It’s tough to feel secure enough to save when your personal balance sheet is in the red. Usually, it makes sense to pay down any debt before you save for retirement.
But there are exceptions:
- Build an emergency fund of cash reserves first. You can build this account the same time you are paying at least the minimums on your debt.
- Your company offers a match on retirement contributions. Make the minimum contribution to get the full company match while making at least the minimum payments on your debt.
- You are on the Public Service Loan Forgiveness track. Make the minimum payments on your student loans and save the rest of your cash flow.
- You have a low interest rate loan.
- You have other goals that you would like to accomplish before your loans are scheduled to be paid off.
An emergency fund is savings – kept in cash – you can use if you lose your job. We usually recommend your fund total 3-6 months of non-discretionary expenses … more if you are on your own and less if you are a couple with two salary earners. The appropriate amount would also vary based on your own comfort level and job security (industry, your experience, and your age).
Company match on retirement contributions
If your employer matches some percentage of your contributions to a 401(k), 403(b) or similar plan, it almost always makes sense to contribute at least enough to earn the company match. After all, it’s an immediate 100% return on every dollar you have saved. Many 401(k) plans include a company match for your contributions up to 2-5% of your salary. If you have student debt, you don’t need to contribute any more than the amount needed to earn the match.
Public Service Loan Debt Forgiveness
The Public Service Loan Debt Forgiveness (PSLF) program discharges federal student loan debt after 10 years (starting after October 1, 2007 at the earliest) of working full-time in a public service job. To have a balance after 10 years of payments, your repayment plan would need to be either the Income-Based Repayment (IBR) Plan, Pay as You Earn Repayment Plan (PAYE), or the Income Contingent Repayment (ICR) Plan.
More information can be found here to see if you qualify. To get the most out of PSLF, you want the greatest amount forgiven. That means you want to make the lowest required payments along the way. After you have a sufficient emergency fund, save the amount beyond your debt repayment in an account targeted for your retirement.
Low interest rate
If you can earn more on your investments than you pay in interest on your debt, you are theoretically better off making the lowest possible monthly loan payments. But keep in mind the return on your investments can vary. In the past 35 years, the US stock market returned 11% annually and the international stock market returned 9% annually (1). But during that time, there was a 12-month period when the markets lost over 40%.
If you have a long-term horizon (10 years or more), and a relatively low interest rate loan, there’s a good chance your investment return will be higher than your loan interest rate. But if you have a shorter-term view, it’s impossible to predict your investment return.
Also, keep tax in mind. If you are saving in a taxable brokerage account, you will owe tax on interest, dividends and any gains you realize when you sell. That reduces your investment return. Some or all of your student loan interest may be tax-deductible, but the rules are complicated. A link is here: Student loan interest deduction.
Remember to keep yourself balanced. Saving just a little for retirement early adds up quickly. If you have plans to make any big purchases before your debt would be eliminated, even on an aggressive repayment schedule, include that savings in your budget. A comprehensive assessment with your financial adviser can help you map out the most appropriate plan of action.
(1) US market is measured by Russell 3000 index; International market is measured by MSCI world ex-US index between 8/1980 and 7/2015.
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