If you’ve got student loans outstanding, it’s a common predicament – should you pay off those loans as quickly as possible first, or save for retirement?
The short answer is this: save for retirement, usually. You can’t use a loan to pay for your retirement. But I’ll break that down and explain why that’s important, and when you might want to focus on paying off debt instead:
Save for Retirement: Focus on the 401(k)
If your company offers a 401(k) – and better yet, a 401(k) contribution match program – do your best to invest in it. For example, if your employer will kick in 3% to your retirement fund if you also contribute that much, aim to hit 3% every year.
The tax benefits, compounding and employer help all make this a smart option, even with outstanding student loans. You stand to gain so much more in the long run.
What about if you’re self-employed or supplementing retirement with something like an IRA? Check out the maximization limits, and contribute what you can. The easiest way to do this is to automate it. Like a 401(k), you can set a certain amount on a regular basis to transfer automatically into your retirement account.
Have an Emergency Savings Fund
After your 401(k) is taken care of, focus on the emergency fund. Yes, emergency funds are boring. And owing money on your student loans is uncomfortable. But a healthy emergency fund puts you in the position to continue to pay down your student loans even when surprises come up (and they always do.)
Plus, if you don’t have an emergency fund and a rainy day comes, you’re likelier to turn to credit cards to bail you out. Credit cards have a higher interest rate, so paying those off would probably take priority over paying off student loan debt. An emergency fund is an important component of staying on track with your money goals.
Pay Off High-Interest Rate Debt First
Student loans are a burden, but the interest rate isn’t likely to be on the high end. The average current interest rate for federal student loans is around 5%. That’s compared to the average credit card interest rate, which is about 16%. So if you’ve got credit card debt that’s been weighing on you, prioritize that first.
Continue to make your minimum payments on all other debt, but do what you can to eliminate high-interest debt.
The Case for Paying Down Debt First
There is one reason you might focus on your student loans more than retirement savings: you’ll get a guaranteed return on your investment. For example, if you’re investing money to save for retirement, there’s no guarantee that the economy won’t crash and take half your retirement fund with it.
But your student loans are there to stay. Anything you invest in paying it off means less money you’ll have to pay later in interest. In that way, it’s helping your money grow through opportunity cost.
So what’s right for you?
The answer is going to be very personal to you and your situation. But if you max out your 401(k), have an emergency fund in place, pay off high-interest debt and then do what you can on your student loans, you’ll be on your way to a balanced financial setup.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes you too should have access to financial resources and fee-only financial planning. For more information on the services offered, contact Katie today.