Pay Off Student Loans or Save For Retirement? Decide in 5 Steps

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Every financial decision you make is a trade-off. When you set money aside for retirement, you have less for paying your student loans — and vice versa. So should you pay off student loans or save for retirement first?

While there’s no hard-and-fast formula that fits every person, you don’t have to choose between paying off student loans or saving for retirement. Here are five steps to take to balance both priorities.

1. First, start a rainy day fund
2. Maximize your employer match
3. Learn the difference between high-interest and low-interest debt
4. Set a retirement savings goal
5. Know your limits

Should I pay off student loans or save for retirement?

If you’re asking yourself this question, first know that it isn’t an obvious answer. You can accomplish both at the same time while also prioritizing one over the other depending on your situation and goals.

Before choosing your top priorities, though, we recommend building your emergency fund.

1. First, start a rainy day fund

Before we take a deep dive into the 401(k) versus loans conversation, let’s highlight an important point: You need to have a rainy day fund, also known as an emergency fund, before you make any other financial moves.

This is the cash cushion that will save you when life takes an unexpected turn. If you lose your job in the same week that your car breaks down, you’ll be glad to have this fund.

Aim to build a rainy day fund that would cover at least three to six months’ worth of your expenses. Consider opening a high-yield savings account to maximize your savings.

2. Maximize your employer match

If your employer matches any portion of your 401(k) contributions, start by adding enough money to your 401(k) to collect your full employer match.

Let’s say your boss will match your contributions dollar-for-dollar, up to 5% of your salary. Assuming you earn $40,000 annually, 5% would be $2,000. So if you manage to contribute this amount to your 401(k), your employer will put in another $2,000, giving you a total of $4,000 invested.

Grabbing your full-employer match is the only guaranteed, risk-free investment you’ll ever make. If you have the opportunity to capitalize on an employer match, make this your top priority.

And if your employer doesn’t offer a 401(k) or a match, consider opening an IRA while repaying student loans.

3. Learn the difference between high-interest and low-interest debt

Not all debt is created equal. Credit card debt often carries an extremely high interest rate — sometimes well into double digits. Student loans, on the other hand, typically carry single-digit, fixed interest rates. Also, student loans interest is tax-deductible.

While all debt types can be a drain on your finances, student loans are typically the lesser of debt evils. That’s because …

  • Interest rates are comparatively low
  • They offer a repayment period that varies from 10 to 25 years
  • You may be able to reduce your monthly payments by refinancing your student loans

While you don’t want to fall behind on your payments, you don’t have to be as aggressive about paying off your student loans as you should be with a high-interest loan such as a credit card. Prioritize paying off high-interest debt (anything with double-digit interest rates) before you start aggressively tackling your student loans.

4. Set a retirement savings goal

Once you’ve prioritized your debt repayment, it’s time to think about your retirement savings goal. When saving for retirement, aim to replace 70% to 85% of your pre-retirement expenses.

Let’s say that you and your spouse currently have a lifestyle in which you spend $80,000 a year. You’ll want to have 70% to 85% of that amount, or $56,000 to $68,000, for each year in retirement.

Let’s grab the number in the middle: $62,000. Multiply this by 25 years, and you arrive at a value of $1.55 million. This is the estimated amount you’ll need in your retirement portfolio (excluding any other sources of income) to achieve an income of $62,000 per year.

Multiplying by 25 allows you to withdraw 4% of your retirement income annually, a rate that financial experts generally consider to be the “safe withdrawal rate.”

Once you have your retirement number, use one of the many free online retirement calculators to determine how much you’ll need to put aside each year to reach that goal by your planned retirement age.

Payoff VS Invest Calculator

  • Monthly payment

  • Interest paid

  • Time to repayment

OriginalWith PrepaymentSavings
Monthly payment
Interest paid
Time to repayment
By paying an extra $317 per month ( total per month), you could pay off your loan in and save .
On the other hand, if you decided to invest the extra $317 per month for , here are your results:
  • Interest Earned

  • Final amount

OriginalWith Extra InvestmentSavings
Interest Earned
Final amount
By increasing your contribution by $317 per month ( total per month) for years, you will increase the balance of your retirement fund by (including interest). The extra amount you contribute will continue to earn interest in your investment account for ~- yr years after you finish contributing. You can see the long term results below:

Can you contribute this amount while still making the minimum payment on your student loans? If so, you’re in good shape. If not, you may need to reduce your monthly expenses or take on a side hustle.

5. Know your limits

At this point, we’ve established a few things about your financial situation:

  • You have savings for a rainy day.
  • You’re collecting your full employer 401(k) match.
  • You’re first paying off credit card debt or other high-interest (double-digit) debt (or don’t have any).
  • You’ve calculated how much you need to save for retirement, and you’re meeting your retirement savings goals.
  • You’re making your minimum student loan payments.

Now, let’s assume that you still have money remaining each month. You’re trying to decide whether to use this money to make extra payments on your student loans or make bigger strides toward your retirement savings. Where do you go from here?

Figuring out the answer starts with knowing your limits.

Limit 1: Your retirement savings maximum

Take note of how far away you are from reaching the IRS maximum on annual contributions. There’s a cap on how much you’re allowed to contribute to your 401(k) each year. In 2021, that limit is $19,500, with an additional $6,500 catch-up limit for those ages 50 and up.

If you’re close to maxing out your retirement account, you might decide to reach that maximum threshold. Cross it off your list. At that point, you can turn your full energy toward aggressively repaying your student loans faster.

Limit 2: The remaining term on your student loans

Take note of how close you are to obliterating your entire student loan balance. How soon would you be able to erase all of your debts?

If you’re close to repaying all of your student loans in full, you might choose to wipe out the remainder of your debt balance. Once you do, you can devote your energy toward building your 401(k) or other retirement savings vehicle.

Not close to either limit? Make a judgment call

Do you want to split your extra money 50/50 between saving more aggressively in your 401(k) and repaying your student loans? Or do you want to emphasize one goal over the other?

To answer the big question of paying off student loans or saving for retirement, first ask yourself these smaller questions:

  • Which of these two issues keeps you awake at night?
  • Which result would give you more satisfaction?
  • Can you expect the long-term returns on your retirement account to be greater than the total amount you’ll spend on student loan interest?

Weigh out the pros and cons of each to decide which approach makes more sense for your finances as well as your personal goals.

Generally, the best strategy is to balance both short- and long-term goals. Choose a goal that gets you excited, and you’ll set yourself up for a happy and secure future.

And once you’ve figured out whether to pay off student loans or save for retirement, consider diversification as a next step. See our guide about whether you should pay off student loans or invest more widely.

Andrew Pentis and Paula Pant contributed to this report.