Should You Save for Retirement or Pay Off Student Loans?

October 17, 2022
Just because you have student loans to pay off doesn't mean you should put investing on hold to do it—you don't have to prioritize one over the other.

Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)

Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)

Student loan payments are set to resume in January after a nearly three-year pandemic pause, resurrecting a perennial challenge for recent grads: Should I pay down my student loans before I start saving for retirement?

Of course, some borrowers may benefit from the student debt relief plan introduced by the Biden Administration and the U.S. Department of Education, which could shave up to $20,000 off qualifying grads' debt balances. But this one-off move won't resolve the bigger issue of how to balance the competing demands of yesterday's debt with tomorrow's financial needs. 

It can be tempting to postpone saving for things like an emergency fund or goals like retirement, especially if you're young and aren't making a lot of money. However, thanks to the power of compounding, setting aside even small amounts when you're young could help you build significant savings by the time you're retired.

It's not impossible to tackle student debt while also saving for retirement. Consider prioritizing these steps:

1. Make the minimum loan payments

The cardinal rule of paying off student debt is: Don't miss payments. Make at least the minimum payment on every loan and ensure the amount fits your monthly budget. If you can't manage the minimum, the Consumer Financial Protection Bureau has resources that can help you negotiate with federal and private lenders.

Don't hesitate. As you repay your loan, you're establishing credit history, and your student loan interest payments may be tax-deductible if your adjusted gross income is less than $85,000 ($175,000 for joint returns). So, there's an upside to making minimum payments on time.

2. Maximize 401(k) contributions to at least get the match

Your next priority is to consider your qualified workplace retirement plan. You'll want to contribute as much as you can afford to your 401(k)—or 403(b) if you work for a nonprofit or 457(b) if you're a government employee—up to your employer's match. Not contributing enough to receive the match (often 5% or 6%) is turning down "free money." 

3. Pay off high-interest-rate debt

Debt with a high interest rate, such as a credit card, can quickly pile up—especially if you carry over your balance from month to month. Start by cutting back your credit card use and put extra money toward your balance. With less debt, you'll be able to save more for retirement and other financial goals.

4. Build an emergency fund

Life happens, and you should plan for the unexpected. Otherwise, you might find yourself relying on your credit card or retirement savings during a financial setback. To give yourself a buffer, we recommend saving at least three to six months of living expenses. Keep the money in a high-interest savings or money market account where it can grow and you can easily access it should you need to make a withdrawal. Even if you put away only a minimal amount each month, every little bit helps.

5. Consider a traditional or Roth IRA

In addition to or in lieu of a workplace retirement plan, you can make tax-advantaged contributions to other types of retirement accounts. In 2022, you can save up to $6,000 a year in a traditional IRA and get an up-front tax deduction. Alternatively, you can save the same amount in a Roth IRA and forgo the tax deduction today but enjoy potential tax-deferred growth and tax-free withdrawals on qualified distributions in the future.1 Also, if your income is less than $34,000 ($68,000 for joint returns), you might be eligible for a Saver's Credit—up to $2,000 ($4,000 for joint returns) for your IRA or 401(k) contributions. 

6. Put additional funds to work

When you're fortunate enough to have leftover funds, use them wisely. After you've paid your debts—and yourself—consider investing the rest in the market. While investing involves risks and you could lose money in the market, you may also gain more from investment returns over the long run.

The bottom line

Juggling student debt can be tricky but investing in your future is worth it. College graduates can successfully manage loan repayment while saving for retirement. You don't have to choose one over the other.

1You need to be over the age of 59½ and have held the account for five years before tax-free withdrawals are permitted.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risks, including possible loss of principal.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

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