Should You Pay Off Student Loans or Invest for Retirement?

If you have student debt, you may be struggling to decide whether you should pay off your student loans or invest your money for retirement.

How you should approach this question depends on your financial picture, but it is possible to work to pay off student debt while also getting on track for a comfortable retirement.

[Read: Best Private Student Loans.]

What Factors Should You Weigh?

Before deciding whether to focus on student loans or retirement, it’s important to understand your debt. It’s not always the best financial move to prioritize fully paying off your student loans.

“Bad debt, such as debt carried on credit cards, typically comes with high interest rates and should be paid down as soon as possible,” says Brian Dudley, senior vice president and financial advisor at Wealth Enhancement Group. In contrast, “good debt,” such as a mortgage or student loan, generally has lower rates, and you don’t necessarily have to pay it off quickly, Dudley says.

There are several factors to consider when deciding how to handle paying off student loans and investing your money. Borrowers with federal student loan debt should also be sure to keep track of the Biden administration’s student loan forgiveness plan, which is currently blocked.

What Is Your Cash Flow?

A cash flow statement tracks how much cash a company takes in and pays out over a set time period. You can apply this concept to your own finances. Knowing how much of your earnings you have left after covering expenses in a given period can help you decide how to manage your debt and investing priorities.

“If cash flow is tight and the loans are a burden to you, I would focus on paying down debt — especially if you may be starting a family, since many need to pay those off before day care expenses begin,” says Ginger Ewing, private wealth advisor at Ameriprise Financial Services.

If your debt is a small line item in your budget, however, Ewing says she would lean toward retirement savings. Pay the minimum on your loans and use the rest of your monthly cash flow to set up a dollar-cost averaging approach to retirement savings. Dollar-cost averaging is the practice of investing a fixed amount on a regular schedule regardless of market fluctuations.

Then, when you get a windfall, such as an annual bonus or holiday gifts, Ewing says you can put this toward paying off your debt.

It’s also important to ensure you have enough liquidity or cash available for emergencies and other expenses or opportunities. “If you pay down debt but leave yourself with little to no liquidity, you may miss out on other investment opportunities in the future, or you may be forced to draw a loan at an even higher rate in the event of a large expense such as an emergency,” Dudley says.

What Is Your Loan’s Rate?

Think of paying off your student loans as a form of investing: If your loan interest rate is lower than the return you can reasonably expect to get on your investments, it may make more sense to pay the minimum on your loans and focus on investing.

Keep in mind that returns on investments can vary. The historical average annual return on a portfolio that is invested equally in stocks and bonds is 9.3%, according to Vanguard.

Also, if you have a private student loan with a variable interest rate, you may be focused on paying it off before the rate potentially goes up.

Broadly, if you have extra funds that you don’t plan to invest, consider using them for your debt. “If you aren’t planning to invest the money and it just sits in a bank account at a lower rate than the debt interest rate, then it will make more sense to pay off that debt quickly,” Dudley says.

What Tax Benefits Are Available?

The tax savings you get from saving for retirement can sometimes be more than the interest costs on a student loan, Ewing says. You can get tax benefits with either an individual retirement account or a 401(k), whether you are using a Roth or traditional.

“If you are eligible for Roth IRAs now, but due to future income expectations aren’t expected to be eligible later, I would prioritize Roth savings now to start that tax-free growth when you have many years until retirement,” Ewing says. “On the other hand, if you have high income now and need the tax savings, consider saving into your 401(k) on a pretax basis.”

Alternatively, you may be able to deduct the interest from your student loans on your tax return. Dudley says to speak with a tax professional to see if this is the case for you and how it would impact the benefits of paying off student loans versus saving for retirement.

[Read: Best Student Loan Consolidation and Refinance Companies.]

When to Prioritize Paying off Student Loans

Given the above factors, you should prioritize paying off student loans rather than putting additional savings toward retirement if:

— Your student loan interest rate is higher than what you could reasonably expect to earn by investing.

— Your cash flow is tight, and your loans are a burden.

— The debt burden is impacting your ability to achieve other financial goals, such as homeownership.

“You should prioritize paying off debt if your debt has a high interest rate and it’s costing you,” says Alan Fletcher, partner at Lift Financial. “If your debt-to-income ratio is over 50%, you’ll run into challenges if you’re trying to make purchases, like a home.” Fletcher recommends keeping your debt-to-income ratio under 43%.

[Read: Best Student Loans for Bad Credit]

When to Prioritize Investing for Retirement

You should prioritize retirement investing over paying off student loans if:

— You could reasonably expect to earn more on your investments than the interest rate on your student loans.

— You’re confident you’ll be able to make future payments on your debt.

— Your debt isn’t stopping you from achieving other financial goals.

Remember that prioritizing saving for retirement over paying off your student loans doesn’t mean you stop making payments on your debt entirely. It’s not ideal to have student loan debt in retirement, so you should plan to get it paid off. You should always make at least the minimum payment first, then you can decide whether to put any available money toward your debt or retirement.

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