Many times, when asking young individuals how much they have saved for retirement I get the same answer. They cannot afford to fund their 401k due to loan payments and other financial obligations. However, I tell them the one thing they cannot afford is starting a 401k as soon as possible.
Focus on the Long-Term Not The Short-Term
When looking at your financial situation you must look at from long term perspective not from today’s perspective. Historically, money invested in a retirement saving account will have the opportunity to provide compound growth. Conversely, money directed student loans and other financial obligations will strictly be a dollar for dollar debt reduction or outflow.
Long-Term Impact On Net Worth By Paying Off Student Debt
Let’s look at an example of a 25 year old earning $60,000 a year with $27,000 of student loans at 6% interest rate. Based on their income and loan balance their monthly student loan payment will be $300 a month for 10 years.
Today their net worth reflects $0 in retirement saving and a negative $30,000 in student loan debt.
Over the course of the 10 years they will pay a total of $36,000 ($300 *120) in loan payments and have a zero-balance due in 10 years. If they continued to delay funding their 401k until their loans were paid off, their next worth in 10 years would have increased by $30,000 by eliminating the debt.
Long-Term Impact On New Worth By Starting A 401K Early
Now lets look at the same situation where the individual starts putting 6% of their gross pay of $60,000 in their 401k today. Additionally, this individual earns an average of 6% annually on their 401k contributions. Even without getting any raises over the next 10 years their 401k balance in 10 years would be $49,000.
If they received an annual pay increase of 3% a year over 10 years their 401k balance would be $55,000.
Long-Term Impact Of An Employer 401k Match
Now lets add a 50% employer match on their 6% employee contribution for a total of 9% of their gross income annually. This would give them a balance of $83,000 after 10 years in their 401k and provided they made all their loan payments $0 in student debt.
Long-Term Benefit Of Starting A 401K and Paying off Student Debt
This combination of starting a 401k early and paying off the student loans resulted in a increase of net worth by $113,000 over 10 years. A total of $83,000 in retirement savings and $30,000 less student debt.
Based on the above example you can clearly see that longer you delay the funding of your retirement the greater the impact on your future next worth.
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