Should a recent college graduate save for retirement or pay down student loans?
At first glance, it seems like an easy question. Retirement is decades away, while student loans typically require immediate attention. Yet by taking a few smart steps, you may be able to get the best of both worlds – paying off your loans while getting an early start on retirement.
With that goal in mind, let's review some of the most important angles to consider.
The Importance of Timely Student Loan Repayment
First, let's establish that you cannot simply ignore your student loans to focus on retirement saving. Missing a single payment can damage your credit score. If you miss nine payments, you'll enter default, a serious financial outcome from which it may take years to recover. Further complicating matters, student loans are rarely dischargeable in bankruptcy.
That said, it's vitally important to stay on top of your loan payments. Make sure you know exactly how much you owe, who your lenders are and how you plan to repay the balance. You can sometimes place your loans in deferral or forbearance, but these options are not recommended unless you're in dire straits, as the interest on your loans keeps accruing.
If your payments are simply too large to leave you anything left to save or invest, there may be other options to explore. There are several federal loan repayment programs available to qualified applicants. These programs can reduce your monthly payment based on your income, or even discharge your debt after a certain number of years, should you meet certain qualifications. If you have multiple loans, you may also consider consolidation.
If you don't qualify for any of these programs, you'll likely need to increase your income, or carve enough money out of your budget to start saving.
Though timely payment of student loans is critical, it's important to keep things in context. You don't want to accelerate your payments to such a degree that you miss out entirely on the tax advantages and company donations offered through most retirement plans.
Most importantly, you don't want to squander the number one savings asset most college grads have – time.
Why Saving Early Is So Important
Saving money for retirement isn't always a top priority for recent college grads. After all, your salary hasn't had time to grow very much, and student loans have to be addressed.
Yet in many ways, this is the ideal time to get started. Many recent grads have relatively few expenses. Those without children, especially, are likely to have more disposable income.
By routing some of this money into your retirement savings now, you can take full advantage of compound interest. When combined with time, compounded interest is the single most valuable money-generating tool available. For example, if you invest $10,000 at a rate of seven-percent, you'll have $10,700 one year later. Not bad, but not life changing, right?
Yet over a long enough timeline that money grows exponentially. After 40 years, your $10,000 would be worth just under $150,000.
By starting to save in your 20s, you get the full advantage of compounded interest. If you wait until you're 40, the benefits are dramatically lower, simply because there's less time for the interest to compound.
Getting Started Today
Retirement savings and student loan payments are two of most critically important financial areas for recent graduates. Ideally, both should be given priority.
Remember, too, that you can start small. If you can only afford to save one-percent of your income, that's still better than not saving at all.
