Should I invest or pay down my student loan debt? How to decide
You probably have heard some people say you should take care of your loans before investing. However, the truth is that there is no one-size-fits-all solution for each person’s unique situation. You need to take a look at your own circumstances and determine which course of action is right for you.
The general rule of thumb is if your student loan debt has a higher interest rate than your projected returns on investment, you should pay down your debt first. If your projected returns earn a higher rate than your student loan interest, you should invest. There is more to consider, though, when it comes to making a decision. Tax deductions and employer matching programs play a significant role in deciding whether to invest or pay down your student loan debt.
Interest you spend versus interest you earn
The current average student loan interest rate is 5.8%. For some, interest on student loans can even be as high as 8%. Let us say your interest is around the average at 6%. When you pay off your student loan debt, you essentially get a 6% return on what you earn in the future by eliminating the debt from your financial responsibilities.
However, if you can invest and have an opportunity to earn higher interest than the 6% you are spending, you might want to consider investing. Long-term investments that generate returns higher than the interest rate of your payment can make up for your student loan interest payments and help you have more income leftover for other investments, such as your retirement account.
Weigh your tax-deductible benefits
Usually, you benefit from a tax deduction when you are paying off your student loans. Depending on your qualification, you might be able to deduct as much as $2,500 dollars from your annual tax liability while paying off your student loans.
The advantages of saving on taxes might offset the advantages of paying off your loans early, which can help make your student loan interest less expensive in the long run.
Calculate your post-tax interest rate
You can perform a simple calculator to estimate your post-tax interest rate to help you make a decision on whether to pay off your student loans or invest:
Student loan interest rate x [1 – marginal tax rate]
If your average student loan interest rate is 6% and you earn $50,000 dollars per year as a single tax filer, you are in the 22% tax bracket for 2020. Using the formula above, you can calculate your post-tax interest rate like this:
6 x [1 – 0.22] = 4.68
The conclusion with this calculation is that the post-tax interest rate you are paying on your student loans is 4.68%. Compare this to what you can potentially earn on an investment, especially with a tax advantaged account like a 401(k), and you might be able to make up for more than what you pay on interest in student loans alone. This means it might be the right decision to pay the minimum amount due on your student loans and use the rest for investments.
Talk to a ProVise CFP® professional about financial planning
Young professionals who recently have finished school and are wrestling with what to do with their debt or if they should invest do not have to face these decisions alone. At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can help you make the right decision for you.
We take the time to get to understand your financial circumstances, goals, risk tolerance and personal values to help you develop and maintain a financial strategy that works for you.
We can also create a written plan for you at a fiduciary standard of care. All of our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.
Are you ready to talk to a professional about what to do with your student loans? Contact ProVise today to schedule a complimentary consultation.