Should I Pay More Than the Minimum Toward My Student Loans?

Should I Pay More Than the Minimum Toward My Student Loans, or Should I Save More for Retirement?

[Interested in testing out some of these strategies for yourself?  Click here to download our free student loan guide, or click here to use our free retirement readiness calculator!]

Over 40% of people under 30 are currently making student loan payments.  That’s a staggering number.  And while we often think of how these payments affect our current financial picture (I certainly know how it feels to see that withdrawal come out of my account every month!), the effect on our financial future is very much overlooked.

Simply put, how will our student loan payments affect how much we save for retirement?

Well, that’s not a hard question to answer.  If we can’t save as much now, we’ll have less later.  Thanks for that, Bill.

Fair enough.  Let me rephrase the question.  Say you are at a point in your career where you have some flexibility in your budget.  Even after you’re making your loan payments, you’re still able to save for retirement each month.

The question then becomes- is it better for you to pay down you loans quickly by making more than the minimum payment, rather than putting that money into a retirement account?

That’s a much more interesting question.  Let’s take a look.

Research Says…

Earlier this year, HelloWallet (a Morningstar-affiliated company) produced a report on the relationship between student loan debt and retirement.  The results, while not unexpected, were alarming.  They found that student loan balances directly correlated with having less money to spend in retirement.

HelloWallet even puts a number on it- for every dollar in student loan debt you owe, you’ll have $0.17 less in retirement.  Financial guru Clark Howard (one of my biggest influences) extrapolated from the report that because of the negative effects student loans have on retirement balances, “… in most circumstances, it’s better to save more for retirement than pay extra toward your student loans…”

Generally speaking, they’re right.  If we are just looking at two goals- paying off your debt versus saving for retirement-  most borrowers will come out ahead in retirement if they make the minimum student loan payment every month now and put their excess savings toward retirement, rather than trying to pay off the student loan ASAP at the expense of retirement saving.

It’s All About Compound Interest

What to do with the money you save each month comes down to the rate you earn and the length of time you are saving.  Investing more for retirement early in your career has exponential benefits to the money you’ll have available at retirement.

Take a look at the numbers.  The chart below shows how much you’ll have at age 65 if you start saving $100 a month at certain ages, assuming a 6% growth rate:

blog-post-3-chart-1

Notice anything?  Take a look at the difference in retirement values if you start saving at age 25 versus age 30.  For the 25 year old, over 25% of the account value at retirement comes from the $100/month invested between ages 25 and 30!

This idea of compound interest clearly illustrates the perils of paying down student loans at the expense of your retirement savings.  The earlier you start saving for retirement, the exponentially better off you will be when it comes time to retire.  The degree to which your student loans impact your saving will directly impact your retirement picture.

Let’s take a look at an example.

Meet Sarah

Sarah is a 25 year old lawyer who is hoping to retire at age 65.  She has a total of $25,000 in loan debt (point taken, after 3 years in law school, she probably has a lot more than that, but let’s keep the numbers easy to work with, OK?) and is on a standard 10 year repayment plan, paying $265.16 each month.  Her loans have a 5% interest rate.

On top of these loan payments, she’s able to save $200 extra per month to put toward retirement.  Once she’s done paying off her loans in ten years, she will put that extra $265.16 toward retirement as well, increasing her total monthly retirement savings to $465.16.  Sarah’s retirement savings earns 7% a year (about what the stock market has historically made on average).

Sarah is wondering whether or not she should continue to save $200 dollars per month for retirement now, or whether it might make sense for her to, say, put $100 of that money each month as an “extra” payment on her student loans to pay off the loan faster, and keep contributing the remaining $100 toward retirement.

What’s Sarah’s Best Option?

In the first scenario (saving $200 a month), by the end of her 10 year loan payment period, the loan is paid off and Sarah has ~$35,000 saved for retirement.  She then increases her payment amount as scheduled, and by the time she retires, her retirement accounts are worth $853,399.48.  Not too shabby!

But, what happens if she uses half of her monthly savings to pay off her loan faster? She is able to pay off her loan in just over seven years, and the second she pays off her loan, she increases her retirement savings per month from $100 to the full amount of $465.16.  Even though she’s able to contribute more over the first ten years in this example, take a look at her retirement account value.  She only has $823,844.59 at retirement this time.

blog-post-3-chart-2

This is a great example of the power of compound interest.  The more Sarah starts to save for retirement today, the more she’ll have at retirement.  Even if she has to pay a higher amount on her student loans.

Some Caveats

Again, there are a lot of factors at play here.  Not everyone is in the same position as Sarah.  This example doesn’t take into account a few points:

  • If your situation is an outlier, I’d recommend crunching the numbers to evaluate the strategy before you make a decision. What do I mean by outliers?  Cases where one of the factors we are looking at is either very high or very low.  For example, If you have a very high student loan balance, or very high interest rates, or are a very conservative investor (ie, you might not want to invest in a way that will lend itself to a 7% annual growth rate as identified above), carefully evaluate these factors before making a decision.
  • Of course, in this post we’re only looking at two goals: paying down student loans and retirement saving. If you have multiple goals you’re trying to save for at once, a more detailed plan is needed.  In particular, if you are weighing paying down student loans quickly versus a more near-term savings goal (ex: buying a house in five years), this decision is much less clear cut and needs to be evaluated.
  • This whole exercise assumes that you can afford to save beyond your monthly budget. If you can’t, definitely make the minimum payments on your loans.  In addition, you should review whether an income repayment plan may be a good fit for you.  Finally, review your budget to see if there are any ways to trim back on spending or increase your income.
  • We haven’t even addressed that most employers offer a match on funds that you invest in your 401(k). If your employer matches, putting extra money toward your loans at the expense of retirement saving becomes even costlier.  Employer matches on 401(k)s are the closest thing out there to free money, after all!
  • Most importantly, Sarah in the example above is incredibly disciplined financially. Not only is she diligently saving $200 a month (either in her retirement account, or split between retirement savings and making payments on her loans), but she also has the discipline to redirect her entire student loan payment amount into her retirement savings the second her loan is paid off.  This is much harder to do in practice than it is on paper, so it’s important to plan ahead and hold yourself accountable.

A Word on Interest Rates

Interest rates on student loans vary wildly.  Some can be as low as 2-3%, others can be in double digits.

Like I mentioned earlier, the average return in the stock market has historically been about 7%.  If your student loan interest rates are higher than this, it’s not a bad idea to prioritize payments to pay down the high interest rate loans first.

Particularly if these high interest rate loans are private loans, refinancing into a lower rate loan is a great option for those who have good credit scores.  For more information on this, sign up for my newsletter to download a free copy of my eBook on student loans.

Conclusion

There’s some good research out there that recommends to usually save for retirement before making extra student loan payments.  Don’t take that as the gospel truth, but generally speaking, this approach is the correct one.  In most cases, the benefits of having money in your retirement account to compound in value over time will outweigh having to pay your student loans a little bit longer.

Carefully look at your personal budget, student loan balance, interest rates, and retirement goals to make these decisions.  And don’t be afraid to reach out to an expert for a second opinion.

[Interested in testing out some of these strategies for yourself?  Click here to download our free student loan guide, or click here to use our free retirement readiness calculator!]

Trump’s Proposed Student Loan Policy Changes

Politics is way, way outside the scope of this blog.  But now that the 2016 Presidential Election is behind us, I wanted to quickly highlight some significant changes that President-Elect Trump proposed during the campaign regarding student loans.

Student loan repayment plans are one of our primary focuses at Pacesetter Planning.  As such, I wanted to share an update on some of the changes possible in a Trump administration.

A New Income Based Repayment Plan?

Currently, borrowers who have federal loans are automatically put on a standard 10-year repayment plan after graduating.  However, there are several alternative payment plans that allow borrowers to adjust their payment term and monthly payment amount based on the borrower’s income.

I won’t rehash all the details regarding who qualifies for which plan here since I outline each of these options in detail in my FREE eBook, “13 Things to Do Before You Make Your Next Student Loan Payment”.  Subscribe to our newsletter here and I’ll send you a free copy today!

Mr. Trump proposed a new version of these income based repayment plans in a policy speech in October.  Essentially, the president-elect argued to allow borrowers to cap payments on federal loans at 12.5% of their monthly income.  Even more, Mr. Trump proposes to forgive all debt for borrowers making these capped payments after fifteen years.

To repeat, payments capped at 12.5% of income, and forgiveness for any remaining federal loan debt after 15 years.

Comparison to Current Policy

It’s a mixed bag, but overall, this proposal compares very favorably to the existing options.  While some of the current plans are limited based on your income level and when you borrowed the loans (again, download my eBook for more details), generally speaking the existing policies allow borrowers to do one of two things:

  • Cap borrowers’ payments at 10% of monthly income, and offer forgiveness after 20 years, or
  • Cap borrowers’ payments at 15% of monthly income, and offer forgiveness after 25 years

How does President-Elect Trump’s proposal compare?  Partially, it depends on your strategy around student loan payment.  For borrowers who want to minimize their monthly payment at all costs, one of the existing income repayment plans will probably be a better deal for you, since they cap payments at 10% of monthly income rather than 12.5%.  But, for people looking to earn loan forgiveness, Mr. Trump’s plan could be a huge bargain.

Cutting the forgiveness window from 20 or 25 years down to 15 years is a big deal for borrowers.  By slightly increasing the monthly payment amount but reducing the payment timeframe by five or ten years, many borrowers will be able to save thousands of dollars in repayment costs over the life of their loans.

Unknowns

Of course, none of this is official policy yet.  As such, there are still many things we don’t know about this proposal.

  • Will the proposal apply to all borrowers? Some of the current income repayment plans allow for individuals regardless of income level to sign up.  But many others restrict eligibility to only those who either have a low income level, high loan balances, or both. We don’t yet know how wide-reaching Mr. Trump’s proposal would be if it goes into effect.
  • Will the proposal only affect newly-issued loans? Or, to put it another way, will this proposal only apply to loans borrowed after it goes into effect?  Trump has not offered details yet on whether or not borrowers who are currently in the process of repaying federal loans would be eligible for the 12.5% monthly income payment cap and 15-year loan forgiveness.
  • Will the proposal actually go into effect? As we all know, and we certainly don’t have to rehash here, President-Elect Trump campaigned on many issues with more passion than he did regarding student loans.  Will this be a high priority item for him?
  • If so, will the plan need congressional approval? In the past, President Obama issued changes to student loan repayment terms without needing to go through Congress.  Will the future President Trump seek to do the same?

We will provide updates on President-Elect Trump’s student loan plans throughout the course of his administration.  But, in the wake of a divisive national election, I wanted to quickly highlight this important proposal and its potential benefits to hundreds of thousands of student loan borrowers across the country.

To learn more about how to implement your own student loan repayment strategy, click here to download a free copy of by eBook, “13 Things to Do Before You Make Your Next Student Loan Payment”.

How Exactly Does Financial Planning Work?

“What is it you do?”

“I’m a financial planner who works with millennials.”

“That’s cool!  But what do you actually do for millennials?”

It’s a great question, and one that I get regularly.  The short answer:

  • I help my clients take stock of where their finances currently stand and work with them to plot out short, medium, and long term goals for the future.
  • We then come up with actions steps to address any potential shortfalls in meeting these goals.
  • I partner with clients to hold them accountable to the plan. Here’s a sample calendar showing how I do so for millennial clients:

sample-client-service-calendar

 

But, how do we come up with a financial plan?  What exactly does that mean?  Let’s go through step by step:

Dream Big

The first step in our financial planning process starts with a big picture discussion.  Talking about where you want your finances to take you is a broad conversation, but it’s that way intentionally.  The beauty of financial planning is that no two people are the same, so everyone’s goals will be different.

That being said, we have a structured process in place to work through the goals discussion.  With each client, we sit down together and develop short, medium, and long term goals.

Long term goals as usually retirement focused, but we don’t stop there.  We talk about savings goals- whether it be for an emergency fund, a new house, or even your child’s college education.  We talk about growing income and monitoring spending.  We talk about goals to pay down debt.  And we talk about goals around credit scores to help make buying your next car or new home more affordable.

This isn’t a comprehensive list of goals that go into a financial plan.  Everyone’s situation is different.  Some of these goals above might not be relevant to you at all, and that’s perfectly ok!  Or, you might have several financial goals that I didn’t mention.  Great! Let’s add them to the list.  My point is that in the process of going through short, medium, and long term goals, I work with my clients to develop a comprehensive picture of where they want their financial journey to take them in life.

People often think of finance as being overwhelming, detail-oriented, and maybe even just plain boring.  But these big picture discussions are often an inspiring way to start the planning process.

Let’s Get Organized!

Now that we know where we’re trying to get to, it’s time to map out where you are financially right now.  The second half of my initial meeting with a new client is to help them get their financial life organized.

I can’t tell you how critical it is to gather all the loose ends of your financial picture in one spot.  When you do, you’ll probably be amazed at just how much you have going for you financially!

And when I say everything, I mean everything.  That money your employer takes out of your paycheck that goes into your 401(k) each month?  Awesome, let’s get a copy of your 401(k) statement and document how much you have saved there already.  Vaguely remember your company sending you a notice about a long term disability insurance plan that you have through your job?  Great, let’s find out how much it’s worth for you.  These details are easy to overlook, but they’re important.

One important note: this is a team activity.  I’ve seen way too many people in my profession begin their first meeting with a client by simply sending them a questionnaire to document what investment accounts they have, how much they want to spend when they retire, how much they owe on their mortgage… the list goes on and on.

Nobody likes to begin a meeting with someone they just met by getting a huge, difficult homework assignment.  I pride myself on helping my clients get organized financially rather than just telling them to do so.  I provide software that helps to aggregate all of your bank and investing accounts in one place.  I’ll help go through your employee benefits with you.  I’ll help you brainstorm other financial items that you may have working for you, but might not even realize it.  Going through these details isn’t always fun, but I do my best to make it painless!

Develop a Plan

After we set some goals and get you organized, we conclude our first meeting and set the next one.  In between, I come up with a draft plan to tie together your goals with the information we got organized to see whether you are on track.  If you are, that’s great!

But usually, there will be a few things that you may need to adjust in order to meet some of your short, medium, or long term goals.  Based on our conversation and analysis, I’ll brainstorm some ways we may be able to help get you to where you want to go.

Plan Discussion

Then, we get back together and walk through your draft plan step by step.  From income to retirement to investments to debt to credit scores- we will cover each of the planning areas relevant to your goals.  We will review where you are now, identify what you’re currently doing to meet your goals, and discuss whether you are on track.

We then will flag the goals you aren’t on track to meet unless we make some adjustments.  I’ll walk you through step by step the potential adjustment options I identified, and invite you to add any that you can think of as well.

Then, we have some decisions to make.  Which adjustment is most important to make?  Which is the easiest to implement?  I don’t believe it’s effective to try to make changes to everything at once.  So, I recommend making one or two changes immediately, and putting together a schedule for when to implement the rest.

Implementation

After our call, I’ll update the plan based on our discussion, send you the “final” version, and set our next check-in meeting.  I put final in quotes, because a good financial plan is a living document.  We will review the plan each year and make updates based on your progress.

The first page of your financial plan will specifically call out the action items to take, in the order you should take them.  You’ll leave our plan delivery meeting with an easy-to-understand list of steps you should take 1) now, 2) in the next few weeks, and 3) in the next few months.  By implementing the changes gradually, not only will you take meaningful steps to improve your financial life, but you’ll do so in a way that will be easier than trying to do it all at once.

Depending on the items in your financial plan, we sit down again anywhere from two to four times a year to review progress and make updates.  See the calendar above for an example of what that schedule might look like.  Regardless of your goals, we will meet at least twice a year to review your budget and rebalance your 401(k). Of course, we’ll also review your progress toward your most important goals and make sure the changes that you implemented are working.

Just like a personal trainer at a gym, it’s my job to do everything in my power to make your financial dreams a reality.  These check-in meetings serve as accountability touchpoints for you, to help make sure you are taking the steps you want to in order to achieve your goals.

And, Of Course…

…you never need to wait until our next meeting to touch base with me.  I’m only a phone call or email away!

I hope this is helpful to show you what working with a financial planner is really like.  Next Thursday’s post will detail an example of how I can help prioritize goals.  If you’re interested in learning more, you can schedule a free introductory call here.

The Pacesetter Planning Philosophy

Most of the biggest decisions you will make about your finances happen in the first ten years of your career.

Think about it.

Getting a first job.  Deciding whether or not to go to grad school.  Saving up to buy a home.  Building your credit score.  Paying off student loan debt.  Deciding how much to put in your 401(k).  Maybe even marrying and having children.  These are major financial milestones that set the pace for the rest of your life.

There’s just one problem, though.

Nobody ever taught us about money.

Odds are, your high school teachers had you memorize elements on the periodic table, but never taught you the basics of how to invest your money.  You probably learned the difference between sine and cosine in trigonometry class, but weren’t taught how to negotiate a raise.

These items are critically important to our future.  And we are left largely to learn about them on our own.

So, where should you go?

Sure, you can go to one of the big financial companies for help. But for the most part, they specialize in working with our parents and grandparents, not with us.

Many big firms are so focused on retirement planning that it can be hard to get quality advice on building your credit score, saving for a home, how to treat your finances when you get married, and your student loan debt.

I have a friend who recently told me that they went to meet with their parents’ financial planner about their student loan debt, and ended up teaching the financial planner about what types of forgiveness programs their loans qualified for.

Seriously.  They went to a financial planner for advice, and ended up providing advice to the financial planner.

Other companies focus more on financial product or insurance sales rather than actually providing advice.  While the Department of Labor recently issued a ruling that is going to force many big firms to legally put their clients’ interests first when it comes to retirement accounts (a novel concept, I know!), the fact is that none of these firms will be obligated to be fiduciaries for non-retirement accounts.

That might seem confusing, but it’s important.  Many big firms won’t legally be required to put your interests above their own until next April. Even then, it will only be on a portion of your accounts with them.

Finally, many of the best financial planners have high account minimums.  I’ve seen firms that will only work with you if you have a million dollars to invest with them.  Maybe it’s just me, but it seems like financial planning might be more valuable to people who are trying to build long term wealth, rather than for people who already have it.

How is Pacesetter Planning Different?

Finding a financial planner who can give good advice on issues relevant to millennials is a huge problem for our generation.  And that’s exactly why I founded Pacesetter Planning.

I specialize in working with people in my generation to lay the foundation for a very successful financial life.  Financial planning shouldn’t just be about how much you need to save for retirement.  It should be able helping you live the life of your dreams now while also keeping an eye on the future.

We can accomplish this in many ways.  For some people, it might mean developing a strategy to pay off student loans. Click here, and we’ll email you my 28 page guide, “13 Things to Do Before You Make Your Next Student Loan Payment.  It may mean working on your budget to make sure you have room to take that trip to Europe you’ve always dreamed about.  Maybe it means working on your credit score so you can get the best interest rate on that house you want to buy.  Everyone has different goals.  All I know is that to me, financial planning consists of way more than “how much do I need to invest with you to make sure I can retire?”

I am a proud fee-only, fiduciary financial planner.  I don’t want to bore you too much with this, but it’s important.  So, let’s quickly break that down:

  • “Fee-only” means that they only way I get paid is through my clients. Many firms get paid by mutual fund or insurance companies to sell their products. This creates an incentive to use those funds, even if a different fund might be better for their clients.  I think this creates a conflict of interest, so I don’t do it.  This allows me to make the best recommendations I can for my clients, based solely on their needs and goals.
  • “Fiduciary” means that I am legally obligated to act in my client’s best interest at all times. This is so important to me that I put it in writing, on my website’s homepage. Check it out!

I want to help make you wealthy, not only work with wealthy people.  My clients’ needs and goals should determine the amount of work I do for them, not the amount of money they have. I want to help people make decisions that will have enormous impacts on their future, not chase the biggest accounts.

This is why Pacesetter Planning is different.  My goal with this firm is to provide top notch service on the financial issues that matter most to millennials regarding their finances.  I want to help you define and achieve your short and long term financial goals.  I’ll be sharing some insights on this blog every Thursday to help you do just that.

Dust off those running shoes and hop on the starting blocks.   We all have a long financial journey ahead of us between now and the time we retire, and a lot of great things to make happen in the meantime.  That’s why at Pacesetter Planning, we’re all about Financial Planning for the Long Run.