Archive for August 3rd, 2012

August 3, 2012

Paying student loans in your 20s, 30s, and beyond interferes with saving for retirement

by Grace

Here’s a couple trying to decide between paying their student loans and saving for their children’s college, but I hope they’re also saving for retirement.

Q: My wife and I have remaining federal student loans of $26,000, with a 3.9% interest rate. Is it best for us to increase our monthly payment from $175 to $300 to pay it down more quickly? Or should we put $125 a month into a 529 plan for the children we plan to have in the next two years?

A: The decision to pay down your student loans or to save money in a 529 plan should include both the financial and emotional aspects.

First consider your overall financial situation. For example, setting up an emergency fund and getting your full 401(k) employer match may be more beneficial uses for the extra cash.

Then compare the advantages of paying off a student loan against what you would gain by putting money in a 529 plan:

A 529 plan is federally tax free and many states also offer tax breaks. But remember that the investment return is not guaranteed. You will be comparing an uncertain investment return on the 529 plan for a child you plan on having to a guaranteed interest rate on your own student loans.

With federal student loans you can deduct up to $2,500 in interest. And you can take it without itemizing on your 1040 tax form. The deduction is phased out for taxpayers with adjusted gross incomes of $60,000 to $75,000 (single filers) and $120,000 to $150,000 (married filing jointly).

Once the loan is paid off, you will have extra monthly cash flow that you could use to save for college. Sometimes the emotional satisfaction of paying off the loan trumps other financial considerations.

Since your children are “planned,” you can set up a 529 plan and name yourself as the beneficiary, and change the beneficiary later. The downside of a 529 plan is that withdrawals that are not used for qualified college expenses are subject to tax and a penalty.

Since you are still planning for a family, keeping your options flexible is a good approach. You can now save money in a taxable account and make a lump sum initial contribution to a 529 plan after your child is born.

But keep in mind that saving for retirement is usually a higher priority than saving for college.

Many middle-aged debtors are struggling to pay their student loans or taking out new loans for their children’s education.

Two-thirds of the nation’s $900 billion in student debt is held by Americans under 40, the Fed estimates. But borrowers over 40 are having a particularly tough time with student debt for several reasons, consumer and higher-education experts say.

Many debtors over 40 are still paying balances from college years ago, while their home values and savings have declined sharply in recent years. Some have stopped payments after losing jobs. Many parents—no longer able to tap home equity to pay for their children’s education—are taking out new student loans to do so. An Education Department program that provides loans to parents to fund their kids’ education is among the fastest-growing of the government’s education loan programs.  (Wall Street Journal)

More Boomers Are Sacrificing Retirement (The Huffington Post)

Student loan debt is a growing problem in the U.S., and not just for recent college graduates. Roughly one in six people over age 50 are carrying student loan debt, according to a new report by Barclays.

 Andy Hough at My Retirement Blog compiled this scary data from the 2012 EBRI retirement survey.  

Here’s how retirement savings breakdown by age group:

25 – 34
76% saved less than $25k, 12% were between $25k-$50k, 6% were between $50k-$100k, 5% were between $100k-$250k, and 1% were above $250k.

35 – 44
61% saved less than $25k, 11% were between $25k-$50k, 14% were between $50k-$100k, 12% were between $100k-$250k, and 3% were above $250k.

45 – 54
54% saved less than $25k, 9% were between $25k-$50k, 9% were between $50k-$100k, 12% were between $100k-$250k, and 17% were above $250k.

55+
40% saved less than $25k, 8% were between $25k-$50k, 12% were between $50k-$100k, 18% were between $100k-$250k, and 22% were above $250k.

All (Combined)
60% saved less than $25k, 10% were between $25k-$50k, 10% were between $50k-$100k, 10% were between $100k-$250k, and 10% were above $250k.

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