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Should I Save Into My 401(k) Or Pay Off Student Loans?

With college costs and student loans at an all time high, it can be difficult to know when to save and when to pay down debt. Learn a few tips to making this difficult decision.

2/3rds of college students graduate with student loan debt. On average, graduates have about $24,000 in debt, with 10 percent of graduates having over $45,000 in debt. And those are just the statistics for students with a 4 year degree. Student loan debt is at an all time high, and very well may continue to rise with the increases in college costs. How should workers with student loans decide between paying down their debt while still saving for the future?

Track your spending: If you frequent this blog, you know I am passionate about the benefits of tracking your spending. Anytime you are trying to balance goals such as debt payoff and saving, you need to know how much you can afford to commit to your spending plan. How much do you have each month to put towards your goals? The best way I know to determine this is to track your spending.

Make at least the minimum payments: No matter what, make at least the minimum payments every month, on time, to your student loans. Student loan debt will (almost) never go away, not even in a bankruptcy. Getting behind on your student loan payments can also disqualify you for payment restructuring should you need it, such as in the event of a disability or job loss. Be sure you always make the minimum payments on time each month.

Get an emergency fund: Once you are making at least the minimum payments on your student loan debt, put the rest of your available money into an emergency fund. You want to have 3-6 of monthly living expenses in a savings account just for emergencies. This way, in the event of the unthinkable happening, you will still be able to pay your bills.

Take full advantage of employer match on 401(k): Next, take full advantage of your employer match on 401(k) contributions. This is free money, and the only reason to not take advantage of it is if contributing to your 401(k) would keep you from being able to make minimum payments towards your student loans, or if you don’t have an emergency fund. Check with your HR department if you aren’t sure if this option is available to you.

Set goals: How fast do you want to be out of debt? Does the thought of being in debt stress you out, or are you comfortable carrying some debt? Sit down and make a plan for when you want to be out of student loan debt. You can then figure out how much you need to pay towards your loans each month to meet your goals.

Check the interest rates: Student loans issued today have a 6.8 percent interest rate, while some issued prior to 2006 have interest rates below 3 percent. The higher the interest rate, the faster you want to pay it down. Remember, paying off a 6.8 percent interest rate loan is equivalent to getting a guaranteed growth rate of 6.8 percent if you were to invest the money.

You have to find the balance that YOU are comfortable with. We all have different levels of comfort when it comes to debt and savings. In an ideal world, you will have a fully funded emergency fund, be making payments towards your student loans so they will be paid off in 3-4 years, and be saving 10%-15% of your income into your 401(k). If this simply isn’t feasible for you, then find the balance that you feel comfortable with. If at all possible, always make minimum payments to your student loans, have an emergency fund, and take advantage of the employer match on your 401(k). Based on the interest rates of your student loans, put any excess money you have each month towards debt pay off or into your 401(k).

So what do you think? Are you having trouble trying to balance student loan payments with 401(k) savings? Have you found ways that have worked for you? Would you add anything to this list? Feel free to share in the comments section below!

Alan Moore is a fee-only financial planner and founder of Serenity Financial Consulting in Shorewood WI. Follow him on Twitter @R_Alan_Moore. You can contact him at alan@serenityfc.com, 414-455-5313, or visit his website at www.SerenityFC.com. Want more education? Download your free guide to the “10 Easy Steps To Securing Your Financial Future Today.”

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

Nuitari (Grand Master Editor) September 22, 2012 at 01:31 AM
On a related note, given this poor economic environment that may very well last into the next decade, should I turn my attention to paying off my house early rather than scrape for these terrible returns? Generally speaking.
Alan Moore, MS, CFP® September 22, 2012 at 01:37 AM
I do not make market predictions. I don't know that the market will have poor returns, the same I don't know it will produce great returns. I believe in the value of paying down mortgages, however with historically low interest rates it isn't as attractive as it once was. Generally speaking, I wouldn't forgo putting money into your IRA/401(k) to pay down debt however. If paying down debt makes you more comfortable, go for it. I have never met anyone that regretted having a paid off home.Try to find a balance that works for you. As you noted, it is hard to make general recommendations without knowing more details.
texashollyberry September 24, 2012 at 03:08 AM
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