Should You Save for Retirement or Pay off Student Loans?

An increasing number of people are graduating from college with student loans to pay back. 44.7 million student borrowers have an average of $37,584 in student loans each and 65% of students graduate with student loan debt in 2020. As a result, an entire generation is entering the workforce with a difficult question: should they save for retirement or pay off student loans?

Both saving for retirement and paying off student loans are critical to advancing one’s financial future. And the good news is that graduates don’t have to choose just one or the other. While the right answer may look a bit different for everyone, it is possible to balance retirement savings with debt payoff.

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In this article

    How important is paying off your student loans?

    For most people, student loans represent the largest financial burden they’ll face in their early adult years. And it’s one that impacts your life and your finances in a myriad of ways.

    First, making student loan payments each month reduces the amount you have to put toward other expenses and future financial goals. Depending on the amount of debt you have, this could represent a sizable portion of your monthly budget.

    Student loan debt also impacts your credit. It may be more challenging to qualify for loans and credit cards with significant debt on your credit report. And missing just one student loan payment can cause you to have bad credit.

    It’s also important to remember that there are few other ways out of student loan debt besides paying them off. Federal student loans have no statute of limitations and can’t generally be discharged during bankruptcy. The government can garnish your wages and tax returns. And most borrowers aren’t eligible for the handful of loan forgiveness programs available.

    Paying off student loans is a more expensive process for some than others. Federal undergraduate loans tend to come with lower interest rates. But for graduate students or those who had to take out private loans, rates can be quite steep. Those borrowers may find that a lot of their money is going to interest each month instead of paying down their balance. It becomes even more important to prioritize those loans.

    [ Read: The Student Loan Moratorium is About to End. Here Are Your Options ]

    How much should you be saving for retirement if you have student loans?

    You may have read up until this point and determined that you should pay your loans off as quickly as possible, forgoing saving for retirement until they’re gone. And while some personal finance experts do recommend that, it’s not quite as simple as that.

    Retirement is likely to be a lot more expensive than your student loans, and investing requires having significant time in the market for compound interest to work its magic. If you wait until your student loans are gone to start saving, then you’ll have to save a lot more per month to catch up.

    You can find a balance so that you can prioritize both student loan payoff and retirement savings in your budget. Here are a few questions to ask yourself to get started:

    1. What is the interest rate on your student loans? In many cases, student loan interest is lower than the return you could expect to get in the stock market. Therefore, you’d actually be earning more on your retirement savings than you’d be spending on loan interest. The lower your loan interest, the more sense it makes to put money toward retirement savings.
    1. Does your employer offer a match on retirement contributions? Many employers offer to match their employees’ retirement contributions up to a certain percentage of their salary. If your employer has this benefit, it’s basically free money, and it’s wise to take advantage of it.
    1. How can you maximize the tax advantages? Retirement contributions have tax advantages. Student loan interest is also tax-deductible, up to $2,500 in 2020. Look at your specific situation and see if there’s a way to get the most of both tax benefits by both saving for retirement and paying down your student loans.

    The benefits of paying off student loans early

    There are plenty of benefits to paying your student loans off early — and they aren’t just financial benefits, though that’s certainly a big piece of it.

    You pay less money overall

    The earlier you pay off your student loans, the less you pay in interest. And depending on the rate on your student loans, that could be a significant chunk. The interest rate on private student loans can exceed 10%, making them quite costly. Even just a few percent on a large balance adds up over time.

    [ See: Should You Bank on Student Loan Forgiveness in 2021? ]

    You have more money for other goals

    When you remove student loans as a line item in your budget, you free up more money for other financial goals, including retirement. You can also reallocate that money toward a house down payment, medical procedures, children and many of life’s other expenses.

    And it’s not just the increased cash flow that will help you reach other goals. You’ll also have a lower debt-to-income ratio, which makes you a more attractive candidate for future loans like a mortgage.

    You eliminate the emotional burden

    For many borrowers, the emotional burden that comes with student loans is as significant as the financial one. Many students don’t fully understand what they’re getting themselves into by borrowing money for school — in fact, almost 70% of students don’t know what the payment amount will be on their first student loan bill. At that time, they may deal with significant stress, resentment, and all sorts of negative feelings. Paying off your loans early allows you to escape that emotional burden.

    [ Read: Student Loan Consolidation and Refinancing Guide ]

    The benefits of saving for retirement early

    While paying off student loans early comes with its fair share of perks, there are also benefits to saving for retirement early. When it comes to investing, you get to enjoy the benefits of compound interest. In other words, your investment earns money. And then the money you earned also begins to earn money.

    The longer your money is in the market, the more you benefit from compound interest. According to an Investor.gov calculator, if you were to invest $325 per month from ages 25 to 65 with an 8% return, you’d have about $1 million waiting for you in retirement. But what if you waited until 35 to start investing? You’d have to save more than twice as much per month to end up with the same amount. Wait another decade, and you’d have to save about $1,850 per month. The person who started saving at 25 only contributed about $156,000 to end up with more than $1 million. The person who waited until 45 had to contribute $444,000 to end up with the same result.

    How can you efficiently save for retirement later in life?

    If you’re further along in life and haven’t started saving for retirement yet, don’t panic. There’s still time for you to catch up. The key is to get started right away.

    Figure out how much you need to save

    The first step is to figure out how much you need to save to retire comfortably, whatever that means to you. Think about the average cost of living in your city, your target retirement date, the average life expectancy and any partners, children or spouses in your life. You should save enough to cover these expenses from retirement to the end of your life.

    Take advantage of employer matches

    If your employer offers a 401(k) or another retirement plan where they match your contributions, make sure you’re taking advantage of it. Failing to contribute at least enough to get the full match is leaving free money on the table.

    Use catch-up contributions

    The IRS increases contribution limits for 401(k) plans and individual retirement accounts for individuals age 50 or older. That way, you can put away more money each year to make up for getting a late start.

    Consider other investment options

    A 401(k) isn’t the only effective way to save for retirement. You can also use an IRA (individual retirement account), which is another tax-advantaged way to start preparing for retirement.

    [ See: Should I Pay Off Debt or Invest My Money? ]

    Check Your Student Loan Rates

    View our top-rated lenders and find the best rates today. It’s quick and easy.

    Speak to a financial advisor

    If you aren’t sure where to start or whether you’ll ever be able to catch up, you might consider speaking with a financial advisor. They can help run the numbers and put together a plan to get you back on track.

    Student loan FAQs

    You can make room in your budget for both 401(k) contributions and student loan payments. If your employer offers a match on retirement contributions, set aside at least enough to get the full match.

    If you fail to pay your student loans, the IRS can garnish your wages, tax returns, and Social Security benefits. Lenders generally can’t seize your 401(k) contributions.

    Depending on the interest rate of your student loans, it usually makes sense to start saving for retirement while you pay off your student loans.

    We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.

    Reviewed by

    • Courtney Mihocik
      Courtney Mihocik
      Loans Editor

      Courtney Mihocik is an editor at The Simple Dollar who specializes in personal loans, student loans, auto loans, and debt consolidation loans. She is a former writer and contributing editor to Interest.com, PersonalLoans.org, and elsewhere.