Saving for Retirement While Paying off Student Loans

Should you save more for retirement or pay off student loan debt?

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Student loan balances are having a significant impact on people of all ages, especially younger employees and those who went back to school or pursued advanced degrees during the past decade. Approximately 70 percent of recent graduates from four-year colleges have student loan debt, and the average graduate of the Class of 2018 finished with $29.800.

Balancing student loan debt payments can become a major challenge while trying to manage other competing financial priorities. Focusing on long-term goals such as retirement may seem like a distant priority. But if you wait too long to get started saving for retirement you will likely encounter bigger challenges in your financial life that overshadow pesky student loan payments.

Here are a few financial planning steps on the priority list that most often should be completed before attacking those student loans with extra payments.

Create a List of Your Most Important Financial Life Goals

There is no doubt that student loan debt creates a significant burden on many household budgets. These loan payments shouldn’t prevent you from pursuing important life goals. While your budget or personal spending plan may seem tight as you make these necessary payments, it is important to have a written financial action plan in place. Having a written plan can help to provide guidance when you are trying to prioritize how to spend your time and money. Taking the time to put your goals in writing and identifying the steps needed to make those goals a reality can increase the likelihood you will eventually achieve those goals. A poll conducted by Gallup found that less than 40 percent of investors actually had a written plan.

Having a written financial plan is helpful no matter what your financial situation may be at the time. Your plan does not have to be overly complicated and a simpler approach is often more effective. For example, "The One-Page Financial Plan: A Simple Plan to Be Smart About Your Money," by Carl Richards, highlights how you can accomplish extraordinary things in your financial life with a basic plan. Unfortunately, many people see the $1.3 trillion in total student loan debt amassed in this country as an impossible mountain to climb.

On a more personal level, you may assume that your student loan debt means that you won’t ever be able to buy a home or achieve financial independence. Instead of focusing only on your student loans, create a simple one-page financial plan that will help you find the best way to fit student loan payments into other areas of your financial life.

Create a Personal Spending Plan 

It is important to track your expenses. But it’s more important to go beyond tracking what already happened in the past and create a spending plan that tells your money where to go in advance. Despite the importance of having a budget, only one out of three Americans actually follow a budget and track income and expenses on a regular basis. Student loan payments are usually 10 percent to 15 percent of discretionary income. Your actual payment amounts will depend on the repayment plan you have chosen.

The process of selecting the right repayment plan goes beyond focusing on your current minimum payments. You should also estimate how long it will take to eliminate your student loan debt and how total interest costs over the life of your loan. Having a spending plan will work those debt payments into your budget and also help you identify ways to save more for retirement and pay down extra toward debt.

You can learn more about how to select the right repayment plan for federal student loans at ​

Maintain a Starter Emergency Fund 

A starter safety net fund typically ranges from $1000 to $2000 in an account separate from your regular checking. This fund is necessary to avoid more costly credit card debt or personal loans if any unexpected medical, auto, or home expenses occur.

Max out the Match in a Retirement Plan

Many companies offer some type of matching contribution to 401(k) and 403(b) retirement plans. If you work for one of those companies, don’t be like the 25 percent of workers who are leaving free money on the table. Take advantage of these matching contributions by at least contributing up to the matching amount. If you have other potentially problematic debt, though, such as credit cards, high-interest personal loans, etc., you may need to wait until you've addressed that before ramping up your retirement plan contributions.

Pay off High-Interest Debt

When it comes to paying off loans and other debt obligations, it is important to realize that some types of debt are more problematic than others. Low-interest student loans or mortgage debt are generally more acceptable and a lower priority since the interest may be tax deductible. Those payments should still fall below 25 percent of your total monthly income. For other more problematic types of debt (i.e., credit cards) with interest rates greater than 6 percent, the best way to prioritize them is to eliminate the high-interest debt.

Set Aside Emergency Fund Savings 

The majority of Americans don’t have enough savings to cover one month of expenses. However, it is generally recommended that you have enough in savings to cover at least three to six months of basic living expenses. The best way to accomplish this goal is to automatically transfer money directly from your paycheck into a separate savings account until you’ve reached your savings goal.

Health Savings Account balances and Roth IRA assets may also be included as part of your emergency fund. Remember that you will ideally want to maintain at least three months of liquid (i.e., easy to access) savings before investing those funds unless you are comfortable with the risk of a market downturn when you need access to your savings.

Make Saving for Retirement a Higher Priority

Make sure you are on track to replace at least 80 percent of your income during retirement (or your own goal) before accelerating your student loan debt payoff date. Saving enough for retirement is a challenge for many Americans right now. It can be extremely difficult to save enough if you are in the early career stages and feel burdened by student loan debt.

While attacking your student loans may feel like a more urgent priority, it is usually recommended to save at least 10 percent to 20 percent of income throughout your working years to achieve financial independence. Prioritizing your retirement savings ahead of making extra payments on your student loans allows you to take full advantage of the power of compounding interest. Student loans are already creating a drag on retirement savings. A Morningstar report found that every dollar of student loan debt is associated with a 35 cent decrease in retirement savings. Don’t let your retirement suffer more by not saving enough. You can use a retirement calculator to see where you stand and try to increase contributions as needed.

Incorporating Student Loans Into Your Spending Plan

It is important to point out that the previous financial planning steps are commonly recommended prior to making extra payments toward education loans. But that doesn’t mean you should just blindly assume that you don’t have any options when it comes to working student loans into your budget.

Your repayment options primarily depend on the type of loans you have (federal or private). Consolidating federal loans or refinancing private loans provide borrowers with options to make loan repayment fit your individual financial plans. In many situations, a few small changes can help simplify the repayment process and, in the case of refinancing, could significantly lower the costs of borrowing through reduced interest rates.

Here are important facts to be aware of when selecting your repayment plan:

  • With federal student loans, you’ll be asked to choose a plan. If you don’t choose one, you will be placed on the standard repayment plan, which will have your loans paid off in 10 years.
  • You can switch to a different plan at any time to suit your needs and goals.
  • Your monthly payment can be based on how much you make.
  • Private loans are made without federal funds and come with fewer repayment options. Contact your lender, loan holder, or loan servicer to find out your repayment options.
  • All federal student loans first disbursed on or after July 1, 2006, have a fixed interest rate for the life of the loan.
  • If you have a direct loan, you can sign up for automatic debit payments through your loan servicer and you will never miss a payment. Best of all, you will get a 0.25 percent interest rate deduction when you enroll.

Creating a financial plan that is simple and flexible is the first step you can take to assume control over student loan debt. If your student loans are starting to feel more like a mortgage payment, just remember that there are ways to fit your payments into your financial plan in a way that doesn’t neglect your need to save for retirement.