Paying Off Student Loans vs. Saving for Retirement
In this section, we will discuss whether you should focus on paying off student loans or saving for retirement. Paying off student debt is an important part of achieving financial stability, while saving for retirement is essential since we all have to stop working at some point in our lives.
Cost of Student Loans
Unfortunately, student debt has risen significantly, with 50% of four-year college graduates taking out loans that range from $18,350 to nearly $40,000 per graduate.
Additionally, interest rates on student loans can range from 5% to over 7%, and the standard loan term is ten years, depending on the type of loan program. Here is an example of how much student loans might cost you by the time you finish paying them off:
Student loan balance: $30,000 Interest rate: 6% Loan term: 10 years Monthly payment: $333 Total amount paid: $39,960 Total interest paid: $9,960
In ten years, you will have paid nearly $10,000 in interest on about $40,000 total.
Cost of Retirement
While the standard student loan term can be ten years, retirement can last for 30 years or more, meaning that retirement will cost significantly more than your total student debt, depending on when you stop working and how long you live.
In retirement, you will need to cover living expenses and medical care (which will increase as you age). Typically, you should replace at least 80% of your income. If you earn $50,000 a year, you will need to save enough to have $40,000 a year in retirement. For a retirement lasting 25 years starting at age 60, you would need at least one million dollars ($40,000 * 25).
There may be other sources of income in retirement, such as Social Security, but it is unlikely to cover all living expenses. In 2021, the average monthly Social Security benefit was $1,555 or $18,660 total for the year.
In other words, over 25 years, Social Security might cover a total of $466,500 based on 2021 benefits, which is far less than the one million dollars needed according to the figures in our example.
The Power of Compounding
Starting to save for retirement early is just as important as paying off student loans because of the impact of compounding. Compounding means you earn interest on your interest.
For example, if you save $50 a month over 20 years, you would have saved a total of $600 a year or $12,000 in total. However, if you earn 6% annual interest and reinvest the earned interest over 20 years, you would have $23,000 – almost double the amount contributed.
Before you start making extra payments on student loans, use a retirement calculator to see if your savings are on track. Once you start saving regularly for retirement, you can consider making extra payments on your student loans.
Maximizing 401(k) Matching Contributions
If you are in your twenties and have student loans, one of the best ways to grow your wealth is to enroll in a 401(k) plan and take advantage of employer matching contributions.
Many companies offer some form of matching contribution for 401(k) and 403(b) retirement accounts. For example, if your company offers a 5% match, that means they will contribute 5% of your income annually as long as you also contribute 5%. In other words, the employer matching contribution is free money. However, you need to contribute a specific amount or percentage of your salary to be eligible for the match.
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If you have student loans, make sure to contribute enough money to your 401(k) account to be eligible for employer matching. Once you are vested in your retirement plan, the money is yours even if you leave your job for another company. Also, you may have the option to request a loan against your 401(k) account in the future if needed.
Understanding Debt Repayment Options
While focusing on retirement savings doesn’t mean you don’t have options for repaying your student loans. You can choose a repayment plan that makes saving and repaying debt easier. Your repayment options primarily depend on whether your loans are federal or private.
Note: Private loans are made without the use of federal funds and come with fewer repayment options. You’ll need to contact your lender, loan holder, or private loan provider to learn about your repayment options. Many private loans can be refinanced to lower the interest rate.
Choosing the plan that best fits your financial situation will help you repay your debt regularly while maintaining retirement savings. If you have federal loans and do not choose a repayment plan, you will be placed on the standard plan, which is a ten-year term. However, you can switch to a different plan at any time.
For many graduates, the best option is an income-driven repayment plan, which calculates the monthly payment based on how much money you earn. In these plans, any remaining debt is eligible for forgiveness after 20 or 25 years.
There are many other types of repayment plans, which can depend on your income or discretionary income or how quickly you want to pay off the loan. You can also consolidate multiple federal loans into one monthly payment.
Important: If you have a Direct Loan, you can enroll in automatic payments through your loan provider. By enrolling in this program, you will receive a 0.25% interest rate discount.
Financial Steps to Take While Repaying Student Loans
While saving for retirement and repaying student loans, you can start making progress on other important financial goals.
Source: https://www.thebalancemoney.com/saving-for-retirement-while-paying-student-loans-4098308
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