Should You Pay Off Student Loans Before Saving for Retirement?

Key Points

  • To put student loans in perspective, understand the difference between "good" and "bad" debt.
  • By prioritizing, you can pay down your loans in a way that balances past debt obligations and future goals like retirement.
  • Put as much as you can on automatic to make payments on your loans and contributions to your retirement accounts easy and convenient.

Dear Carrie,

I'm 24 and came out of school with $80,000 in college loans. I've been luckier than most of my friends and have a full-time job, but I'm wondering whether I should pay off my loans before I start saving for retirement. What do you think?—A Reader

Dear Reader,

This is a great question and absolutely timely. With total student loan debt now topping  1.4 trillion dollars, there's real concern about how this debt is preventing young people from buying a home, saving for retirement, or starting a family.

But it doesn't have to be this way. It all depends on how you prioritize. You—and every graduate who's struggling with debt—can make choices on how to pay down your loans that will help balance past obligations and future goals.

Obviously, you have to pay at least the minimum on your student loans and never miss a payment. But beyond that, you can create a system to stay on top of your loans while at the same time contributing to your financial future.

Understand the difference between "good" debt and "bad" debt

The first thing is to realize that not all debt is equal. Some of it can actually work for you. For instance, debt that's lower cost and is potentially tax deductible, such as a mortgage or a student loan, can fall into the "good" debt category.

On the other hand, high-cost debt, such as credit cards and car loans, is definitely in the "bad" debt category. It's the most costly, especially over time. Think about it: when you borrow money to buy something like a car, you're paying extra in interest to own something that is depreciating in value. That’s a double whammy!

In other words, good debt can actually be a financial tool but bad debt can be a financial nightmare. Most student loan debt falls into the “good” category because it allows individuals to invest their education and increase their earning potential. Moreover, student loans often offer flexible repayment options and low interest rates, and the interest may be tax deductible, meaning it may not be advantageous to pay it off aggressively at the expense of working toward other financial goals.

Strike a balance between debt payment and saving

From my point of view, your top saving priority should be retirement. So once you've accounted for the minimum payments on your student loans, here's how I suggest you prioritize your savings and payments:

  1. Contribute enough to your company retirement plan to take full advantage of your employer match. This puts extra money in your pocket.

  2. Build an emergency fund to cover at least three to six months of essential expenses.

  3. If you have a credit card balance or a car loan, focus on paying those down next, starting with the highest interest loan.

  4. Save more for retirement. Because you’re starting in your twenties, you should be in good shape for retirement if you can save 12-15 percent of your gross salary throughout your working years. (Those who postpone starting to save for retirement have to increase this percentage.) 

To me, these first four points are important for everyone. Once you have a handle on them, you can tackle other goals according to your personal needs and preference.

  • Save for a child’s education. (Notice that retirement comes first.)
  • Save for a home. (Again, retirement first!)
  • Pay down other debt, including your student loans.
  • Save even more. Once you have money saved beyond your emergency and retirement funds, add to your long-term savings in a taxable account.

These final four savings priorities will evolve as your life changes. The main thing is to keep saving even while you're paying down your student debt.

Understand the difference between saving and investing

As you look ahead, it’s also essential to understand that saving for the future and investing for the future are two different things. Saving means putting your money in a safe place—for example, in a federally insured bank account. You won’t get a big return, but when it comes to your emergency fund or any other money that you know you will need in the next one to three years, safety is paramount. 

When you’re preparing for a goal that's many years out (such as retirement), it may be appropriate to invest some of your money in the stock market so that you have the potential to outpace inflation. Don’t hesitate to consult with an investing professional as you build a diversified portfolio.

Stay on top of student loans

Don't get me wrong. It's great that you're focusing on paying off your student loans right away. As you figure out your other savings and payment priorities, you'll want to continue to keep a sharp eye on them. To make it easier, organize your loan documents so that you always know the amount owed, interest rate, term of the loan, minimum monthly payment, and repayment date. A simple spreadsheet should do the trick.

Also explore repayment options. Federal loans have more repayment alternatives than private loans, including graduated repayments, income-based repayments and public service loan forgiveness. Consider consolidating loans to possibly lower interest rates and monthly payments.

Make it all automatic

Finally, put as much as you can on auto-pay—monthly bills, including student loan payments, and your savings. Your 401(k) contributions automatically come out of your paycheck, but don't stop there. You can set up automatic transfers from your checking to your other savings accounts as well. Once you have money to invest, you can even direct your savings automatically into a brokerage account to start building a diversified portfolio.

I give you a lot of credit for taking your student loans seriously, and for thinking about retirement this early. If you can handle both, you'll be putting yourself in a better position to not only enjoy the benefits of your education, but also to handle whatever the future holds with greater confidence.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

 

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