How to pay down your student loans without sacrificing retirement savings

Key Points
  • College graduates who have student debt have 50 percent less in retirement plan assets than those who have no loans by the time they reach age 30, research shows.
  • Planning for retirement may seem daunting when you are facing high student loan balances, but not investing for the future will negatively impact your wealth.
  • Make sure you consider your interest rates, tax liabilities and refinancing options when deciding how to best allocate your money.
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If you have student loans, watch out. Your retirement wealth may be reduced.

College graduates who have student debt have about 50 percent less in retirement plan assets by the time they reach age 30 compared to those who have no loans, according to research from the Center for Retirement Research at Boston College.

And just having student loans — no matter the size of those debts — was enough to affect the size of individuals' retirement savings.

"This result suggests that young graduates consider the simple existence of a student loan — rather than its size — to be a constraint on their 401(k) saving," the research said.

Not saving enough for retirement in your early years can have a lasting impact, particularly when it comes to lost investment earnings and the potential sacrifice of an employer match.

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When juggling high loan balances and a long time horizon until retirement, it can be difficult to decide which financial goal should be your priority.

"In reality, most new graduates should probably be doing a little bit of both," said Christine Benz, director of personal finance at Morningstar.

That is because making regular payments to whittle down your student loans will enable you to make steady progress toward financial freedom. Meanwhile, you should be contributing at least enough to your retirement plan to receive an employer match, if you are eligible for one.

But after you reach those initial hurdles, there are some key things to consider when deciding where to put your extra money to get the most bang for your buck.

Evaluate your rates

The first thing you want to look at when deciding where to focus your money is the interest rate you are paying on your student loans versus the return you would expect to earn on your investments.

"Debt pay down is guaranteed," Benz said. "If you pay more on your debt, that means that you will be able to retire that interest rate that much sooner."

If the interest on your student loans is 5 percent, it might be hard to match that return on an after-tax basis through your investments, she said.

"Arguably, over the next 10 years you won't be able to earn a 5 percent return on a balanced portfolio, or it might be a stretch," Benz said.

If you have a longer time horizon, say 30 or 40 years until retirement, that could make it easier to out earn the interest rate by investing in a long-term stock and bond portfolio.

Still, there is one key rule of thumb to keep in mind.

"The higher the rate, the higher your hurdle for your investment portfolio is," Benz said.

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Mind your tax bill

Be sure to take into account the kinds of tax advantages you may get from investing.

If you have a company retirement plan or an individual retirement account, you will get a tax break either when the money goes in or out, depending on what kind of account you own, Benz said.

Traditional 401(k) plans and individual retirement accounts take pre-tax money. Roth 401(k) plans and IRAs let you put in post-tax money, which then may be used for tax-free income in retirement.

If you're a lower income saver, you may be eligible for a saver's credit on your IRA or 401(k) contributions. The amount of that credit varies based on your adjusted gross income, and counts towards contributions of up to $2,000 for individuals and $4,000 if you are married and filing jointly.

"There's a good case for taking advantage of that, even if you have high interest rate debt," Benz said.

At the same time, you want to mind the potential tax deductions you may receive for your student loan debts.

You can deduct up to $2,500 of interest paid toward student loans in one year. But high-income individuals may not qualify, Benz noted.

"If you're above the threshold for deductibility, that would tend to put the advantage on pay down," Benz said.

As new tax rules go into effect this tax year, many more people will generally claim a standard deduction rather than itemizing their deductions.

The good news for borrowers is that student loan debt is not one of those itemized deductions, Benz said.

"Even if you're not an itemizer, you can take advantage of the student loan deduction, assuming your income is below the threshold," Benz said.

Be opportunistic about refinancing

If you have not done so already, refinancing your student loans can be an opportunity to lower the rates you are paying on your debts.

Many debtors are paying in the range of 6 percent to 8 percent on their loans today, according to certified financial planner Douglas A. Boneparth, president and founder of Bone Fide Wealth, while some are paying higher rates. And some refinancing options may bring what you're paying down to rates as low as 3.5 percent to 4 percent, he said.

If you currently have a federal student loan, you need to be aware of the flexibility you will give up by refinancing with a private lender. That includes the ability to participate in income-driven repayment plans or forbearance options.

"The federal government might not be the cheapest game in town, but they're often the most flexible," Boneparth said.

Do not bury your head in the sand regarding your student loan debt. Take action. There is a plan for everyone.
Douglas A. Boneparth
president and founder, Bone Fide Wealth

As such, you want to be comfortable that you're going to be able to make the loan payments from the time you refinance to the time that note matures, Boneparth said.

Refinancing your federal student loans with a private lender will also prevent you from participating in the Public Service Loan Forgiveness Program, said financial advisor Roger Ma, founder at Lifelaidout.

Lenders currently offering competitive rates for refinancing include SoFi and CommonBond, according to Ma.

First Republic Bank also offers attractive rates for refinancing student loans into personal loans, Ma said. But you must live in an area the bank serves, and meet credit score and loan balance requirements.

Do a gut check

Even if it makes more sense to put money towards retirement over the long haul, some student loan borrowers cannot get past the debt looming over them.

In that case, it's perfectly OK to prioritize paying down the debt over saving for retirement.

"You don't necessarily have to do what's mathematically correct," Ma said. "You have to take into account your own peace of mind, as well."

You also want to be sure you keep your overall financial situation in mind. If you have high interest credit card debt that is 20 percent or 25 percent, you need to focus on that before you take on your student debt that is at 10 percent, Ma said.

And you should take the time to review your financial picture — including your student loans — annually.

"Be informed about it," Boneparth at Bone Fide Wealth said. "Do not bury your head in the sand regarding your student loan debt. Take action. There is a plan for everyone."

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