Should you knock out student loans before investing for retirement? Here's how to decide.
Corey Forsythe graduated from pharmacy school with a degree and $200,000 in student loans. He's in no rush to pay them off.
Forsythe, who is now 35 years old, has been chipping away at the balance by paying down $950 a month. But for the last eight years, a bigger priority for him has been investing in the stock market. It's a different approach than many of his peers.
"I have a lot of friends who are still trying to pay off their loans as fast as possible, even going as far as still living at home," Forsythe told BI. "After paying them off, their net worth was zero."
With President Donald Trump restarting collections on defaulted student loans, the question of how to manage student loan debt is once again at the forefront of many people's minds.
It can be difficult to balance paying off student loan debt with other financial priorities like saving for retirement, and there's no universal answer. But in some cases, it can be beneficial to make smaller loan repayments and focus on other financial goals, experts say. Keep the following factors in mind when making decisions about student loan debt.
There are programs to help reduce the burden of student loans, so be sure to check if you qualify for any of them, Rae Kaplan, the owner and head attorney at Kaplan Law Firm, told BI. Reducing the amount of student loans you have to pay will free up your resources to invest and save for other financial goals.
There are several income-based repayment plans available. If you work in the public sector and have federal loans, check to see if you qualify for Public Service Loan Forgiveness, a US federal program that forgives the remaining balance on your student loan debt after 10 years of repayments.
Forsythe is enrolled in the Pay As You Earn repayment plan, which requires him to pay 10% of his discretionary income monthly. After 20 years of qualifying payments, his remaining student loans will be forgiven.
"For me, I'm paying the minimum to keep them at bay, but my main goal is to build my assets and invest in index funds," Forsythe said.
In a case like Forsythe's, "the strategy there would be to keep your payment as low as possible on your federal loans while investing as much as possible into your retirement," Kaplan said.
Compare interest rates and investment returns
If your loan interest rate is high, it's smart to prioritize paying that off to prevent the loan size from growing.
The S&P 500 returns around 10% on an annualized basis, or 7% after inflation. The interest rate on student loans depends on the type of loan and the individual, and the current federal interest loan rate is 6.53%. If your loan rate is close to or above your investment return, it's a safer bet to prioritize paying off the loan.
Bruce Maginn, advisor at Solomon Financial, recommends extending the terms of your repayment plan to spread out payments over a longer period of time, making your monthly payment smaller. This frees up cash for living expenses, retirement savings, and other financial goals.
"If your monthly payment is so much that you can't make your payments on time, you'll have late payments, and that's going to create a negative impact on your credit score," Maginn said. "So the next time you go to get a car loan, instead of paying 2 to 5%, it may be 18%."
Kaplan suggests looking into refinancing your student loans for a lower interest rate, if possible.
"If your credit is good, you can refinance a private loan with a different lender," Kaplan said. She suggests looking into private lenders like SoFi and Earnest.
"If you can get that private loan from 15 to 18% interest down to 6%, that massively reduces your monthly payment and the overall cost of the loan, thereby freeing more money up for retirement savings," Kaplan said.
Prioritize your 401(k) contributions
Take advantage of your company's retirement benefits, Maginn recommends.
For those who are too aggressively focused on paying down their student loans, they can miss out on contributing to their employer-sponsored retirement plan, and most importantly, getting the employer match, which can often be 5 to 6%, Maginn said. That's when, once again, it's helpful to extend the time horizon of your payment plan and pay smaller amounts each time.
Your employer might also be able to help you pay down your loans. Under current law, employers can provide up to $5,250 in annual student loan repayment assistance. Under the SECURE Act 2.0, employers can offer a 401(k) match even if you're not contributing to your retirement account, as long as you're making student loan payments.
Not all employers will offer this, but check in with your HR manager to see what benefits you might be eligible for.
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