In our “This or That” series, we’ll help you weigh your options when it comes to choosing between two financial scenarios.
Today, we explore whether it makes more sense to prioritize paying down student loans faster or ramping up retirement savings.
That time when you’ll finally be free of the daily grind to travel the world, start a second-act gig or simply sip lemonade on your front porch.
And we’re all familiar with the rallying cry that’s supposed to help make that happen: Save as much as you can toward your nest egg now!
The obstacle? A little something called student loans.
According to the Brookings Institution, the average household carrying college debt owes about $25,700 in student loans.
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Get started with a free financial assessment.
Having that kind of five-figure balance hanging over your head probably means you’re focused on paying down that amount in the here and now—rather than putting any money toward your future.
And who can blame you? The longer it takes to pay off that sum, the more you’ll shell out in interest payments.
But on the flip side, the longer you wait to plump up your nest egg, the less time you’ll have to take advantage of compound growth.
So if you’ve got some extra dough to put toward a goal, where should it go? Should you pay off your student loan faster, or build up your retirement account sooner?
To help you decide, we sought insight from a student loan expert and a financial planner into how to balance the two equally important financial goals.
When Does It Make Sense to Prioritize Student Loans? The biggest reason you may want to focus on paying down your loans first is if you have a high interest rate—say, 8% or higher.
“There are people who have interest rates that are super, super low—such as 2% or 3.5% for newer loans—who’d be much better off saving more for retirement, rather than paying off a student loan aggressively,” says Heather Jarvis, a North Carolina-based attorney who specializes in student-loan education.
Of course, it’s possible you’ve got multiple loans at different rates—some fixed and some variable. If this is the case, you might be tempted to consolidate your loans, in the hope of getting a lower overall interest rate.
But before you make that move, you should do some research to see if it would actually work in your favor, particularly if you have federal loans.
“What consolidating really does is give you access to longer terms of repayment, as well as other repayment and forgiveness provisions,” Jarvis says. “But since federal consolidation loans are based on the weighted average of the underlying loans, you wouldn’t actually improve your interest rate.”
RELATED: Understanding Student Loans 101
If you have private loans, refinancing through a bank may allow you to open a new loan at a more favorable interest rate. The savings from refinancing can be significant if, for example, you have a much better credit score now (hello, 720!) than when you were a recent grad and struggling to pay those bills on time with a meh 620.
If you're thinking of refinancing federal loans through a private lender, however, Jarvis says to be wary, noting that you would lose the special protections that federal student loans carry, such as deferment or forbearance.
“Over time, your investments will potentially earn at least 6% or 7%, so if your loans have a lower interest rate, it doesn’t make sense to pay off your student loans early.”
In general, it’s worth running any loan balances and interest rates through a calculator first (like the one at studentloans.gov for federal loans) to see how much you’d potentially pay to consolidate—and check your credit score to gauge the likelihood of nabbing a low interest rate through refinancing.
It may make more sense to keep your loans separate and be aggressive with your high-interest loans, while paying the minimum on the low-interest ones.
When Does It Make Sense to Prioritize Retirement Savings? Almost always, especially if your employer offers a 401(k) match of any kind, says Matt Shapiro, CFP, a financial planner with LearnVest Planning Services.
“If it’s between putting an extra $5,000 into your 401(k) with an employer match or putting it toward your student loan, it’s kind of a no-brainer,” says Shapiro, citing the example that a 50% match would essentially grant you $2,500 in free retirement contributions. “But if you put $5,000 toward your student loans instead, you might save just a few hundred dollars [in annual interest payments].”
If you’re on track with your retirement goals, it still may be wise to prioritize retirement unless your student-loan interest rates are very high.
“Over the long run, your investments will potentially earn at least 6% or 7%, so if your student loans have a lower interest rate than that, it typically doesn’t make sense to pay them off early,” he explains.
The Big Takeaway: Retirement savings should generally be the higher priority because time is your ally when it comes to compound growth.
Admittedly, you may be tempted to focus on paying down those student loans regardless to get that albatross off your neck. But think twice if that’s your motivation.
“Some people are especially freaked out by debt, and there’s a huge psychological benefit [to paying it off],” Shapiro says. “But from a financial perspective, it’s often a less efficient use of funds than putting aside money for retirement.”
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.