Should You Save for Retirement or Pay Off Student Loans?

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:

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.

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." 

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.

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.

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. 

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.

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.