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Prepaying Your Student Loans Or Saving For Retirement—Which Is Best? (Online-Only Article)

By Wesley W. Lyon, II July 2019
Personal Finances Debt Management
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New dentists today are coming out of school with an average of almost $300,000 of student loan debt. Most report that they only worry about the student loan debt in the morning, noon, and night – the rest of the time they’re carefree!

This constant emotional burden makes planning to reduce or eliminate student loan debt their top priority. As a result, most are focused solely on using all available funds to pay off their student debt as quickly as possible. While no one ever went broke getting out of debt, that’s not the best choice for most young doctors.

Consider the situation of two recent dental school graduates, Steve and Jackie. Each graduates dental school with $287,331 of student loan debt, at a 5% interest rate. Steve opts for the most emotionally appealing strategy, electing to pay off his student loan debt over a 10-year period, requiring a monthly payment of $3,035. He will begin saving for retirement once those loans are paid off in 10 years, and promises to then save $4,336 a month before taxes (equal to $3,035 after taxes based upon a 30% combined federal and state income tax rate).

On the other hand, Jackie elects to payoff her student loans over the regular 20-year payment term, requiring a monthly payment of $1,904. This allows her to begin saving $1,637 a month for retirement now into her 401(k) plan over the next 20 years.

Fast-forward 10 years and let’s check in.  Now age 38, Steve has completely paid off his student loans, but has no savings and a net worth of zero. Alternately, Jackie has $178,782 remaining on her student loan debt, but has accumulated a 401(k) balance of $301,621, based upon an 8% investment return, and shows a net worth of $122,870.

Now let’s check in 20 years after graduation.  Steve, age 48, has not only paid off his student loans, but has accumulated $798,475 in his 401(k) plan, based upon saving the $4,336 a month for 10 years at an 8% return. On the other hand, Jackie also paid off her student loans, but has a total 401(k) retirement plan balance of $971,211, or $172,735 more than Steve.

OK, let’s fast-forward to age 65 when both doctors are approaching retirement to see who’s ahead. Jackie’s additional 401(k) balance of $172,735 at age 48 has now grown to a $639,123 advantage at age 65, again based on an 8% return. Assuming this amount is paid out over 30 years in retirement, it would yield an added retirement benefit of $4,689.66 a month, based upon an 8% return. This translates into extra income in retirement of $56,276 a year for Jackie, or an additional $1,688,277 over her remaining projected 30-year life expectancy.

Thus, there is a huge advantage to paying off your student loan debt over time, so you can begin saving for retirement right away. But wait—there’s more! Under current federal student loan rules, any student loan balance remaining after 20 years is automatically forgiven. So why would you elect to prepay your student loan debt, when there’s an outside chance you could have a balance remaining after 20 years that would be forgiven?

Plus, there’s even more! Current Democratic presidential hopefuls are tripping over themselves to cancel your student loan debt NOW! Granted, there’s no guarantee that any of the contenders advocating this student loan forgiveness will be nominated to run by the Democrats, or actually win the election. And even if they win the election, there’s no guarantee that Congress will go along with this, as they’ll have to raise $2.2 trillion in taxes to foot the bill. However, since that prospect is out there, it makes almost no sense to be prepaying your student debt now when the government may forgive all or part of your debt in the future.

We realize that this is a highly emotional decision, and many young doctors don’t want to be confused by the facts. But why not choose a course of action that is predicted to make you $1,688,277 better off over your lifetime? You’ll be glad you did!

* For more information on Wes Lyon’s tax and business planning service for new doctors, provided through John K. McGill & Company, Inc., call 877.306.9780.

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