You'll also have a lower debt-to-income ratio, which makes you a more attractive candidate for future loans like a mortgage.
For many borrowers, the emotional burden that comes with student loans is as significant as the financial one. Many students don't fully understand what they're getting themselves into by borrowing money for school — in fact, almost 70% of students don't know what the payment amount will be on their first student-loan bill. At that time, they may deal with significant stress, resentment and all sorts of negative feelings. Paying off your loans early allows you to escape that emotional burden.
While paying off student loans early comes with its fair share of perks, there are also benefits to saving for retirement early. When it comes to investing, you get to enjoy the benefits of compound interest.
In other words, your investment earns money. And then the money you earned also begins to earn money. The longer your money is in the market, the more you benefit from compound interest. According to an Investor.gov calculator, if you were to invest $325 per month from ages 25 to 65 with an 8% return, you'd have about $1 million waiting for you in retirement. But what if you waited until 35 to start investing? You'd have to save more than twice as much per month to end up with the same amount. Wait another decade, and you'd have to save about $1,850 per month. The person who started saving at 25 only contributed about $156,000 to end up with more than $1 million. The person who waited until 45 had to contribute $444,000 to end up with the same result.
If you're further along in life and haven't started saving for retirement yet, don't panic. There's still time for you to catch up. The key is to get started right away.
The first step is to figure out how much you need to save to retire comfortably, whatever that means to you. Think about the average cost of living in your city, your target retirement date, the average life expectancy and any partners, children or spouses in your life. You should save enough to cover these expenses from retirement to the end of your life.
If your employer offers a 401(k) or another retirement plan where they match your contributions, make sure you're taking advantage of it. Failing to contribute at least enough to get the full match is leaving free money on the table.
The IRS increases contribution limits for 401(k) plans and individual retirement accounts for individuals age 50 or older. That way, you can put away more money each year to make up for getting a late start.
A 401(k) isn't the only effective way to save for retirement. You can also use an IRA (individual retirement account), which is another tax-advantaged way to start preparing for retirement.
If you aren't sure where to start or whether you'll ever be able to catch up, you might consider speaking with a financial professional. He or she can help run the numbers and put together a plan to get you back on track.
You can make room in your budget for both 401(k) contributions and student-loan payments. If your employer offers a match on retirement contributions, set aside at least enough to get the full match.
If you fail to pay your student loans, the IRS can garnish your wages, tax returns and Social Security benefits. Lenders generally can't seize your 401(k) contributions.
Depending on the interest rate of your student loans, it usually makes sense to start saving for retirement while you pay off your student loans.
Student loans and retirement are two of the largest financial burdens that most people will face in their lifetime. Many college graduates face the difficult decision of whether they should be prioritizing both expenses or wait until they are debt-free to begin saving for retirement. The good news is that you can effectively do both simultaneously, eliminating your student debt while also preparing yourself for a comfortable retirement.
This article was written by Erin Gobler from The Simple Dollar and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to firstname.lastname@example.org.
Source: The Simple Dollar