Should I pay off my student loans early or contribute to my workplace 401(k)?
Provided by: Duane J. Silbernagel
For young adults with college debt, deciding whether to pay off student loans early or contribute to a 401(k) can be tough. It’s a financial tug-of-war between digging out from debt today and saving for the future, both of which are very important goals.
Unfortunately, this dilemma affects many people in the workplace today. According to a student debt report by The Institute for College Access and Success, nearly 70% of college grads in the class of 2014 had student debt, and their average debt was nearly $29,000. This equates to a monthly payment of $294, assuming a 4% interest rate and a standard 10-year repayment term.
Let’s assume you have a $300 monthly student loan payment. You have to pay it each month–that’s non-negotiable. But should you pay more toward your loans each month to pay them off faster? Or should you contribute any extra funds to your 401(k)? The answer boils down to how your money can best be put to work for you.
The first question you should ask is whether your employer offers a 401(k) match. If yes, you shouldn’t leave this free money on the table. For example, let’s assume your employer matches $1 for every dollar you save in your 401(k), up to 6% of your pay. If you make $50,000 a year, 6% of your pay is $3,000. So at
a minimum, you should consider contributing $3,000 per year to your 401(k)–or $250 per month–to get the full $3,000 match. That’s potentially a 100% return on your investment.
Even if your employer doesn’t offer a 401(k) match, it can still be a good idea to contribute to your 401(k). When you make extra payments on a specific debt, you are essentially earning a return equal to the interest rate on that debt. If the interest rate on your student loans is relatively low, the potential long-term returns earned on your 401(k) may outweigh the benefits of shaving a year or two off your student loans. In addition, young adults have time on their side when saving for retirement, so the long-term growth potential of even small investment amounts can make contributing to your 401(k) a smart financial move.
All investing involves risk, including the possible loss of principal, and there can be no guarantee that any investing strategy will be successful.
Have you heard about the newest employee perk?
What’s one of the most cutting-edge employee benefits right now?
Company-provided student loan assistance for employees who are paying back student loans.
With a record amount of student loan debt attached to the incoming workforce (visit finaid.org to see a student debt clock that now tops $1.3 trillion), companies that rely on a college-educated workforce–and want to attract and retain the best workers–are starting to offer student loan assistance to meet this immediate financial concern of many employees.
How do these programs work? Generally, an employer will contribute a certain amount each month toward an employee’s student loans, typically from $100 to $250 per month, up to a lifetime cap (for example, $10,000). Programs may restrict participation to employees who have been with the company for a minimum period of time, and may require employees to remain at the company for a certain period of time after they receive loan repayment benefits.
But participants beware: Unlike matching 401(k) contributions that companies may give to employees, money given to help repay student loans is considered taxable income. Yet for college graduates facing thousands of dollars of debt and years of loan repayment, this employee benefit can be an attractive perk. Along with the actual financial help, borrowers may get a psychological boost from knowing that they have a plan in place to successfully pay off their loans and that their employer is invested in the outcome.
Even with the early hype, company student loan repayment programs are still a relatively uncommon employee benefit. According to a 2015 employee benefit survey by the Society for Human Resource Management, these plans were offered by only 3% of the more than 450 companies surveyed. Essentially, a handful of large employers that hire a large number of college grads are at the forefront of this trend.
Industry observers expect a lot of pent-up demand for this employee benefit as millennials’ student debt burdens continue to garner widespread attention and employee retention efforts intensify as the economy improves. A company’s contribution probably
won’t cover 100% of a young employee’s student debt, but it might make a meaningful and welcome dent.
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This article is meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. Waddell & Reed does not provide legal or tax advice. This information is prepared by an independent third party, Broadridge Investor Communication Solutions, Inc. and is provided for informational and educational purposes only. Waddell & Reed believes the information has been obtained from sources considered to be reliable, but does not guarantee the accuracy of the information provided. This information is not meant to be a complete summary or statement of all available data necessary for making financial or investment decisions and does not constitute a recommendation. Please consult with a tax professional regarding your personal situation prior to making any financial related decisions. Also note that the information provided may include references to concepts that have legal, accounting and tax implications. It is not to be construed as legal, accounting or tax advice, and is provided as general information to you to assist in understanding the issues discussed. Neither Waddell & Reed, Inc., nor its Financial Advisors give tax, legal, or accounting advice. Nothing contained herein is intended as a solicitation or an offer to buy or sell any product or service mentioned and they may not be suitable for all investors.
Duane Silbernagel is a Financial Advisor in Lincoln City, Oregon offering securities through Waddell & Reed, Inc., Member FINRA and SIPC. He can be reached at (541) 614-1322 or via email at DSilbernagel@wradvisors.com.
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