The Student Loan & Retirement Savings Quandary

Robert DowdAugust 9, 2019

Financial Planning

Everyone knows or has heard about the student loan crisis in America and its effects on the U.S. economy. The debt amount is over $1.5 trillion, which makes it the second largest component of household debt – with an average default rate in the 10% range. For individuals not wanting to be part of another negative statistic, they are determined to pay off their loan. In the process they may be tempted to postpone saving for the less immediate need, such as retirement. A study found that approximately 29% of Americans between the ages of 18 and 29 postpone retirement savings because of student loans.

The problem with that strategy is the individuals delaying retirement savings are missing out on the benefits of compounding during their early professional careers. Even small amounts can add up to be significant earnings by the time they are looking to retire. Individuals should not have to choose one option over the other and carefully putting together a plan can help develop a strategy to overcome their student loan dilemma and save for retirement. Below are a few steps to consider:

Never Miss A Student Loan Payment

As there are many rules when it comes to student loan repayment, the most important one is to never miss a payment! At the very least, an individual should be making the minimum payment on all their loans. Unfortunately, the minimum payment is the LEAST a borrower needs to do to avoid late fees and to have a good repayment history on their credit report. Student loans can negatively impact a credit score and missing payments will certainly contribute to that. These loans are not going anywhere anytime soon and the only way to  remove the burden is to pay them off!

Utilize the Company’s 401(k) Match

The first bill one should pay each month, or paycheck, should be to themselves! This simple statement emphasizes the need to save and not to postpone to a later date. If the employer offers a 401(k) plan and has a match contribution (for example, employer will match 100% up to 3% of salary), it should be utilized up to that amount at the minimum. This is “free money” because it’s an additional 3%, totaling 6%, contributed towards your retirement savings and can make a significant impact over time.

Pay Down Highest-Interest-Loan First

If there is room available in an individual’s budget, one should generally allocate addition funds towards the loan with the highest interest rate (unless other debt includes any “teaser rate” loans with a very low rate but only for a specific time). This strategy is called the “debt avalanche method” and may provide a great benefit to the borrower. Once that specific loan is paid in full, use that total payment amount and allocate it to the next highest interest rate loan. This could dramatically decrease the repayment term on all the individual’s student loans.

The extra prepayment amount could be as simple as what is left in the budget at the end of the month. Each extra dollar allocated towards the loan balance will result in interest savings in the long run.

Available Tax Advantages

It is important to be mindful of the tax breaks available for both student loan repayment and saving towards retirement. When paying down student loan debt, there is the ability to deduct $2,500 of interest paid during a calendar year. The “catch” on qualifying for the deduction is being under an income threshold, so high-income earners may not qualify, which may be a reason to accelerate payments. The contributions made towards a 401(k) are made with pre-tax money and result in a dollar-for-dollar tax deduction. There are no thresholds required, other than having enough earned income to cover the contribution amount. A combination of the two tax strategies may provide a favorable tax return for a given year.

As simple as this decision may seem, there are a lot of factors that may sway a decision to favor one side more than the other. Since borrowers must repay the student loan debt, that must be part of the monthly budget. There is “free money” left on the table if a company offers a match program and an individual does not contribute towards their 401(k). If the budget allows, there should be a debt repayment strategy put in place. Lastly, tax breaks should also be considered in reaching a decision as to where the greatest benefit lies.

If you have any questions, please give us a call at 610-651-2777 and we will help you put together a plan to find your answers.



Bankrate.com Article


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