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Should I Pay More Toward My Student Loan Debt or Add to My Retirement Savings?

Written by Equifax Reporter on November 19, 2015 in Retirement  |   No comments

Saving for retirement during your lifetime is one of the smartest financial investment decisions you can make. In fact, the sooner you start, the further those hard-earned dollars go, thanks to the power of compound interest. However, many young people are more concerned about student…

SudentLoansOrRetirementSaving for retirement during your lifetime is one of the smartest financial investment decisions you can make. In fact, the sooner you start, the further those hard-earned dollars go, thanks to the power of compound interest.

However, many young people are more concerned about student loan debt than they are about retirement planning. According to the Consumer Financial Protection Bureau (CFPB), student loan debt is estimated at more than $1 trillion. And on the flipside, a 2015 study by Moody’s Analytics, a research and consulting firm, finds that millennials have a savings rate of negative 2 percent.

Throw in other expenses such as car loans and insurance into the mix, and it’s not that surprising why today’s millennials, adults under age 35, are not saving as much.

So what’s a college graduate saddled with debt to do? Is the decision as simple as an either/or scenario?

The bottom line is: There’s no single answer that works for everyone.

Depending on the situation, the pro-and-con scale of paying down debt vs. saving for retirement may tip in one direction or the other.

The obvious advantage of paying off student loans is the potential cost savings down the road. School loans collect interest. The longer it sits unpaid, the larger the interest bubble tends to grow.

But paying down the loan at the expense of a long-term savings account means you could miss out on critical funds. Financially speaking, the advantage of being young is the greater period of time to capitalize on compound interest and investment returns.

So let’s do some math.

The average class of 2015 college graduate has approximately $35,000 in loan debt, according to an analysis of government data by Mark Kantrowitz, publisher of Edvisors, a web resource on paying for college.

If you wanted to pay that off in five years at the average 6 percent interest, you would have to pay just over $675 each month. By the end you will have spent an extra $5,600 in interest. For 10 years, the monthly payment is around $388 and you will have paid around $11,630 in total interest.

The cost savings is immediately apparent: $6,000 extra dollars in your pocket if you rush your student loan payments. That’s nothing to sneeze at.

But what about the loss of potential savings?

Let’s say you invest a nominal amount, just $100 each month, into a traditional IRA which grows about 7 percent each year. You start right now, and never invest a dime more than $100 each month until you retire at age 65. That account, before taxes, will be worth $256,331 when you retire.

Now let’s say you wait until you’re done paying off your student loans to start saving. If you wait five years: That account just shrunk dramatically to $177,496 before taxes.

That’s a $78,835 difference for doing nothing more than starting five years later. If you wait 10 years, you lose more than $50,000 on top of that.

“The key is doing both [retirement planning and student loan debt],” says Greg McBride, chief financial analyst at Bankrate.com. “The trap people fall into is they say they’ll start saving as soon as they pay off the debt. Five years go by, 10 years go by and they still haven’t paid it off,” he says.

In the meanwhile, they haven’t started saving anything either.

McBride highly encourages young people to not forego savings. Make it a priority to pay toward both financial obligations, even if the contributions start off small, he says.

A meager $60 a month can grow into $100,000 in 35 years. As you finish paying off your student loans, consider just upping your retirement contribution rather than suddenly filling your checking account with spending cash, McBride says.

Curious to do your own calculations? Check out some online calculators, which can tell you how much you can save if you start investing now, how much delaying savings will cost you and see how different payment levels will impact your student loans.

The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.

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