In a previous Lifehacker post, we suggested that you might want to wait before paying off anything less than $50,000 on your student loans, even if there’s a very small chance that amount of debt will actually be forgiven. Instead—since we’re still in pandemic—we pointed to financial advice that suggests setting payments aside for an emergency fund that covers at least six months of your expenses. But what if you’re feeling pretty comfortable and have already topped-up your emergency fund?
Consider investing in a 401(k) or IRA
As a general rule, you don’t necessarily want to focus exclusively on paying down debt at the expense of putting some money into retirement savings. Why? Because the savings you accrue through retirement savings can be a bigger long-term payoff than the short-term benefits from of closing out your loans, particularly those that come with low-interest rates, like student debt (to be clear, the assumption here is that you will always make minimum payments on all of your debt). The reason for this is compound interest—per Forbes, a dollar saved in your twenties is worth $16 in retirement, compared to $9 saved in your thirties, and so on, so the sooner you can put some dollars away, the better.
When to pay off debt versus investing
As a general rule, traditional personal finance advice suggests putting aside 10% of your income into retirement savings. A more finely tuned approach, however, would be to base your decision on a comparison of annual interest rates and the expected term-length for both your projected retirement savings and outstanding debt. Per this Lifehacker post, it works like this:
Generally, you can expect a return of 6%-8% annually, once all the peaks and valleys are smoothed out. So if you expect your portfolio to grow by 6% this year, and your student loan interest rate is 8%, you probably want to focus on knocking out your debt and the interest that’s accruing more quickly than your portfolio is likely to grow.
Say you expect a 6% return and your interest rate for your student loans is 4%. Then it makes more sense to invest.
But what if student loans are zero interest?
Since there’s a zero-interest freeze on student loan payments until the end of September, it makes sense to put some money into a retirement account, provided that you have topped up your emergency fund and you have a low-interest student loan that is manageable. On the other hand, if you want to shorten the length of your student debt payment schedule, saving up a lump sum to be paid in September (or whenever interest resumes) will go a long way, especially if you’re trying to reduce the total interest paid on your loan (plus, a lump sum payment is tax deductible).
Either way, it really goes back to comparing the interest rates and term length between debt repayment and when you expect to retire, and deciding on a solution that’s best for your financial situation—this could include a mix of both options. For instance, if your employer offers matching contributions on your 401(k), you’d want to match that to the highest dollar amount allowed, if you can (as employee contributions are essentially free money), then use the rest of your money on a lump-sum debt payment when the student loan moratorium expires in September.
The only sticking point on this is the outside chance that up to $50,000 in student loan debt could be forgiven by President Biden, although it’s more likely to be $10,000—if there is any debt to be forgiven at all. For that reason, you still might want to wait until there’s an update on debt forgiveness, and stash your payments into a savings account until the student loan payment moratorium is lifted.