Many student loan borrowers are torn between saving for retirement and paying down their student loans.
Student loan borrowers often assume that you can only pursue one of these goals at a time. After all, every dollar you put towards retirement is a dollar you can’t use to pay down student loans.
What if it was possible to build a retirement and make student loan debt disappear at the same time?
It might sound surprising, but there are at least four different strategies that can be used to work towards both milestones.
Use Student Loan Forgiveness to Build a Bigger Retirement
The federal student loan forgiveness programs can be excellent opportunities to eliminate student loan debt. For borrowers with large student loans and a smaller income, these programs can be life-changing.
Borrowers on income-driven repayment plans can have their remaining balances forgiven after 20 to 25 years worth of payments. Those employed by the government or an eligible non-profit can have their loans forgiven after just ten years of payments.
Unfortunately, there is some risk in chasing after student loan forgiveness. Borrowers can take time to make sure they understand the rules of loan forgiveness, but nothing is guaranteed. While the concern over the high rejection rates in the media may be exaggerated, there is no denying that forgiveness comes with a bit of uncertainty.
Borrowers worried about qualifying don’t have to skip the program entirely. Instead, they can chase after student loan forgiveness but protect themselves if it doesn’t happen.
One option is to open a savings account as a Plan B fund. Borrowers make the minimum student loan payments as they pursue forgiveness, and any additional funds that they have available go into the Plan B account. Going this route allows borrowers to attack their debt aggressively, but also try to maximize forgiveness opportunities.
If it becomes clear that forgiveness won’t happen, the Plan B fund can be used to put a huge dent in the debt balance. If forgiveness does work out, the Plan B fund can be used as a huge head start towards retirement.
Refinance and Build a 401(k) or IRA
Borrowers who won’t benefit from student loan forgiveness also have a way to lower student loan payments and save for retirement.
Companies like SoFi, Splash, and CollegeAve all refinance student loans for borrowers with a decent credit score and income. These companies pay off the older high-interest loans in full, and a new loan with a lower interest rate is created.
By refinancing, borrowers can free up some additional cash each month. This additional money can be put towards retirement in a 401(k) or an IRA.
For example, suppose a borrower pays $500 per month on their student loans. They may be able to refinance and get the monthly payment lowered to $350. By refinancing, they have an additional $150 per month available. Instead of pocketing that money, it can be put aside in an IRA for retirement.
Depending upon the terms of the student loans, a borrower can refinance student loans to get them paid off more quickly AND use the additional funds available each month to save for retirement. The key to the process is finding the lowest refinance rates available.
Get Your Employer Involved
One of the best ways to build a retirement is to take advantage of employer matching programs. If your employer offers a dollar-for-dollar match, it means each retirement contribution essentially doubles from day one.
Unfortunately, some student loan borrowers do not take advantage of this program because they feel they need every dollar from their paycheck to pay down student loans and pay for the essentials. (Editor’s Note: Passing on an employer matching program is usually a bad idea as it is essentially passing on free money.)
A recent ruling from the IRS could make a big difference for the borrowers who can’t afford to utilize matching programs. The IRS said that an employer could link 401(k) matching contributions to student loan payments made by an employee.
This is a significant development because it means an employee could theoretically use their monthly student loan payments to maximize their employer contributions to their 401(k).
Because this is relatively new territory, many employers don’t know about this option, and many others will be hesitant to do so. However, some employers may embrace the opportunity. The matching cost to the employer is the same whether the match is based upon a student loan payment or a retirement contribution.
Talk to your boss or HR department to discuss the fact that the IRS may allow matching contributions based upon student loan payments. Many companies are looking for ways to attract young, talented people, and this could be very appealing.
Turn Retirement Tax Breaks into Lower Student Loan Payments
This is my favorite student loan hack.
Borrowers on IDR plans like IBR, PAYE and REPAYE can tweak their AGI to get lower payments by putting money in a retirement account.
As most borrowers know, when IDR payments are calculated, the government usually uses your most recent tax return. The important number pulled from the tax return is the AGI or Adjusted Gross Income. A higher AGI means higher student loan payments, and a lower AGI likewise means lower monthly payments.
Contributions to a 401(k) or a traditional IRA lower the AGI. Accountants call tax breaks that lower the AGI above-the-line deductions. For each dollar that is put in a 401(k) or IRA, the AGI is reduced by one dollar.
If a student loan borrower puts $300 per month in an IRA, their AGI will be $3,600 lower the following tax year. The lower AGI means a lower tax bill AND lower student loan payments. Borrowers can use the federal government’s student loan repayment estimator to see how changes to their AGI would change their monthly student loan bill.
Putting money in a 401(k) or IRA provides student loan borrowers with three primary advantages:
- A lower tax bill in April,
- A lower monthly payment on an IDR plan, and
- A larger balance in their retirement accounts.
It is worth noting that a lower monthly IDR payment can mean spending more in interest over the life of the loan, so borrowers should factor total loan cost into their planning. However, for borrowers who will eventually qualify for federal student loan forgiveness, this option can result in a larger portion of the loan balance being forgiven.
Final Thought: Plan Ahead and Know the Rules
The strategies outlined in this article are fairly advanced and have the potential to get confusing for borrowers.
All student loan borrowers should familiarize themselves with the terms of their student loans and understand how the debt impacts their finances.
Those who understand and plan can create strategies like the ones mentioned above to eliminate their debt quickly and efficiently. They will also be empowered to meet other important financial goals, such as retirement.