Student loans have become a hot button issue as many young workers graduate with increasingly large debt burdens. There is a good deal of popular wisdom, but little guidance on one major concern: Should workers prioritize paying off student loans ahead of schedule or prioritize saving for retirement?
To answer this question, we looked at our own user data and the Survey of Consumer Finances, a nationally representative survey conducted the by the Federal Reserve. We also built an illustrative model to examine the impact of the decision to pay off student loans ahead of schedule.
Should Workers Prioritize Paying Student Loans?
First, in analyzing both our user data and the survey data, we found that student loans exert a slight crowding-out effect on retirement savings. After controlling for age and income in HelloWallet’s user data, one additional dollar of student loans was associated with a $0.17 decrease in retirement savings, and in the Survey of Consumer Finances, one additional dollar of student loans was associated with a $0.35 decrease in retirement savings. There are a number of reasons why the results differed slightly – HelloWallet’s users are not representative of the working population of the United States, for example – but the fact that these two data sources are directionally similar is certainly suggestive of student loans crowding-out retirement savings.
Second, using the model we built, we found that there are very few circumstances in which paying down student loans ahead of schedule leads to a higher net wealth at retirement, particularly if a worker receives an employer match on retirement savings. A hypothetical 25 year old worker making $50,000, paying off a $20,000 loan, and receiving a 5% match on their retirement savings can accumulate 15% more savings at retirement if they focus on saving for retirement instead of waiting to save for retirement and dedicating all of their discretionary dollars toward paying off their loans ahead of schedule. Even if expected returns in the stock market are lower than the interest rate on the loan, saving for retirement wins out. This is because retirement savings, particularly for a young worker, will compound over a long time horizon. Furthermore, interest on student loan debt is tax-privileged for single workers earning less than $80,000.
Don’t Let Loan Payments Crowd Out Savings
These analyses demonstrate the importance of prioritizing retirement savings over paying off student loans ahead of schedule, particularly if an employee can take advantage of an employer match on retirement contributions. Further, they demonstrate the need for sound personal financial guidance.