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Why is paying additional money towards high-rate debt recommended before saving extra for retirement for young people?

I've seen many advisors recommend paying extra towards high interest student loan debt before saving extra for retirement. I'm 25 years old and my self-directed retirement accounts Roth and 457(b) are in 100 percent stocks. I have some student loan debt that is 6-7 percent on a 15-year repayment plan.

Assuming a very conservative 5 percent annual growth in my retirement account, how does a dollar invested at 5 percent that is able to grow over 40 years exceed the benefits of paying off debt at 6-7 percent that will be paid off in the next 15 years?

College Tuition, Debt, Financial Planning, Retirement, IRAs, Stocks
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May 2018

That's a great question. And good for you for thinking so deeply about your finances at a very young age. Very impressive! Now to the question.

Here is my formula for to achieve financial freedom:

  1. Spend less than you make
  2. Save and invest the difference
  3. Avoid debt, especially high-interest credit card debt

A 6 -7 percent student loan debt is not what I would call high-interest debt. And if that is the only debt you carry, and you can comfortably make the payments and still save, an argument can be made to stay the course.

Here's something else to consider. If you paid off those student loans more quickly, say in 8 years vs. 15 and put the payments you were making on the loans into your retirement accounts, how much more would that add to the retirement pot?

Without the actual numbers (how much is going to your Roth and 457(b), amount of your loan payments), it's impossible to calculate the actual numbers. You can do this yourself, though. Calculate how much more you would have at your 5% rate if you put the money into your retirement accounts vs. staying on the loan repayment schedule. 

And don't forget, you're adding 6-7 percent to the cost of that money every year the loan is unpaid. Look at the loan principal and payment schedule and total up the interest saved for whatever period you reduce the loan by (8 years, 5 years, etc.). That savings can also go to your retirement accounts.

I think you'll find you'll be way ahead by paying off the debt early and putting that money to work in your retirement accounts or other investments.

Kudos again for trying to get this right. I hope this is helpful. Good luck!

May 2018
May 2018
May 2018