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Making Retirement a Possibility Despite Massive Student Debt

Student loans make it hard to save for retirement, especially when you have a lot of debt. However, it is still possible to save for retirement.

Written By: Michael P. Lux, Esq.

Last Updated:

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Student debt poses a significant threat to retirements in the United States.

Retirement plans are built on the notion that workers setting aside some money from each paycheck can expect to live reasonably comfortably in retirement. Compounding interest powers an essential component of this system. A little bit of money saved in your 20’s or 30’s can become a tidy treasure by the time you are in your 60’s.

How is a borrower supposed to save for the future when they are still paying for the past?

It may seem like student loans prevent retirement from ever happening. However, it is possible to save for retirement – even if a borrower has a sizeable student loan debt. The key is to find a balance in planning for both goals.

Savers generate sufficient funds for retirement by making their money work for them. As time passes, interest accumulates, the interest compounds and balances grow. Borrowers, meanwhile, have time and interest working against them. Paying off student loans is like trying to hit a moving target. As borrowers accumulate the funds to pay down their debt, the debt has grown.

The question for student loan borrowers becomes: How do I flip the script? How do I get time and interest working for me instead of against me?

The Most Important Thing…

The best time to plant a tree was 20 years ago. The second best time is now.

Chinese proverb

Start saving now. Saving for retirement isn’t something that begins after paying off student debt. Eliminating all debt isn’t a prerequisite to saving for the future. Even on budgets strained to the max by student debt, it is possible to get the foundation in place to build a retirement.

It may be easy to dismiss retirement issues as future problems and focus on the present instead. However, subscribing to this line of thought can be a huge mistake. Tiny steps taken today can have life-changing effects. It can mean not having to work into your 70’s. If you or a loved one gets sick, it can mean getting the necessary treatment. It can even mean helping your kids pay for school, so they don’t have to face the same hardships.

Retirement Basics and Terms to Know

Before getting into strategies behind saving for retirement while also paying down student debt, it’s essential to understand some basic concepts.

We’ve designed the following terminology to serve as an elementary introduction. We encourage savers to further educate themselves before making any investment decisions.

Retirement Vehicles

These are the types of accounts that hold retirement funds. Rather than being actual investments, retirement vehicles are the locations where various retirement assets are stored. They include:

401(k)s, 403(b)s, and 457 Plans – These plans are accounts provided by employers. 401(k)s, 403(b)s, and 457 plans have different rules regarding factors like eligibility and withdrawals. However, for our purposes, they are pretty much the same. These accounts allow individuals to put money aside for retirement before it is taxed. This means savers won’t pay taxes until they pull the funds out of their accounts.

Individual Retirement Account or IRA – An IRA works like a 401(k), as it allows individuals to set aside money for retirement before it gets taxed. The crucial difference is that employees aren’t dependent upon their employers to set up an IRA. Anyone can set up an IRA to save for their retirement.

Roth IRA – A Roth IRA works similarly to an IRA in that anyone can set up a Roth account. The chief difference is that the government taxes contributions to the Roth IRA, but withdrawals are tax-free. So, if you believe your future tax rate will be higher, a Roth IRA can be a great option to save money on taxes.

Brokerage Account – A brokerage account is an account that holds investments, but it does not come with any particular tax advantages.

Retirement Investments

Retirement investments are the assets that savers purchase. Savers purchase these particular assets because they are betting that the assets’ value will increase in the future. Savers store these retirement assets in the previously mentioned retirement vehicles. Common investments include:

Stocks – When savers purchase stocks, they are buying a collection of shares in a company. A share represents a piece of ownership in the company. As the company’s value increases, the value of the shares increases.

Bonds – Bonds are financial instruments in which an entity issues a bond by “borrowing” money from the investor. The issuer agrees to pay back the amount borrowed, plus interest, on a specific date. The entities issuing bonds include governments, banks, and many other companies.

Mutual Fund – A mutual fund is a collection of various assets, such as stocks and bonds, managed by a financial services company. The idea behind a mutual fund is that it allows individual investors to own many different kinds of assets in one affordable financial instrument. Target-date retirement funds are a common example of a mutual fund.

Risk – Any investment comes with risk. Risk is the chance that a particular asset could lose some or all of its value. Typically, an investment’s risk level is a predictor of the returns and losses the investor might experience from the investment. The riskier an investment, the higher the potential return but, the greater the chances of a loss. For instance, there’s a general consensus that U.S. government bonds are very low-risk. Accordingly, government bonds usually offer the lowest returns. But, if the investor holds these bonds to full-term, the government reliably pays back the promised returns.

Diversification – The greater the variety of investments held, the more diversified the individual’s account is said to be. By diversifying, investors can reduce long-term risk while still generating solid returns. Some mutual funds, such as target-date funds, are broadly diversified to minimize risk.

Employer Matching Retirement Programs

Many employers offer retirement contributions to their employees through employer matching. Terms vary from one employer to the next. But, the general idea is that for each dollar an employee contributes, the employer will also contribute a dollar up to a specific amount. This matching is usually associated with a workplace account, such as a 401(k).

Employees should utilize these programs whenever possible. If you have dollar-for-dollar matching, it means you are essentially doubling your investment from day one.

Due to the tremendous opportunity provided by employer matching, student loan borrowers should look to maximize employer matching under just about any circumstance. Of course, borrowers will want to make sure they make minimum payments on all their debt. But after that, maxing out matching should be the next priority.

The math is pretty straightforward. Rather than using one dollar to pay down student debt, that dollar can immediately turn into two dollars towards retirement. That is a substantial net gain for borrowers.

Unfortunately, employer matching is typically limited to a small portion of salary. As a result, employer matching is a good start, but not the end of retirement planning.

Student Loan Interest Rates vs. Earning Interest

The challenge for student loan borrowers is to strike a balance between earning interest to grow a retirement balance and paying down interest to eliminate student loans.

Most retirement investments come with risk and can produce a range of potential returns. Meanwhile, student loan debt has a reasonably predictable interest rate.

The question for borrowers is how much risk they are willing to tolerate. Investments can produce huge returns, but paying down student debt provides a guaranteed benefit.

Using Tax-Advantaged Accounts

Tax-advantaged accounts, such as 401(k), 457 plans, and IRAs, allow retirement savers to put money towards retirement before paying any taxes. This leaves student loan borrowers with a difficult judgment call.

Suppose a borrower has $100 per month that they can either use for retirement or use to pay down student debt. If the borrower is in the 25% tax bracket, they can either put that entire $100 in a tax-advantaged account and save for the future, or they can pay taxes now and use the remaining $75 to pay down student debt.

On the surface, putting money in the tax-advantaged account seems like a no brainer. The problem is that when the money comes out, it will get taxed. This reduces some of the advantages to this account.

We typically suggest borrowers with extremely high-interest rate student loans, starting at about 10%, to aggressively pay down their student loans before making retirement contributions. Those with lower interest rate loans should consider setting aside money for retirement in tax-advantaged accounts before aggressively paying off their loans. Those that are investing in broad stock market mutual funds, such as an S+P 500 index fund, can expect an average return of 7-10% according to most financial experts, but those numbers can vary greatly from year to year and are dependent upon the nature and quality of the mutual fund.

Those who want to start saving for retirement right away but facing high-interest rate student loans should consider finding a student loan refinance company that might offer a lower interest rate. Going this route can save money on student loans and allow borrowers to grow a retirement balance.

Special Note for Income-Driven Repayment Plan Participants – Borrowers who are on a federal income-driven repayment plan such as IBR or PAYE can get lower payments by contributing to a tax-advantaged account. This is because these contributions lower an individual’s Adjusted Gross Income (AGI) on their tax return. A lower AGI means less discretionary income, and less discretionary income means lower monthly payments.

Utilizing Forgiveness Programs

Participation in student loan forgiveness programs can also influence retirement planning with student loans.

This is especially true for borrowers working toward Public Service Loan Forgiveness (PSLF). These borrowers can get lower payments by making retirement contributions which leave a larger loan balance to be forgiven after ten years.

Most borrowers will find that money goes further when saving for retirement instead of using it to pay down balances that would otherwise be forgiven.

Deciding Between Saving for Retirement and Paying Off Student Loans

The smart strategy is to attack high-interest debt first. Don’t worry about ultra-low interest; you can start saving before you eliminate all your debt.

A general formula for student loan borrowers would be to put their money towards the following:

  1. Employer Matching Programs
  2. High-interest student debt (~10% or higher)
  3. Tax-Advantaged Retirement Accounts (401(k)s, 457 plans, etc.)
  4. Medium Interest Student loans (~5-7%)
  5. Other Retirement Savings (Brokerage accounts)
  6. Low-Interest Student Loans (<3-4%)

Ultimately, the strategy will depend upon a saver’s tolerance for risk and the borrower’s desire to eliminate debt. Student loan forgiveness programs can also adjust priorities as can student loans refinanced at a lower interest rate.

The key for any individual is to understand their options. Whether saving for retirement or paying down student loans, the goal is the same: a healthy financial future.

Finally, it is critical that all borrowers…

Don’t Procrastinate!

Managing student debt and saving for retirement can both be stressful endeavors. They can also seem complicated. Student loan borrowers have to understand repayment plans, forgiveness terms, and lender rules. Retirement savers need to figure out the proper retirement vehicles and investments.

It is easy to dismiss these issues as future problems and focus on the present rather than worrying about a far off future that might never happen. Subscribing to this line of thought can be a huge mistake.

Most of this article discusses dollar allocation options, how income can be put towards retirement or how to pay down student loans. What we didn’t discuss is the fact that money can also be used for shopping, entertainment, or fun. There are certainly many more pleasurable ways to spend money, but retirement and debt elimination should both be top priorities.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

1 thought on “Making Retirement a Possibility Despite Massive Student Debt”

  1. Ahhahahahahaha…. Great one!

    Now tell me how someone who has never been hired to work for more than $14/hr that has a student loan from 2000 capitalizing at 8.25% can afford anything.

    My Student Loan in 2000 was roughly $33,000. The Fed set it at 8.25%, which made my monthly payments $404.75.

    I grossed $4,795 in 2000. Like I could pay $404.75/mo. I grossed $18,642 in 2001. $15,818 in 2002. $15,931 in 2003. $20,328 in 2004. $20,280 in 2005 and $22,880 in 2006. I didn’t break 150% of “Federal Poverty Level” until 2007. So for the first seven years after graduation my only options were Deferment & Forbearance.

    Oh Look! IBR (Income Based Repayment) was started in 2007! I made $27,480 in 2007 (167.54% FPL) … my 25 year IBR payment was around $150 IIRC. Let’s call it $200. SO I get to cut my gross monthly earnings from $2290 to $2090. OK. And let’s see where that leads us…

    Ah… at the end of the 25 years, I get to have my now $204,635.16 “loan” forgiven… which means, using my 2018 AGI and 2019 tax tables, I get a $46,076 Tax bill from the IRS… AFTER paying $60,000 ($200*300 months)

    Wow. And given that my average annual income over the last 18 years has been LESS than $24K, what are the odds I could amortize “up” to a flat schedule?

    Well, that would be $451.62/mo. So, I’d get to live on $1,548.38 gross/mo. AND I would have the pleasure of paying $112,453 total over 20 years. But at least I avoided “loan forgiveness” and the tax man, right? No! Going all 25 years at a mere $200/mo only costs $106,076‬ – a full $6,377 less! WHOOPEE!

    This system was DESIGNED to crush people who couldn’t find professional work immediately, especially at higher interest rates, and keep them from ever getting ahead – all to increase the “asset value” of the “student loan debt”.

    And it works smashingly well.

    Oh, & FWIW… If I get a Wage Garnishment, (25% of discretionary income) it will only cost me around $100/mo until I die in 30 years give or take. That’s only $36,000 – or roughly equal what my original principal was. Gotta love math.


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