One of the frequently asked questions we get from our blooom clients is – “I am still paying on my student loans, how much should I contribute to my 401k, if anything?” Unfortunately, student loan debts are hindering retirement savings for a huge segment of millennials and Gen Xers. Paying your student loans instead of saving for retirement can translate into hundreds of thousands of dollars less in your 401k by the time you reach retirement. If anything, this problem has been getting worse. Average student loan balances have risen steadily over the past 20 years. In 1993, the average graduating student owed less than $10,000. This went up to $35,000 for the unfortunate class of 2015 (source Mark Kantrowitz, wsj.com). Personally, when I walked down the Hill at my college commencement in 1995, I was also dragging along $29,000 in student loans. My point is: you are definitely not alone with this burden.
Student loans or retirement savings? A simple answer.
For those of you in the workforce with access to participate in your employer sponsored retirement account (such as a 401k or 403b), you are likely juggling your student loan re-payment and retirement contributions. Maybe you’re wondering what balance should be struck between these two. Fortunately, the advice is fairly straightforward. IF your employer offers a match on contributions that you make into your 401k, PLEASE, PLEASE DO NOT miss out on this free money! So even if you are saddled with student loan payments, I still strongly encourage you to contribute to your 401k. But: ONLY enough to get the maximum employer match.
What does the employer match get you?
The employer match can take on many different shapes and sizes. Oftentimes it looks like this: For the first 6% that you contribute to your 401k, your employer will match $0.50 on the dollar. In other words – if you contribute 6% of your paycheck, they will match another 3%. Put in different terms, if you make $50,000 per year and you elect to put 6% into your 401k, you are saving $3,000 towards your retirement (6% of $50,000). On top of this, your employer is contributing another $1,500 into your account (3% of $50,000). Try this one on for size: your $3,000 contribution just received an automatic 50% return before any investment return!
There’s an exception.
I’m glad we are clear on that! However, while you are paying off those student loans, I want to make sure that you do not contribute even a penny more than what’s necessary to get the maximum employer match. If your employer doesn’t offer a 401k or 403b OR doesn’t make any kind of matching contribution, then my advice changes. Your sole financial focus should be to get rid of that student loan “ball and chain” as soon as humanly possible. The last thing you want to do is still pay off student loans when you are trying to put your own kids through college. Or worse: when you are trying to retire! So in this case, you should not be contributing anything to your 401k. Instead, put all of your financial resources towards paying off this debt as fast as you can.
Moderation is key.
You may not like what I’m about to say, but if you are still paying off student loans you should NOT be indulging in things like: brand new car purchases (or worse – car leases), a new 80” HDTV, the latest/greatest MacBook, expensive vacations, or designer watches. Make it a singular goal to get all non-mortgage debts out of your life at a relatively early stage (before age 40 ideally). Then, and only then, by all means, start treating yourself to some of those types of purchases. The mistake that many Americans make is that they are unwilling to delay gratification. They end up attached at the hip to car loans, credit card loans and student loans for a majority of their working lives. I can promise you – the more you are burdened by debt, the more likely you’ll find yourself trapped in a job that you can’t stand. And simply because you can’t afford to leave. You might have heard this song before: “I owe, I owe, so it’s off to work I go, I owe, I owe….”
Be (debt) free!
There is one single trait that financially independent people have in common more than any other singular trait: they are debt free. I don’t care how much you earn, how great your investment portfolio performs, whether you own a business, where you grew up, or how wealthy your parents were. If you can find a way to get out of debt quickly, you will forever change your financial trajectory. Period.
Published on February 17, 2016