These days, hardly anyone graduates college without at least some student debt. In fact, FinAid.org says that in 2007-08, graduating seniors carried an average of over $23,000 in debt – including state, college, private and federal student loans. Many recent college graduates are in a hurry to get out from under that load of debt, but before you start making extra student loan payments, you also need to think about how you’ll save for retirement.
Today’s college graduates are seeing in the previous generation the consequences of failing to save for retirement. Our parents and grandparents have to work longer or live on less than comfortable retirement incomes simply because they never made retirement savings a priority. So instead of rushing to pay back the thousands of dollars you probably have in lower-interest student loans, consider the following concepts when deciding whether to pay off student debt or save for retirement.
Interest Rate Basics
Really, when you get into any discussion of whether to pay off debt or save, you’re playing the interest rate game. According to popular investing site Investopedia, investment experts in the 1990s and early 2000s would calculate retirement savings based on about an 8% rate of return, but today’s investment experts feel that this is much too high and are more likely to use a 4% to 5% rate of return.
What does this mean for paying off student loans versus saving for retirement? It basically means that if your student loans have a higher interest rate than 5% to 6%, you may actually be better off paying them down first, before you start saving for retirement. While this is not necessarily true across the board – such as in situations where you can have your student loans forgiven for being in a public service job – it is generally true that you’ll get more bang for your buck by paying off loans if they have a higher interest rate than your expected rate of return on savings.
You probably already know that you should pay off high-interest credit cards before making any move towards saving money, since you’ll never get a good enough return on your savings to beat the interest you’ll be shelling out on credit cards. If you’re dealing with credit card debt along with student loan debt, check out some of the best credit cards for a balance transfer, which could help lower your monthly minimum payments so you can pay off the debt faster.
Start Saving By 30
It’s generally true that you need to focus on getting the best possible financial return for your money. That could mean saving thousands of dollars by paying off higher-interest debt or even student loans, or gaining more money with your retirement savings. But it’s also true that you should start saving for retirement as early as you can. One Los Angeles Times columnist asserts that people who don’t start saving for retirement until they are 35 have a very hard time catching up and being ready to retire on time.
So if you’re a brand new college graduate, you may still have a few years to throw money at your debts before worrying about saving for retirement. But as you approach the big 3-0, it’s time to get serious about paying yourself first. Even if you can only save a little at a time while still paying off debts, at least you’re getting started!
Consider Extra Incentives
One other thing to consider when it comes to saving for retirement or paying off student loans is extra incentives that may be involved with these financial goals, especially saving for retirement. It can be hard to look at the entire picture, but you need to take more into account than just expected rates of return. Here are some of the other things to consider when making this important financial decision:
• If you’re in a public service industry, your student loans could be forgiven in 10 years, anyway, and even if you aren’t in public service, there’s a chance that your student loans could be forgiven in 25 years. If the loans are going to disappear, then you’re definitely better off contributing to retirement.
• If your employer offers matching options for retirement savings, then you should try your best to meet the matching limit each year. Even if your rate of return is going to be lower than your student loan interest rate, you don’t want to leave that free money on the table.
• Consider tax incentives for both options, as well. Certain retirement savings contributions can net you tax reductions, as can paying interest on your student loans. Keep in mind that if you make extra student loan payments, the extra will be going to principal rather than interest, so these payments won’t help at tax time.
If you’re unsure of the entire package of financial incentives for your job’s retirement plan or for retirement savings in general, talk with a good financial advisor to look at your options more closely.
Balance Both Goals
For many graduates, the best option is to balance both the goal of saving for retirement and the goal of paying off student debt. While you may not be able to save the recommended 10% of your income while paying off student loans, you can save at least some money. While saving for retirement, you can add just a few extra payments to your student loan debt, which can pay down the principal significantly faster!
Balancing both goals is often the best option, but to find out what would work best for you, you’ll need to examine all your options, figure out your retirement savings goals and probably talk with a qualified financial advisor to come up with a personalized game plan that meets your needs and goals.
Daniela Baker is a personal finance blogger who frequently writes about retirement and the challenges we face. She helps families compare balance transfer deals at Credit Donkey