Get Out of Debt Guy

Should I Payoff My Navient Student Loans or Save for Retirement?

Posted January 29, 2015

Dear Steve,

I'm 34 years old, single, graduated a college when I was 26. Currently I have 2 student loans: 

1. Navient Student Loans: $ 25,387.21, 5.25%, monthly payment of $ 235.41
2. AES Student Loans: $17,152.33, 5.125%, monthly payment of $ 186.68

I have about $10k in a saving account (with 1% interest), and a rollover IRA with about $2000.

Recently I got a job with $120k salary, but they do not offer 401K

With my current job I have about $3000/month that I can put in my saving account or pay extra for my student loans. Since I'm in mid 30s I would also like to start saving money for my retirement. I would like to know what would be the best way to use the extra money each month:

1. Make contribution to my rollover IRA, and/or open a new Traditional/Roth IRA
2. Use it to pay off student loans first
3. Keep making minimum amount for student loans and put the money in saving account (or open CD?)

Judith"

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Dear Judith,

First off, thank you so much for writing to me. I think I can get you pointed in the right direction. And congratulations on the new job and great salary.

What I'm about to share is just my personal opinion. If you talk to 50 people about investments I'm sure you'd get about 45 different opinions. My advice comes more from a financial safety net and dealing with debt point of view and less of a life is always rosy so maximizing investments is the primary goal.

A Roth IRA offers you some advantages. The tax-free growth means you won't owe any taxes on the proceeds when you eventually withdraw them. That's a huge benefit if you don't want to pay taxes later when you are taking money out.

With a traditional IRA there are two different versions; deductible or nondeductible. Since you have no retirement plan at work you'd probably qualify for the deductible variety where your investments in the IRA would be deductible from your taxes when you file. You'd have to talk to a tax advisor about which IRA is best for you.

If your Adjusted Gross Income is less than $116,000 you can invest up to $5,500 tax free annually in the Roth IRA.

While you'd pay tax on those investments now, the money will grow tax free. You're lucky if you start saving now and use the benefit of time to make it grow even further. A $5,500 yearly investment in a Roth IRA will be worth about $1,000,000 in 31 years at a 10% rate of return. Your deposits would have only been $170,500 over those 31 years.

I'm a huge fan of investing money you can access in case of an emergency or need. One type of investment that has performed well is a S&P 500 mutual fund. These funds have a rate of return that nearly matches the rate of return of the stock market. These types of funds take the guesswork out of the performance of the fund and trying to figure how to invest your money. 

Just as an illustration, the Vanguard 500 Index Fund has had a 11.1% rate of return since its inception in 1976. If you had invested $10,000 in the fund in 2004, and made no further contributions, it would be worth about double today.

In case you're are wondering why I've covered all this investment ground without talking about your student loans, its because the rate of return on your investments could be about double, or more, than the interest rate you are paying on your student loans. If you just focused on paying off the student loans first you'd lose out on the extra 5% return you can make now and have compounded with extra time.

So how about this strategy:

  1. Make your maximum IRA contribution each year. Right now it's $5,500.
  2. Find a mutual fund or investment vehicle outside of the IRA that provides you with a suitable rate of return and make monthly investments of $2,000.
  3. Use $250 each month to build your emergency fund savings account.
  4. Use the last $290 to payoff your highest interest rate debts before you get to the low rate student loans.

For the record, the math here was $3,000 a month on an annual basis equaled $36,000. If we take out the $5,500 investment that left $30,500 and if we divide that amount monthly we have $2,541 a month to play with.

Steve Rhode
WRAL Get Out of Debt Guy

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About this Blog:

Steve Rhode has had careers in opthalmology, real estate and as the head of a nonprofit debt counseling firm. On his blog, he offers hard-won, free advice about getting out of debt, consolidation and making the right choices as you manage your money.