Student loan debt in America grows by $2,726 every second.*
Luckily for some, companies are beginning to embrace programs to help recent grads pay down their debt. One such platform offered to employers was created by Student Loan Genius.** The program can match an employee’s student loan payments by contributing to their 401(k).
I wish every company had such a benefit.
But what many millennials don’t realize is that you don’t need the right employer offering such a benefit because the tax code tremendously benefits people already.
For many millennials, being debt free is a proud badge of honor. Many strive to pay down student debt as fast as possible — to put that chapter of their life behind them and move on.
Eliminating debt becomes a higher priority than maximizing wealth.
The result is millennials pay down tax efficient debt in a tax inefficient manner.
This approach lessens the opportunity to achieve financial independence or early retirement.
Here’s How To Pay Student Loan Debt To Maximize Wealth:
A quick 5% example: An extra $1,000 to pay off student loans means you’ll save $50 on interest. If you put that same income into your 401(k) then it is pretax, so $1000 is actually ~$1,300 (25% tax rate). Adding in $40 net interest ($50 of interest lowers your tax bill by ~$10) and you’re saving $260.
Outside of the additional monetary gain of $210, the real benefit of this tax-efficient approach is the intangible benefit associated with developing the habit of saving early in life.
Recently, I was asked by a reader, why I care so much about personal finance. The answer is because I love to figure out ways to make the system work for you instead of against you.
Needless to say, investing in your future has a positive impact on any individual, and in many cases, a couple or a family.
Applied on a personal level, this strategy saved me an extra $7,000 in 2015 alone. More importantly, it removed the stress of student loan debt from my relationship & given my girlfriend and myself confidence that we’re ready for the next steps in life (i.e. marriage, homeownership, starting a family, taking care of our parents, etc.).
How Emotions Factor In
As with all form of investing, being aware of your emotions plays a critical role in sticking with a strategy. Maintaining the courage of our convictions is easier said than done.
The choice is between feeling good about having less debt OR feeling good about having more wealth.
Which of these would you be happier with?
The answer is not black or white; it depends on the individual. A big factor that could lead to having less debt is if the interest rate on our loans was much higher than the example provided above.
I would argue the emotional benefits of maximizing your wealth surpass the benefits of having less debt.
By taking the opposite approach to student loans, we can realize early retirement and financial independence at an early age. Or, if someone prefers, they can more easily afford nicer cars, luxury vacations, and/or a bigger house.
For me, buying my future freedom is the expensive purchase I have my sights set on.
The benefits and costs of paying into a 401k vs paying extra money towards student loan debt is NOT obvious and it is NOT part of a standard high school curriculum.
There is even a minor degree of controversy in this approach. I can tell you from firsthand experience how many looks I get when I say I’ve poured every dollar into the stock market instead of paying my student loans. People will look at you funny.
Five More Benefits to This Tax-Efficient Strategy – In Case You’re Not Convinced Yet:
1. If you have student loan debt right now, you can tap into these rewards right now. You don’t need to wait to purchase a house or have a small business.
2. When an individual rushes to pay down student loans, they often don’t translate all the student loan payments into retirement contributions when they’re done. More often, the reward is buying something and increasing the spending on various categories.
3. As a percentage of your income, the amount of money going to pay down student loans should inherently decrease, assuming your income is rises.
4. Building up a pre-tax account leaves you with an asset. Worst case scenario, you could tap into with fees and interest. Think of it as the safety net you want to avoid, but it is there if you absolutely need it.
5. The last benefit I’ll mention here is student loans serve as a hedge against inflation.
To a lesser extent, this approach works with mortgages as well, but I will leave that discussion for another day.
So the next time someone asks you, “What’s the quickest way to pay off student loans?” consider whether they’re aware of ALL of their options.
Let me know what you think of this approach in the comments below. For anyone thinking the extra costs associated with investing will drive up their tax preparer costs, I’ll remind you many places offer free online filing.