This week I want to comment on the issue of paying back student loans. I recently met with a young couple to assist them in organizing their finances. They both work and earn a six figure combined income but have student debt, mortgage debt, car debt and credit card debt to pay. They have little saved for retirement right now, but that was a big part of the reason they came to see me.
I realize that young people today start with a lot of challenges before them. Jobs are harder to come by than many times in the past, many folks are starting life with an overhang of student loans and there is a great deal of peer pressure to live for today and forget about tomorrow. That is a pretty tall order to tackle. However, let me share an illustration I gave them.
Let’s say you are 20 today, you intend to work until 65 and then live 30 years in retirement. You want a retirement income from your savings of $50,000 a year in today’s dollars exclusive of Social Security (if it exists 45 years from now). Let’s assume inflation is 3% per year and we earn 6% per year on our savings. If we calculate the future value of $50,000 today 45 years from now we get about $189,000 per year. If we want $189,000 per year, adjusted for inflation, for 30 years we need over $3.9 million saved at age 65! Obviously it would be difficult for most people to save $3.9 million but not if we let good old compound interest do its thing. For example, a dollar saved at age 20 earning 6% compounded for 45 years is worth $42.64 at age 65!
The key is to start early. In order to have $42.64 at age 65 if you save at age 40, you have to save $2.56 – about two and a half times as much as at age 20. Clearly, there is much greater benefit to saving early, BUT, how do you square it with paying off all that student debt? The key is to balance the needs in a way that best fits your specific circumstances. As the linked article points out, sometimes the best strategy is to stretch out the maturity on the student debt thus lowering the payments so you can start saving the difference. Then, as your situation improves, you can reduce the maturity to pay it off sooner. Or, you may be able to refinance or restructure the loans into those with a lower interest rate, permitting you to save the difference.
Saving for retirement is usually the last thing on any 20 year olds’ mind but it should be high on the list. I see people every day who waited until they were 50 to start saving seriously and, because they started so late, many will have to work until their late 60’s or beyond in order to accumulate the funds they need. Don’t let that happen to you. If you need help in this area, give me a call and let’s get together.