Should Student Loans Be Paid or Saved for Retirement With Interest Frozen?
In a previous Lifehacker post, we suggested that you wait before paying back less than $ 50,000 on student loans, even if the chances of the debt actually being forgiven are very small. Instead – since we’re still in a pandemic – we pointed to financial advice that suggests deferring payments to an emergency fund that covers at least six months of your expenses. But what if you feel pretty comfortable and have already replenished your emergency fund?
Consider investing in a 401 (k) or IRA
Typically, you do not necessarily want to focus solely on paying off your debts by putting money into retirement savings. Why? Because the savings that you accumulate from retirement savings can be larger long-term payments than the short-term benefits of closing your loans, especially those that come with low interest rates, such as student debt (for clarity, the assumption here is that you will always make the minimum payments on all your debt). The reason for this is compound interest: According to Forbes , a dollar saved after twenty is worth $ 16 after retirement, compared to $ 9 saved after thirty, and so on, so the sooner you save a few dollars the better. …
When to pay off debt or invest
Typically, traditional personal finance advice suggests saving 10% of your income for retirement savings. However, a more accurate approach would be to base your decision on a comparison of annual interest rates and expected maturities for both your projected retirement savings and outstanding debt. According to this Lifehacker post , it works like this:
Typically, you can expect a 6-8% return per year after all the peaks and valleys have been smoothed out. So if you expect your portfolio to grow 6% this year and your student loan interest rate is 8%, you probably want to focus on paying off your debt and interest, which accumulates faster than your portfolio, probably will grow.
Let’s say you are expecting a 6% return and your student loan interest rate is 4%. Then it makes sense to invest.
But what if student loans are zero interest?
Since there is a zero interest student loan payment freeze in effect until the end of September, it makes sense to put some money into your retirement account, provided you have funded your emergency fund and have a low interest student loan that you can manage. … On the other hand, if you are looking to shorten the length of your student debt payment schedule, accumulating a lump sum due in September (or whenever interest returns) will go a long way, especially if you are trying to reduce the total amount of interest paid on your loan (plus the lump sum is not taxable). Either way, it really comes down to comparing interest rates and the length of time between debt repayment and retirement, and making the decision that best suits your financial situation – this could involve a combination of both . For example, if your employer offers matching contributions on your 401 (k), you’ll want to match that against the maximum dollar amount allowed if you can (since employee contributions are essentially free money) and then use the rest of your money. on a lump sum payment of debt following the expiration of the student loan moratorium in September.
The only sticking point in this matter is the external likelihood that President Biden can forgive up to $ 50,000 student loan debt, although it will most likely be $ 10,000, if there is any debt to be forgiven at all. For this reason, you can still wait until there is an update on debt forgiveness and stash your payments in a savings account until the student loan moratorium is lifted.