Why You Should Save for Retirement While Paying Student Loans - Student Tax OPtion

Why You Should Save for Retirement While Paying Student Loans

More and more students are turning to student loans in order to earn a degree. As that becomes the norm, many are wondering whether putting off their retirement savings in favor of quickly paying off their student loans makes the most sense.

Amy Ouellette, director of retirement services for Betterment and Betterment for Business, says that is not the right move. Instead, Ouellette says paying off student loans and building up retirement savings should happen at the same time.

In the long term, putting off saving for retirement can do more harm to your financial life. Not only do you miss out on the direct contributions building up your account, you will lose the potential interest on the balance that you could receive. Because the default student-loan payment plan is structured for 10 years, Ouellette says graduates shouldn’t wait to save for retirement.

By waiting an extra 10 years before you begin to save for your retirement, “you could be missing out over half of the possible savings,” Ouellette states. This is due to the compound interest of a retirement savings account, where savings snowball by earning interest and growing based on the total balance, rather than a fixed amount every year.

And because of the impact compound interest has on your savings, you could actually save more without contributing more. Business Insider’s Tanza Loudenback explains this with the following example:

“Chris and Jennifer both invest $100 a month at a 5% annual compound rate of return. Chris begins investing at age 25, putting away $100 every month until 65 and Jennifer begins saving $100 a month at age 35.

“An extra 10 years of saving means that Chris has about $162,000 in his bank account, while Jennifer has $89,000 by the time she is 65. Chris’ balance is nearly double Jennifer’s and he contributed only $12,000 more of his own money.”

As we see in this example, the more time you are contributing to a retirement savings account, the more you will gain in the long term. Even small contributions to a retirement account will make a difference when mapped out after decades of compounding interest.

But student loan debt can be a real burden for many. In the class of 2018, about 69% had student loans and the average student owed $29,800, according to Student Loan Hero. Saving any amount can be difficult with the average minimum student loan payment around $393 per month. Ouellette recommends living within your means to avoid defaulting on your loans.

“You want to make sure that you’re able to pay the minimum amount on your student loans to not get yourself behind on those,” she says.

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After housing, food, car payments, utilities, and your student loans, the resources left become precious. While it can feel overwhelming to plan on an additional portion of your monthly income becoming unusable, it’s important to remember that you can start small with your monthly contributions. To make it easier on yourself, Ouellette recommends the following:

Find out if your employer offers a 401(k) with a match.

Luckily, many employers offer to match your contribution to an employer-sponsored 401(k). Though they may have a limit on how much they will match every month, the additional savings will of course help. Ouellette says, “Save enough in the 401(k) to get the match so that you don’t leave free money on the table.” For those whose employer doesn’t offer a 401(k), look into opening your own retirement account, called an IRA, and contribute to that instead.

Decide what you can reasonably contribute.

According to Ouellette, it would be ideal to work your savings up from 5% to 10% of your salary if your employer doesn’t offer to match. However, “if you can’t, that’s ok,” she says. “Start with a 3% contribution rate and you’ll notice that it doesn’t seem as painful as you might expect.” The important thing is to make saving for retirement a monthly habit, even if it’s just 1%. From there, try increasing your percentage every six months.

Anyone with student loan debt has the urge to pay it off. It might become one monthly payment that you resent every time it comes due. And it can seem never ending, especially with such high amounts of student loan debt. However, the benefits of diverting some of your income stream to your future will make a huge difference.

Ouellette concludes by saying it’s best to “take a more balanced approach,” and not prioritize extra student loan payments. “Build your savings muscle at the same time as you’re working to pay down your debts.”

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