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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8 Responses to “Paying student loans in your 20s, 30s, and beyond interferes with saving for retirement”

  1. The first young couple has really got the cart before the horse. They’re worrying about whether to pay off their student loans or save for their yet-unconceived childrens’ college. In their situation, they may well need the extra $125 a month either for infertility treatment, adoption, or unexpected medical care. Considering what those things cost, $125 is so little!

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  2. Yes, they seem naive. Although, we don’t know if they’re saving gobs of money for retirement and other “emergency” needs.

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  3. Yes Bonnie, it’s scary.

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  4. The other thing to bear in mind is that a lot of people are going into their pre-retirement years with a lot of debt (credit card, mortgage, student loans, whatever), so that their situation may be much worse than it appears when we look purely at their savings (lots of people who earn good salaries have both high debt and some retirement savings). Every so often in the housing bubble news pieces, there’s some sad tale of a homeowner who was foreclosed upon 40 years after they originally bought the house (i.e. 10 years after the house should have been theirs, free and clear).

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  5. Good point about the debt, Amy. Every once in a while a casual conversation with someone I know to be living an affluent lifestyle will reveal that they are in debt up to their eyeballs, often with a mortgage that has not diminished much over the 20 or so years they lived in their home because i’s been “HELOC’d” so much. These people with very little savings are not always the ones you might expect.

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  6. “I have known a number of people in my age group with little retirement savings because they dipped into their savings during extended periods of unemployment.”

    Aside from unemployment, I think it’s also a cultural norm to cash out the 401(k) when switching jobs. Nearly half of workers do so:

    http://www.investmentnews.com/article/20091029/FREE/910299997

    Between cashing out for job changes and cashing out for home purchases and cashing out to pay for kids’ college, it’s a miracle anybody’s got any money in a 401(k).

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  7. I’m pretty sure that by “cashing out” they mean taking out of retirement entirely, rather than rolling over to a new plan. What I’ve never seen spelled out is what percentage of people who cash out when job changing are doing so because of unemployment, and what percentage are just being stupid. I guess the sums involved are often so small that people don’t feel bad about liquidating retirement accounts, even considering the brutal taxes and penalties.

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