If you have student loans, you already know they can be overwhelming. But as any responsible spender knows, they aren't the only demand on your budget.
Along with rent or a mortgage, the day-to-day business of living and any credit card debt you have, there's also saving for retirement, that period of 20 years—or far longer—during which you may need to live almost completely off the money you've saved. The thing about retirement savings is that there's no substitute for starting early—and it can be incredibly difficult to make up for lost time.
If you're wondering how on earth you're supposed to put money in your IRA or 401(k) when your student loans have already laid claim to your budget, you're not alone. In fact, there are plenty of questions LearnVest Certified Financial Planners™ hear on this topic every day: Is one goal more important than the other? Which should I pay first? And if I don't have enough money to pay both ... which should I choose?
We asked Katie Brewer, CFP® with LearnVest Planning Services, for help with one of the hardest money to-dos of all: Prioritizing which of these financial goals should receive your hard-earned dollars.
First, Take a Closer Look at Your Student Loans
"When it comes to retirement and paying student loans, it doesn't have to be one or the other," says Brewer, "And in fact, it shouldn't be." She explains that loans and retirement savings both feel urgent because, in a sense, both are urgent.
Student loans are a pressing debt that needs to be repaid, and missing a payment has the potential to tank your credit score (and after nine months of not making full payments, you go into default, which tanks your credit score and may turn your account over to a collections agency, among other similarly unpleasant things). Your first step is figuring out where you stand.
1. Know What You Owe. Brewer says student loans are best tackled with a routine. "Approach your student loan payment like your rent: It’s a fixed expense you have to pay every month, so it has to fit into your budget," she says. "If you are struggling to make the minimum payments, and you’re okay with extending your repayment period, call your lender and see if there's anything they can do to help reduce your monthly payments. Once you have that number, it can be a good idea to set up auto-payments so that you never miss one." As with all auto-payments, these should come from your checking account, which should be monitored to make sure payments are being made and that there's enough money in your account to cover all of your costs.
Generally speaking, Brewer cautions, by no means should your student loans be deferred or put into forbearance in order for you to contribute to retirement. "Many types of loans still gather interest during deferment or forbearance, which means you'll have to pay more later," she explains. "These measures aren't for people who are working on prioritizing their savings—they're for people who truly can't afford their payments, as a temporary fix to keep them out of default." If you're having serious problems finding the money to pay your loans, learn more about those options at Student Aid.
2. Find the Best Way to Pay. For federal loans, there are actually seven different repayment plans, and they aren't one size fits all. While all borrowers are automatically enrolled in a standard repayment plan if they don't choose otherwise, to make your money go furthest, you should be using the plan that best fits your needs. If you need help, consult our guide to federal student loan repayment plans, which breaks down how each plan works, as well as its pros and cons.
If you have several federal loans, consider consolidating, which means combining all of your loans into one monthly payment. You can consolidate private loans as well, but they'll remain separate from any federal loans you might also have, meaning that if you have both federal and private loans, the fewest number of payments you would be able to make is two. There are caveats to consolidating—for instance, it has the potential to lengthen the repayment period—so you'll want to consider carefully whether it's the right move for you (the Student Aid checklist can help with that). If you do want to consolidate, apply through the government's Borrower Services website.
3. Portion Out Your Budget. The 50/20/30 rule tells us that at least 20% of our budgets should be dedicated to our financial priorities—the payments that build a secure financial future, like loan repayments and retirement savings. "Especially for people with outsized student loan payments, designating a full 20% of their monthly budget to financial priorities isn't usually the problem," explains Brewer. "More often, they run into trouble when these large payments take up that entire 20%, and then they still need to find room in their budgets to save for retirement." The free LearnVest Money Center can give you transparency into how much of your budget goes to financial priorities, and where you may be able to find a few additional bucks to save for retirement.
Now, onto your retirement strategy.
Retirement: Why Start Now?
Money saved today for retirement is more valuable than money saved tomorrow—literally, it has the potential to be worth more, thanks to the compound interest earned by your accounts. "One of the first things we work on with clients is how they'll save for retirement," says Brewer. "Think of it as a reasonably paced jog toward retirement if you start now, versus a mad dash to the finish line if you wait until later." How do we start running?
1. Make a Plan of Attack. First things first: Where will you keep your retirement savings? This isn't a money-under-the-mattress situation, or even the right time to use a savings account. There are specific accounts that exist solely to save and invest your money for retiring, like employer-sponsored 401(k)s and individually opened IRAs. To figure out which options are available to you and how to start taking advantage of them, use our checklist: I Want to Save for Retirement.
"If money is tight, your retirement and student loan contributions aren't the place to cut back."
2. Have a Goal in Mind. While it's nearly impossible to predict exactly how much money you'll need in retirement down to the penny (seeing as that would mean you need to know exactly how many years you'll live), what you do want to figure out is a number called your replacement ratio, or what percentage of your current salary you'd need to live on once you retire.
Generally, LearnVest experts recommend replacing 70% to be financially secure, but those who are planning to live on a tight rein may be able to make do with 60%, and those who want to live it up in their golden years should plan on replacing 80-100%. For more specific numbers, you can consult a financial planner or use an online retirement calculator from a reputable source such as Kiplinger.
3. Don't Be Afraid to Start Small. Brewer recommends starting with small retirement contributions and increasing gradually as you earn more. "If you can’t contribute all that you want to right away, start by saving 1% to 2% of your gross income, then increase your savings percentage every six months," she says. "That way, you can get a head start on retirement without having to restructure your entire life to fit it in. It can be scary to realize you aren't on track for a financially secure retirement, but one of the most important things you can do is get off the bench and into the game." And those who start saving early are more likely to stick with it over the long-term.
The Bottom Line
When it comes to student loans and retirement savings, the tricky part isn't figuring out which is more important—it's figuring out how to contribute to two similarly important goals. "If money is tight, your retirement and student loan contributions aren't the place to cut back," Brewer says. "Your discretionary spending, or your larger fixed costs—think rent or utility bills—are probably better targets for downsizing before the money you're investing in your future."
The bottom line, Brewer explains, is that while student loan payments must be made in full, it's important not to let retirement savings fall by the wayside completely when money gets tight. “You should calculate out how much you need to be saving to be on track for retirement, but keep in mind that if you can’t swing that amount right now, it’s better to start contributing something than nothing at all. Automate your contributions and when you get a raise, it's the perfect time to consider accelerating your retirement savings.”
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 advice. Please consult a financial adviser for advice specific to your financial situation. LearnVest Planning Services and any third parties listed in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.