How to Balance Student Loans and Retirement Savings

Student loans can feel like a giant, lead-filled ball and chain that borrowers must drag behind them. If your balance is over $100,000, it can feel like you’re stuck with a mortgage, maybe even before you have your first mortgage.

Some borrowers grew up allergic to debt, so they focus their attention on aggressively paying down student loans ASAP. In turn, they neglect retirement savings, thinking they can handle that savings piece later.

Others deprioritize their education loans by requesting repeated periods of forbearance or ignoring their student loans altogether. This can lead to student loan default and other financial issues like bankruptcy.

Which comes first: student loan repayment vs. retirement savings

Picture this — you finish graduate school in May with a $220,000 student loan balance and a 6% interest rate. Then, five to six months later, toward the end of your six-month grace period, your first bill arrives.

Your loans are on the default 10-year Standard Plan (unless you choose another plan), and you are completely shocked to see the $2,442 monthly payment that’s due.

Your first job offers a salary of $85,000 per year. In addition to the taxes withheld from your shiny new paycheck, you’ll pay nearly $30,000 in student loan payments — every year, for the next 10 years.

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Do I have to pay my loans off in 10 years?

Instant ramen tastes pretty good — and it’s cheap — so should you pay off your student loan balance and eat like a college student for 10 years?

There’s an argument in favor of eliminating your debt as soon as possible, such as the mental relief of being student debt-free faster. The downside is that you’ll likely sacrifice other life-building goals, like saving for a home down payment, saving for retirement, and experiences like travel and marriage.

Staying on a Standard Plan works for borrowers with large salaries compared to their debt balance. For example, if you’re making $200,000 and have $50,000 of student loans, it’s likely best to pay that off as soon as you can. You can also consider overpayment or student loan refinancing to save money on interest charges.

Paying off loans while maximizing retirement savings: Is it possible?

Are you a fan of the FIRE (Financial Independence, Retire Early) movement? Maybe you’re confident that you can accomplish everything simultaneously — eliminate student loans, maximize your retirement savings and afford your current living expenses.

Let’s review the numbers using an $85,000 salary. Here’s what we would subtract:

• Maximum 401(k) savings: $20,500
• Taxes withheld (25% rate): $16,125
• Annual student loan payments: $28,800

Remaining annual spending money: $19,575.

It’s nearly impossible to live off $1,600 per month, especially if you have a family to support. Thus, our dilemma — there must be a balance between paying off student loans, saving for retirement and daily living expenses.

How to save for retirement while paying off your student loans

If your student loan balance is greater than your annual income, consider an income-driven repayment plan (IDR). The four IDR plans offered by the Department of Education calculate payment amounts based on 10% to 20% of your discretionary income.

For example, given a $220,000 student loan balance and $85,000 in income, your monthly payment on the Pay as You Earn (PAYE) plan is $538. The PAYE plan is calculated based on 10% of your discretionary income.

The calculation is a little bit complicated, but the message is clear: income-driven repayment plans give you the flexibility to pursue other financial goals.

A low student loan payment means more savings overall

Once you’ve found the best repayment plan for your personal situation, you can find other places to save or pay down debt.

Remember, in our initial scenario, the standard repayment plan costs $2,400 per month. By utilizing an income-driven plan and paying $538 per month, this borrower saves $1,862 per month, which can be used for other purposes. That’s more than enough to maximize their 401(k) savings ($20,500 per year in 2022).

Alternatively, if you have credit card debt, you can combine your debt repayment and retirement savings. Credit cards have some of the highest interest rates for consumer debt. If you use a credit card, try to pay it in full every month.

401(k) savings can reduce your monthly student loan payments

Let’s continue our story. If this borrower elects to max out their 401(k), their monthly student loan will drop to $368 per month. How?

Income-driven repayment is calculated based on your adjusted gross income (AGI). Take your total annual income and subtract any pre-tax retirement savings, including any 401(k), 403(b), or IRA savings, as well as Health Savings Account (HSA) savings.

In other words, the more you save, the lower your student loan payment. Let’s review our initial math again using an $85,000 salary. Here’s what we would subtract:

• Maximum 401(k) savings: $20,500
• Taxes withheld (25% rate): $16,125
• Annual student loan payments: $4,416 ($368 per month)

Remaining annual spending money: $43,959.

Our initial monthly spending number after maxing retirement savings, paying taxes, and paying the standard plan monthly payments was $1,600 per month. Now, after finding the right IDR plan, our borrower has $3,663 per month.

What if I can’t afford to max my retirement savings?

As a consultant with Student Loan Planner® and a financial advisor, I have this discussion frequently. It’s overwhelming to set $20,500 aside into a mystery account that we can’t touch until we turn 59 ½ years old.

If you can’t make the leap to maximize your retirement savings today, start smaller. Start with 10% of your income. In our scenario, that’s $8,500 per year (10% of $85,000).

Then, as you get annual raises, you can increase your savings percentage. For example, if you get a 3% to 5% raise at your job, increase your 401(k) savings by 1% to 2%. Before you know it, you’ll reach the maximum annual contribution.

Shouldn’t I focus on Roth IRA contributions instead?

If you pay attention to personal finance, you’ve noticed an overwhelming recommendation to save into a Roth IRA or make Roth contributions into your retirement accounts at work.

The Roth retirement savings rules are great — you put the after-tax money into your Roth account today, and once you retire, you get to take the money out tax-free.

Although this type of account is great for retirement savings, it could mean higher student loan payments along the way.

Pre-tax retirement savings are ideal for your student loan repayment plan

When you pursue an income-driven repayment plan, you want to pay the least amount possible on your student loans. Crazy as that sounds, IDR plans are built for long-term forgiveness, either at the end of your IDR plan or through Public Service Loan Forgiveness (PSLF).

IDR forgiveness takes 20 or 25 years to reach, and PSLF can be done in 10 years. After these periods, your remaining federal loan debt is forgiven. The forgiven amount is taxable under IDR, but tax-free through PSLF.

Contrary to other types of debt and everything we’ve ever learned or read about debt, paying the least amount possible to the Department of Education allows you to save for retirement, purchase a home or pursue your dreams.

What can reduce my student loan payment so that I can focus on savings?

Retirement savings are incredibly important, as boring as that may be. Most of us worry (or should worry) about what retirement might look like, but many don't until it’s too late.

There are a few strategies that can help lower your student loan payment so that you maximize your ability to save toward other goals. These strategies include:

• Maxing out contributions to a 401(k) or another employer-provided plan.

• Maxing out contributions to a Traditional IRA (this has income limits).
• Maxing out contributions to a Health Savings Account (HSA).
• Grow your family! The larger your family size, the lower your student loan payment.
• If you are married, consider filing your taxes separately (get advice from a tax professional first).

We review all these options in our consultations. In one hour, we help you maximize your student loan repayment savings and review options, like IDR taxable forgiveness, so you can reach your other life goals.

Balancing these goals isn’t easy, but that’s why Student Loan Planner® and the financial planning field exist. Let us help you.