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Should I Save For Retirement or Pay Down my Student Loans?

During the first few years of your professional career, you may face a difficult financial choice: Should you focus on saving for your eventual retirement or pay down student loans instead?

This may feel like an impossible choice to make. While you may want to leverage matching funds through an employer-sponsored 401(k) retirement plan, you may also feel overwhelmed by the burden of your student loan debt. And although you may make more money now than you ever have before, cash may still feel tight.

But there are some good guidelines you can follow to determine the best solution for you. Here is what to consider.

 

Weighing your options

If you look at the two options — save for retirement or pay down loans — you can make a baseline determination about which is the mathematically better choice. The answer lies in the interest rates on your student loans, your anticipated long-term rate of return on retirement investments, and whether your employer will match any of your contribution to your retirement account.

Let's start with interest rates. Look at the interest rates on your loans, as well as the rate of return you can reasonably expect from the money you contribute into your retirement plan (which you can then invest into the market for growth).

While there are no guarantees when it comes to investing, you can look at historical average rates of return to estimate what your own return could be over a period of decades. The S&P 500, for example, is the index most often used to generalize average market returns over time. Over the last century, its average return has been about 10%.1

That doesn't mean you should bank on this return every year. Also, this rate of return doesn't account for inflation, and the S&P 500 is just one index in the market. When assuming your own rate of return, it's best to take a conservative approach that falls around 5-6%.2

Now, take a look at the interest rates on each of your student loans. Are any of these greater than or less than 6%?

If the interest rates on your student loans are greater than 6%, it may make more financial sense to focus on paying these loans off as soon as possible. That's because the interest you're being charged for your student loan debt will cost you more than you can reasonably expect to earn from the money you allocate to your retirement plan's portfolio. If the loan rates are less than 6%, however, the numbers say you are better off making your normal monthly payment on what you owe and contributing any extra cash flow to your long-term investments.

Of course, you also need to take into account the extra money you could receive from your employer via a match when you contribute to your retirement plan. That could further sway the numbers to point toward investing as the better option.

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Does your employer offer matching funds for your retirement plan? If so, this is free money, so you should aim to max out this benefit.

 

The emotional burden of student loan debt

While the math might say you should invest as much as you can right now, that doesn't account for the reality of the daily emotional burden student debt can cause. If your student loan debt feels completely overwhelming, causes intense stress, or keeps you up at night, then it might make more sense to aggressively pay those loans off as quickly as possible.

Another consideration may be the size of your student loan balances. If you have $10,000 in debt left to repay, you might want to put your retirement savings on pause in order to throw everything you've got at that balance and repay it ASAP — especially if you can do it in a year or less.

 

Hidden costs of waiting to save

On the other hand, you probably don't want to entirely ignore what could be the biggest advantage you have for growing wealth: time. Time is a critical factor when it comes to investing, because time is what makes exponential compounding growth possible.3

The earlier you begin, the easier it will be to grow your assets over time. The longer you wait to invest, the more you will need to save each month in order to catch up. If you ignore the need to save for retirement while you pay down debt, you incur a big opportunity cost that can be difficult to make up for later. Opportunity cost4 is the benefits or earnings you miss out on when you choose one option over another — like skipping out on savings contributions while you focus on paying down debt.

 

A strategy to help you save and repay debt

You may need to work within the constraints of a tight budget — but that doesn't mean you have to make a binary choice when it comes to saving or repaying debt. It is possible to do both.

Aim to pay at least the amount you owe each month on your student loan debt. You don't want to fall behind on payments or pay less than what's due, as that will only serve to accelerate how much debt you accumulate. It can also negatively impact your credit score, making it harder to borrow money for a car or a home in the future.

Then, turn to your retirement plan — and remember your employer match. It may be small; it's common to see employers offer to match your contribution, up to 1% to 3% of your salary. That's free money to you. Can you contribute at least enough to your plan to secure this match? If so, set that contribution as a starting point.

Now you can evaluate what you have left over at the end of each month. If you feel you have more money you can contribute to either debt repayment or retirement, then you can decide what is best for your situation based on your goals and your preferences.

If you can't stand your debt, maybe that money goes toward paying off student loans as quickly as possible. On the other hand, if you have aggressive financial goals like early retirement, it may make more sense to bump up that retirement plan contribution so you can achieve your aims.

Important disclosure information

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

  1. J. B. Maverick, "What Is the Average Annual Return for the S&P 500?" Investopedia, updated January 3, 2024. Accessed April 3, 2024. Back
  2. Rachel Hartman, "What Is the Average 401(k) Return?," U.S. News, published September 21, 2023. Accessed April 3, 2024. Back
  3. James Chen, "Exponential Growth: Definition, Examples and Formula," Investopedia, published February 13, 2024. Accessed April 3, 2024. Back
  4. Adam Carpenter, "What Is Opportunity Cost?" U.S. News, updated December 23, 2023. Accessed April 3, 2024. Back