There is never enough money to go around. Each month you make important decisions which impact your long-term financial well-being.High student loan debt and low retirement account balances arehot topics affecting millions of consumers. In 2016, graduates completed school with an average of $37,172 in student loan debt - enough to cause many Millennials to delay life events such as marriage, starting a family, or buying a home. Baby Boomers are now reaching retirement age, yet over 60% have less than $100,000 saved to fund up to 30 years of their lives post-work.
After college graduation, many face the question of defining top financial priorities and creating a long-term plan for financial security. Is it better to tackle student loan balances head on - paying the debt off as quickly as possible - or make minimum loan payments and build retirement accounts and other financial reserves?
Student Loan Debt Challenge
Student loan debt reached a new high in 2017 topping 1.3 trillion dollars across 44 million US borrowers. The only debt class with higher balances is mortgages. Students graduating with professional jobs are keen to eliminate debt quickly rather than face more than a decade of loan payments which can reduce the ability to qualify for a home loan or other financial achievements. New options create more affordable monthly payments, butlead to paying significantly more over time due to interest accumulation.
Retirement Funding Challenge
With Baby Boomers reaching retirement age at a pace of approximately 10,000 per day,underfunded retirement accounts are another hot topic. Seniors with inadequate retirement funds find themselves working longer and living on less to prevent running out of money. Millennials, with decades of work ahead, may decidesaving for retirement is a lower priority. There is abundant evidence illustrating the advantages of beginning earlier, which leads to a stronger financial position down the road with fewer out of pocket dollars.
Other Financial Priorities
Besides paying off student loans and setting aside enough for retirement, experts recommend building an emergency fund containing six months’ worth of savings, eliminating high-interest credit card debt, and paying off a mortgage to establish financial security. Debt reduction leads to lower cost of living and can preserve investments in retirement. Today, many seniors enter retirement still carrying debt from multiple sources.
When considering the long-term consequences, there are advantages to eliminating debt first over retirement.Before developing a set plan, consider the following factors, which could help you accomplish both goals in the most efficient manner.
- Interest rate versus income potential. Low-interest rates are one of the primary benefitsof student loans, making them an attractive way to pay for college if you lack the funds or failed to secure enough free money in the form of scholarships and grants. Congress sets the interest rate each year, and for most loans, it remains below 6%. The S&P, on the other hand, averagesover 6% in any 10-year rolling period for the last 50 years. It is possible to choose investments that will provide a healthier return than the interest paid on the loan, without taking on undue risk. When you achieve a higher rate of return, it can be an advantage to paying down debt at a slower pace, allowing you to start earlier and accumulate larger balances overtime.
- Got time until retirement? The earlier you begin, the more time your money will compound in an investment account, increasing total balances. As you get closer to retirement, you must set aside more money and rely less on compounding to reach your financial benchmarks. There is also the issue of cash flow in retirement. The more debt you have on the books, the more you must earn to pay the bills.For those returning to school mid-career, relying on minimum payments for 20 or 25 years may creep into your retirement years.
- Other Sources of Income. Pensions, real estate, and other forms of income available in retirement can reduce the amount of personal savings required. Due to the reduction in companies offering pensions, for many Millennials, it will take more personal funds than previous generations to successfully build wealth.
- Find all free money options to free up money.Employer benefits matching retirement contributions in 401ks or other employer retirement accounts are a source of free money, as high as 6%, which should not be passed up. Always capitalize on free money resources that help reach your financial goals without paying more out of pocket.
Often the best strategy with student loans, from a purely financial standpoint is to make the minimum payment and take the extra funds to begin retirement savings, even in your 20’s. However, carryinghigh-interest credit card debt or have no emergency savings, could alter the strategy, based on your age and your goals. The low-interest rate and generous repayment terms can push student loan repayment further down the list of financial priorities.
High-interest debt, such as credit cards, require a different level of attention. Companies typically charge double-digit interest rates and then compound the interest daily, which multiplies the problem and makes it very difficult to make a dent in the debt, using the minimum payment method. It could take 30 years and require payments overthree times the original balance with that strategy.