As the cost of college education has increased, students are now graduating with record amounts of college debt. You are may be one of these students that has a lot of debt after graduating with your degree. The debt hangs over your head, it consumes money that could go towards a house payment, car payment or saving towards your retirement. You may be torn between paying down your school loans or saving for retirement. We get it, and we hope that this article helps guide your decision if your debating between saving for retirement or paying down your student debt.
Having student debt is not entirely bad, some of the positives are that you can deduct the interest from your income taxes, if you have student debt and graduated from college you are likely to have landed a higher paying job then someone who didn’t go to college, you’ll also over your career make over million dollars more then a person with just a high school degree. So those are some of the positives that are associated with graduating and the student debt that comes along with it.
Your Available Options
If you graduated school and have started working, your making some money and are now debating if you should start saving for retirement or maybe you are not even thinking about retirement, but you should. Here are basically your 3 options when it comes down to student debt and retirement saving
- Save for retirement while making minimum student loan payments
- Pay Off your Student Loans while not saving for retirement
- A combination of both making your student loan payments while saving some money for retirement
While the decision will ultimately rest with you and while the best option will depend on your circumstances, we would highly recommend starting to save money for your retirement early on, due to the power of compounding your returns. Additionally, starting to save for retirement early will increase the likelihood that you reach your financial retirement goals. The earlier your start savings, the greater the power of compounding will be.
So, I have your thinking about saving for retirement, but you don’t know how to proceed. Well I can help you with that. The 3 most common methods to save for retirement are
- Company 401K Plan – Many companies offer a 401K plan, and many that do offer a 401K plan also contribute to their employees plans via company matching contributions. Whether your company matches or not if they offer a 401K you should take advantage of it. There are also take advantages to contributing to a company 401K plan in that your contributions reduce your taxable income.
- Roth/IRA – The second most common method for saving for retirement is either a IRA/Roth Account. In an IRA, the contributions that you make are pretax and you are taxed a capital gains rate when you take out a distribution from your account. On a Roth account, your contributions are after tax, so when you take a distribution that distributions are not taxed.
- Savings Account – You can also save for your retirement by putting money away into a savings account. A savings account will give you a bit more flexibility in terms of accessing your savings, it will also give you the least investment options and tax benefits.
There are some situations where paying off your student debt first makes more sense then saving for retirement.
Ideally, if you able then you should both make your student loan payments and put some money towards saving for retirement. However, there are also some situations when you should save more towards retirement then payoff your student debt and there are other times when paying off your student debt makes more sense then saving for retirement. We’ll cover both of those situations below.
Paying off Student Debt over Retirement
- If the interest on your student debt is over 7-8%, its wiser to pay down your debt than to save for your retirement. Here is why. If your saving for retirement, you’ll probably invest that money in the stock market in order to make that money work for you and grow. Over any 30 year historic period in the stock market that average return has been around 8%. So if your paying a higher interest then what you can make in the stock market, its better to pay off your debt then save for retirement.
- If you are in a job that you know your not going to say long in, it’s not a company that is part of your long-term plan, and they don’t offer a company match for your 401K contributions, then it’s better to pay down your student debt
When Investing for Retirement makes more sense
First off due to the power of compounding, you’ll be better off investing for your retirement then paying off your student debt most of the time, its better to start early. Here are a couple times when you should devote more money towards retirement then paying off your student debt.
- If you work for a company that offers a company match on your 401K contributions. Basically, its free money, which you should take advantage off. For example say the company offers a 100% matches up to 4% of your salary. So you put 4% of your salary aside and they match 4% of your salary then your basically saving 8% of your salary a year. Your contributions also reduce your taxable income and help save for your retirement.
- If the interest rates on your student loans is less than 4%. If you are not paying a a high interest rate on your student debt, it makes no sense to pay down your student loans when you have low interest rates. That money can be better allocated towards saving towards your retirement.
You having graduated college, are working and making some money and maybe debating if you should save for retirement? While everyone’s financial situation is different, and you must do what is best for you, there are many benefits both short term and long term which you can benefit from by starting to save for retirement. If your saving for your retirement via a company 401K Plan, you maybe eligible to take advantage of the companies matching contribution for 401K contributions. You always want to take advantage of any opportunities for free money and the ability to lower your taxes if possible. If your saving via Roth/IRA there are tax benefits to each and we recommend that you consult a tax/investment professional in order to find your optimal investment options.