Is it better to pay down my student loan or put money in a 401(k)?
I am in my early 30's and my student loan balance is around $40,000.
Answers | 6
Whether or not it makes sense to pay off the student loan in full really depends on a number of factors and your personal situation.
As a professional advisor, I would probably start by asking if you have an adequate emergency reserve. There are lots of opinions on this but I would say that a bare bones minimum would be three months of fixed living expenses (though I'd feel more comfortable with six months).
Then the next question would be what other priorities are you trying to meet: home purchase, paying down credit cards, weddings, etc.
So it depends on what your resources are as well as your cash flow. If you have sufficient cash flow, I would recommend the following priority for using it:
1.) pay yourself first - 10% preferably through retirement savings and non-retirement savings
2.) pay extra towards high interest credit cards - not deductible and very expensive
3.) pay extra towards the principal on your student loans - at least you may be able to get a tax deduction on the interest.
For something more specific to your situation, I recommend speaking with a financial planner - not necessarily one in your backyard just because they're close to you - but one who is going to provide unbiased advice not tied to the purchase of a product.
1. What type of debt is it (Federal or Private)
2. What type of job do you have
3. When did you incur the debt
4. How much money do you make
5. What are your life and professional goals
I work with a lot of teachers and other public servants. Many don't make a lot of money, but because of their jobs and the type of student loan debt they have, can take advantage of certain programs to have a substantial portion of their debt forgiven. If this describes your situation, then get with a financial advisor who understands this area well.
If you have a great job, make good money, then pay it off ASAP, after you save for an emergency fund and several months living expenses.
While each individual’s situation is unique, there are some general guidelines in what should be done before reducing student loan debt or begin investing in a 401(k):
1. Build emergency savings equal to three to six months of compensation.
2. Pay down any debt where the interest is not tax deductible such as credit cards.
3. Pay down any debt with high interest rates.
4. Verify that you are covered with sufficient liability limits for property casualty insurance (auto, home, renters, etc.)and have savings to meet deductibles.
5. Verify that you are sufficiently covered by health insurance and disability income insurance and have additional savings set aside for total out of pocket maximums and deductible periods.
6. Verify that you have enough life insurance for your dependents.
7. Verify that you do not have any big ticket expenses looming in your near future such as home purchase, car purchase, wedding, etc.
The prudent way isn’t sexy, but if you are covered above, you are ready to put your extra money to work. If I can assume that the student loan interest rate is not high, you are not adding to your loan balance, and you are making your payments. You will generally do better by investing in your 401(k) because you will get the benefit of compounding, growth on top of growth. Compounding is better the earlier you can start. How you allocate among your investment options within your 401(k) plan is something that you should first discuss with an investment professional.
There are some who will argue that debt reduction is always the best option for more reasons than just the financial ones. I believe that some debt (low interest rates and interest that may be tax deductible) is acceptable if the result is investing for retirement sooner than later.