Student Loans vs. Saving for Retirement: Why It Shouldn't Be One or the Other

July 1, 2015

A friend’s recent post on social media got me thinking about a topic a lot of millennials give an inordinate amount of thought to: student loans.  (Myself included -- check out this post I wrote for The Dime last year.) Currently, Americans hold about $1 trillion in student loan debt, or about $9,000 for every household in the country. The growing unaffordability of college has become a concern for everyone from state and local policymakers, all the way up to President Obama—who, earlier this year, introduced a plan to make the first two years of coursework at community colleges free for those who meet certain qualifications.

Just last month, the New York Times came under criticism for publishing an op-ed in which a literary critic and proud scofflaw advocated for student loan debtors to follow his lead by defaulting on their loans.

The link my friend shared was a Wall Street Journal op-ed by Bryan Wolff, Chief Financial Officer of pet sitting tech startup DogVacay. He posits Congress ought to create a program whereby employees can deduct the full amount of their student loan payments as a tax write-off, and employers should be given tax incentives to make matching payments toward their loans. Wolff theorizes this would be the best way “…to pay down the $1 trillion of student debt on the federal government’s books, not to mention unburden a generation of workers weighed down by student loans.”

My problem with this proposal is not so much the policy itself, but rather the frame of Wolff’s argument in terms of retirement. He says 401(k) plans are a good way for employees to save for retirement tax deferred, and points out employers who offer a 401(k) are doing so to attract top talent with what he says is the most-requested employer-paid benefit. Where I stopped following Wolff, and started getting worried about my generation’s mindset when it comes to retirement was here, where he gives his understanding of why retirement has societal benefit:

“The increased retirement savings also could potentially offset future Social Security obligations that are currently projected to bankrupt our government.”

Okay, no. First of all, increased contributions into retirement accounts are not going to solve problems with Social Security. Benefits are paid based on how much you earn in your career, not how much you save. Secondly, though the problems with Social Security are many, it’s a far cry from that claim. Therefore, it shouldn’t be a surprise that Wolff then proceeds to dispense even more bad financial advice, claiming:

“…for some employees, contributions to 401(k)s and equivalent retirement accounts can be an inappropriate use of marginal earning dollars.

Many younger workers in their 20s who are carrying around expensive student debt should not be participating toward a 401(k), as they should be paying their loans down first.”

Are you paying attention, fellow millennials? In most cases, this is dead wrong. Unless you have absolutely no disposable income (and to be sure, many of us are struggling financially) or your loans are through a private lender with much higher interest rates than the current cap on loans issued through the Department of Education, then you are missing out by not contributing at least something towards to your retirement, in addition to paying down your student loans.

Why? The obvious answer is part of a student loan payment—the interest—is already tax deductible for lower and middle income earners, so unlike credit card debt (which comes with much higher interest rates in most cases, and has no tax benefits) it’s not the worst type of debt to carry. Incorporating this tax benefit into your financial plans will help inform how much your monthly payment should be.

The not-so-obvious is answer is you aren’t necessarily better off paying down your student loans instead of saving for retirement. Here’s an example of why: one worker contributes annually towards a retirement account starting at age 25, making annual contributions until they reach age 32; another worker doesn’t make any contributions until they reach 32 and starts saving the same amount annually as the younger worker at age 33, continuing until age 65. Assuming the same yearly rate of return, although the second worker made annual contributions over four times as long as the first worker, and had four times greater principal than the first, the second worker still had a smaller nest egg than the first worker at retirement1. That’s the power of the time-value of money and compounding investment returns. Even if it takes you 20-30 years to pay off your loans, you will be in a better position for retirement the earlier you start saving.

Sure, you can wait to contribute to your 401(k), but you’re missing out on the best investment tool there is, which is time—something you can never, ever get back. Not only that, but who’s to say employers wouldn’t stop offering retirement plans altogether and offer bigger matches on student loan repayments? By the time younger employees have their debts paid off—even if it’s much faster than originally planned—they will be completely on their own, and way behind, on their own retirement planning.

Clearly student loans are a burden for millions of millennials, but financial planning needs to take a holistic, rather than an all-or-nothing, approach.

1(source: International Foundation for Retirement Education, Fundamentals of Retirement Planning, page 1-11)