Repaying College Loans Early: Bad for Retirement?

The finding of a 35% loss in retirement savings due to student loan payments was based on the Federal Reserve’s Survey of Consumer Finances, which covers a much broader population than the HelloWallet users but is based on household finances rather than the finances of individuals. Both sets of data, however, show evidence that “higher levels of student loan debt are associated with lower levels of retirement savings even after controlling for age and income,” according to the report.

“People are often anxious to pay off their debt as soon as they can but if they do, they can potentially miss out on saving a good amount of money for retirement,” says Jake Spiegel, senior research analyst at HelloWallet and co-author of the report.

Using the example of a 25-year-old employee earning $50,000 annually with a student loan of $20,000 and an effective employer match of 5% of salary, the study found that if he or she could only take advtange of half that match because of early loan payments, that employee would have $341,000 less saved for retirement at age 65.

The study makes a few recommendations for student loan borrowers to help them maximize retirement savings:

• Don’t pay off student loans early. That leaves less money to save for retirement and less money to compound over time. “Contributing even one dollar in the market over 40 years is a lot more valuable than paying off a loan in 20 years,” says Spiegel.
• Contribute enough money to retirement accounts to get the maximum employer match, which is typically half of the first 6% of salary. Not paying off a student loan early increases the possibility of having the money to maximize an employer match. “It’s free money,” says Spiegel. Also, saving more money in tax-deferred retirement accounts reduces income taxes. 
• Take advantage of income-based loan repayment plans, which can also increase the ability to save more for retirement. These plans cap loan repayments on federal student loans at 10% of discretionary income.
• Borrowers with adjusted gross income of $80,000 or less should remember that they can deduct the interest on student loan payments for as long as they pay interest on that loan. Paying off the loan sooner means losing that deduction.

— Related on ThinkAdvisor:

• Will Student Debt Crush Recent Grads’ Retirement?
• 4 Tax-Efficient Ways to Pay for College, Pt. 2: 529 Plans and Trusts