How to Find the Balance Between Student Loans and Retirement Savings
Student loan interest accruals resumed September 1st and payments will be due in October for the first time in three-and-a-half years. According to a new survey from Credit Karma1, 56% of borrowers will have to choose between paying their loan or necessities like rent and groceries when the pandemic forbearance ends.
Student loan payments can greatly affect your finances, whether you took the loan(s) out yourself or co-signed for someone else. I recently had a conversation with a colleague preparing for student loan repayments to restart. Here's my perspective on some questions that you might be asking as well.
Q: What are some strategies to juggle my student loan payments and retirement contributions?
A: First, figure out exactly what you owe, update your information, and find out if you’re eligible for loan forgiveness. After that, opt for an income driven repayment program such as the new SAVE program if you’re allowed. Eligibility is based on discretionary income; it’s equal to the difference between your adjusted gross income and 225% of the poverty level2.
The next step is to lower your taxable income by contributing to your retirement accounts. There are a few strategies. Contributing to 401(k), Traditional IRA, or HSA can help you save for other goals and lower your student loan payment.
Also, keep in mind that when tax season comes around, eligible student loan borrowers can deduct up to $2,500 of the interest paid on their student loans annually under the current IRS tax code. This deduction is limited to interest payments only, and not to any amount you paid towards the principal. It’s important to point out that this is a deduction, not a credit. It won’t give you a dollar-for-dollar tax bill decrease, but it can lower your taxable income.
Q: I have five student loans all with different interest rates. Should I consolidate?
A: I suggest you proceed carefully. While consolidating or refinancing your loans might give you a lower interest rate, it’s important to understand what you’re giving up. Transferring your loans disqualifies any future forbearance or applying for any income driven repayment programs. Also, in the current interest environment, low rates are likely behind us for the foreseeable future.
Q: This payment will make a really big difference in my monthly cash flow. Should I shift gears and reduce my savings?
A: Now’s a good time to reevaluate your budget and ask yourself what your priorities are. The options are limited in this scenario. If your student loan payment is getting turned on again, you can either adjust your budget to lower discretionary spending or cut back on your savings. While the answer depends on your individual financial situation, in most cases you always want to have sufficient emergency liquidity.
One possibility, if you have sufficient equity in your home, is to get a (HELOC) Home Equity Line of Credit. That can make it more comfortable to have less of a liquidity reserve. Now, I’m not suggesting that you borrow on the HELOC. But pretend for a moment that your target is to have a $50k cash reserve, and you’ll have to dip into it by $500/month to pay your student loans. If you have a HELOC in place, you can have confidence knowing that while your liquid cash is going down, you have access to the equity in your home as a safety net. Tapping your cash reserves should be temporary, though; make sure to take steps to adjust your spending and use your next raise to rebuild savings back to the $50k target (used for this hypothetical).
Ultimately, loans are an obligation and creating a plan to pay them off will help protect your future financial freedom. Here are my five important points:
- Evaluate if you’re eligible for loan forgiveness.
- Find the right repayment plan for you.
- Prioritize your retirement contributions.
- Make sure you have other sources of emergency liquidity.
- Cut back on discretionary spending.
The best advice will be tailored to your unique personal financial situation. Having a personalized plan can help you make smart financial decisions with confidence. If you’re wondering how a financial plan could help you reach your goals, let’s talk.
Stu Malakoff, CDFA®, CPFA, CRPC® I President, Bend Wealth Advisors
CERTIFIED FINANCIAL PLANNER™
523 NW Colorado Ave. Ste. 100
Bend, OR 97703
Direct 541.306.4325 IText 541.920.1115I Office 541.306.4324 Istu@bendwealth.com
Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Bend Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.
Securities offered through Raymond James Financial Services, Inc., member FINRA / SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Bend Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services. Any opinions are those of Stuart Malakoff and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.
Sources
1. Credit Karma
2. studentaid.gov
