Should you pay student loans off or invest in a retirement account?
One recent college graduate offers three tips that can help guide the decision.
When I graduated from college, I was happy to have my degree and a job lined up — but, even with those two accomplishments under my belt, there came an immediate sense of responsibility. While I was lucky to receive some financial support during my undergraduate career, I still came out with $33,000 in student debt. Add to that a monthly rent payment, a new car loan, utilities, groceries, etc., and you can understand why the decision to pay student loans became a top priority.
I quickly realized, though, that my “pay student loans” goal couldn’t be my only goal. Even though I was decades from retirement, I knew that investing early could pay off exponentially, thanks to the extra years of compound interest.
That still left me to figure out how exactly to save long term and pay student loans back as quickly as possible. Ultimately, as with most things, I discovered that the answer is about finding balance and adjusting as needed based on your current situation.
Whether you use more of your salary to pay student loans or choose to invest it in your retirement account, here are a few things worth keeping in mind:
Tip 1: Pay student loans off in order of rate
It’s not uncommon for your total student loan balance to be spread out over several smaller loans. If one of these loans has a particularly high interest rate, it can drive your total monthly payment up. As you decide which loans to pay off first, see if you can pay extra on the loan with the highest interest rate. If you’re able to pay this loan off early, not only will you save more money in interest, but it can also reduce your overall monthly payment.
On the other hand, if the interest rates are relatively low on your student loans, you may not be in a huge rush to pay them off, leaving you more money to put into your retirement account.
In addition, if the after-tax interest rate on your student loans is higher than the expected return on your retirement savings, you may want to pay more attention to paying off debt. Considering your rates all around can help you prioritize effectively.
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Tip 2: Consider an employer match, if available
One reason you might choose to prioritize a retirement account over paying down debt is if your employer offers an aggressive match program. With many qualified retirement plans (QRPs), such as a 401(k), a 403(b), or a governmental 457(b), your employer will match your contribution up to a certain level; so if you don’t contribute enough, it’s essentially like leaving money on the table that could help you build a larger retirement fund faster.
No workplace retirement plan? Think about opening a Roth or traditional individual retirement account (IRA). With either account, you’ll still be able to leverage the tax advantages associated with these retirement savings accounts.
Also, beginning in 2024, some QRPs and SIMPLE IRAs may choose to match student loan repayments. This is an optional provision, so check with your plan administrator to see if this option is available for you.
Tip 3: Customize your strategy
When you’re trying to pay student loans back or add a retirement account, there’s no one perfect strategy. The important thing is to look at where you are now and come up with a plan that makes sense for your overall financial situation. But you also can’t set it and forget it. Make sure you’re taking the time to reevaluate your strategy at least once or twice a year. Your situation will change as you get raises, change jobs, take on additional debt, etc., so make sure you’re adjusting your plan accordingly. Something else you may want to consider is that distributions from a QRP or an IRA may be subject to a 10% additional tax if taken before age 59 1/2.
As for me, after reading success stories about how other new grads had formalized strategies to help them pay student loans back and still save in a retirement account, I felt encouraged. Some people subscribed to radical saving methods; others took advantage of resources from employers. What I learned is that creating a balance between saving in a retirement account and paying off student debt will look different for everyone — but they’re both equally important.
