Saving for retirement while paying off your student loans feels impossible.
On the one hand, you know you should prepare for retirement, and the best way to do that is to save money. But you can’t save money because you need to pay off your student loans.
It feels like a lose-lose situation either way.
84% of borrowers agree. They say that their student loans hurt their ability to prepare for retirement.
Fortunately, some may find a nice balance between paying off a loan and saving for retirement at the same time. Here’s how.
It starts with an income-based repayment plan
The monthly student loan payment average is almost $400 dollars a month.
That’s a sizeable amount.
To lower your monthly payment, the best thing you can do is get on an income-based repayment plan.
You likely qualify if you’re paying back direct federal loans. They’ll base your payments on your adjusted gross income and a calculation using the poverty limits for an individual or family.
The remaining amount is called your discretionary income which they use to base your monthly payment.
Since I walk step-by-step through the income-based repayment plan in another article, I won’t go too deep into the specifics on those plans here.
The important thing when thinking about retirement is the adjusted gross income.
If you can lower your AGI, you can lower your monthly payments. Retirement saving is just one approach.
Should you do it? Since there’s no magic answer, here are some pros and cons to weigh in your decision.
What are the pros of retirement savings?
First, if your employer matches your 401k contributions, you’ll essentially earn free money for your retirement.
Employer contributions vary, but you should make it a goal to contribute the max amount that they’ll match. If you can’t swing that now, consider working up 1% each year.
There’s another pro to starting your retirement savings before you fully pay off your student loans.
It’s called compound interest. Starting your savings 5-10 years earlier can result in hundreds of thousands by the time you retire.
And finally, contributing to retirement will lower student loan payments.
Because your take-home pay is lower thanks to your 401k contributions, the federal government treats it as if you have less money to spend every month, and then lowers your student loan payments.
Depending on how much you contribute to retirement, you could see your monthly payment drop as little as $50/month to cutting your monthly payment in half.
These are some of the pros. What about the cons?
What are some of the cons?
One of the biggest questions borrowers have about saving for retirement is if retirement saving changes student loan interest rates.
Your interest rate won’t change if you increase your retirement contributions.
However, the amount of interest you pay will change.
It’s like the difference between a 15-year mortgage and a 30-year mortgage. Most people take the 30 because it means they can afford the monthly payments. However, they’ll end up paying a lot more for the house by the time they’re through.
It’s the same with a student loan. You’ll pay less per month if you contribute to retirement. But you might end up paying more in the long run. If your payment is too low, you may not even pay enough to cover the interest.
Keep in mind that up to $2,500 in interest payments is deductible on your taxes if you make less than $70,000 a year.
So what should you do?
I recommend looking at this student loan repayment calculator and trying out some different figures. Chances are there may be an option down the middle that strikes a good balance between saving and paying off your loan.
If you’re going for the PSLF, I suggest you make the smallest monthly payment you can.
Since you have to make 120 payments, why not make them small and bank on the forgiveness at the end. This may free up some money for retirement.
On the other hand, if you’re the kind of person who needs to remove your debts before you think about anything else, it may be best to hold off on retirement savings.
I’m also happy to look at your case and walk you through your options.