Life is about making choices, and this is especially true when it comes to making a monthly budget, regardless of your age.
In your twenties – and even in your thirties and beyond – that monthly budget could include student loan repayments. After all, 43.2 million Americans owe an average of $ 39,351 each, for a total of $ 1.73 trillion, according to research organization EducationData.org.
And if you find that your budget allows you to pay more than the minimum payment owed on your student loans, your gut might tell you to speed up your loans to pay them off faster. But is it the best budget choice to make?
Maybe not if that means ignoring your retirement savings. So what should be your priority: attacking your student loan payment or financing your 401 (k)? Here are the advantages of both.
More decisions: Where to put your money: savings or retirement?
Benefits of Accelerating Student Loan Payments
You can speed up the repayment of your student loan by paying more than the minimum monthly payment and you will reap financial benefits:
Your loan will be repaid sooner than expected. Prepaying the loan early means you can increase your emergency fund or start saving for big expenses, like a wedding or a house. Or you can then add to your retirement account.
Your credit score will improve as your debt-to-income ratio decreases. This is advantageous if you want to get a home loan, for example.
You could save a significant amount of interest, especially if you have a large amount outstanding or private loans with higher interest rates than federally guaranteed loans. Student loan calculators are readily available online and can give you an idea of your savings.
Benefits of funding your 401 (k) account
But what if you want to take that extra money and put it into a 401 (k) account through your workplace? Here are some of the benefits:
The earlier you start saving, the more time you have to earn interest or invest the funds, and you won’t have to make up for lost time later to make sure your retirement is adequately funded. Fidelity estimates that you will need to save 15% of your annual income if you start saving at 25, 18% at 30, and 23% at 35.
You can benefit from matching funds. Your employer may offer to match every dollar you contribute, up to a specified amount, such as 5% of your salary. If you earn $ 50,000 and put 5% in your 401 (k), that’s $ 2,500 your employer will match per year. You can’t beat that.
The money is paid on a pre-tax basis, which means you won’t pay tax on this income in your reporting year. This will save you money at tax time.
More to consider
Paying off your student loans and saving for your retirement doesn’t have to be a proposition. But it can be made easier by the choices you make, including where to work.
A question to ask potential employers, in addition to whether a 401 (k) match is offered, is whether paying off the student loan is part of the benefits package.
“The best bet for those just starting out in their careers is to work for an employer that recognizes and accepts the challenge of saving for retirement while paying off student loan debt by offering assistance for both. A growing number of employers are offering student loan repayment assistance as a benefit to financial well-being, ” said Patricia Roberts, COO at College donation.
In fact, under the Internal Revenue Code, employers can offer up to $ 5,250 per employee per year in tax-free student loan repayments until Jan. 1, 2026, Roberts said.
More help: 30 ways to get rid of your debt
You must make at least the minimum payment on your student loan each month. If not, your credit score will likely be affected. Even a payment 30 days late will have a negative impact on your FICO score since payment punctuality accounts for 35% of the score calculation. Late payments stay on your credit report for seven years, according to the Experian credit bureau.
Keep reading: 19 ways to budget and manage your debt
One factor to remember is that the interest rates on federal student loans are relatively low. Over the past five years, interest on undergraduate student loans has been 4.11%, EducationData.org said. For current undergraduate loans, it is even lower at 2.75%. The money invested in your 401 (k) could possibly earn more than 4.11% interest. So if you use the extra money in your budget for an extra student loan payment instead of investing it, you could actually lose money.
The decision to pay extra each month for your student loan balance or put it in a 401 (k) or other retirement account is a personal decision. There is no one-size-fits-all approach and your financial situation should be considered as a whole.
A financial advisor can help you determine what is the right decision for you and your financial goals.
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Last updated: September 13, 2021
This article originally appeared on GOBankingRates.com: 401 (k) Vs Student Loans: What Should You Invest The Most Money In?