The average student loan payment, according to credit.com, is $393 a month. That represents almost 20% of the monthly household income after taxes. During your prime working years, you may be tempted to postpone saving for retirement or maxing out your 401K contribution. If you’re on a federal income-based repayment plan, however, saving for retirement while paying off your student loans may actually reduce your monthly student loan payment.
Most federal repayment plans calculate your monthly payment based on your adjusted gross income (your net pay after deductions for taxes). The lower your net income take-home pay, the lower your monthly student loan payment may be. Not all federal repayment plans will result in a lower monthly payment. The eligible repayment plans include:
- Revised Pay as You Earn Repayment Plan (REPAYE)
- Pay as You Earn Repayment Plan (PAYE)
- Income-Based Repayment Plan (IBR)
- Income-Contingent Repayment Plan (ICR)
The nuts and bolts of 401k plans
A 401k is a retirement saving plan sponsored by some employers. You are able to save some of the income you earn from your paycheck before taxes are taken out. Typically, the employee elects a certain percentage of their income to be withheld and paid into their 401k plan. The maximum limit on employee withdrawals to 401k plans changes annually and may be subject to cost of living adjustments. In 2020, the maximum limit on employee elective deferrals (for traditional and safe harbor plans) is $19,500. Up $500 from 2019. Many companies match the employee’s 401k contribution up to 100%. Significantly funding your retirement nest egg. Taxes are not paid until the money is withdrawn from the 401k account.
In addition to contributing the maximum amount to your employer sponsored 401k plan, you can lower your monthly taxable income by contributing other monies from your paycheck into a flexible spending account. A flexible spending account or flexible spending arrangement allows you to set-aside money from your paycheck, pre-tax, to use to pay for certain out-of-pocket health care costs. The effect of participating in an employer sponsored flexible spending account is lower taxable income.
Furthermore, lowering your taxable income can also make you eligible to deduct student loan interest. If your modified adjusted gross income falls below $70,000 this year, the IRS will allow you to deduct the interest you paid on a qualifying student loan debt.
While all of these steps can lower your monthly student loan payment, it will also typically extend the repayment period and amount of interest you pay on your student loan debt. For individuals with growing families or who were not able to save for retirement as they desired, saving for retirement is critical to a comfortable old age, when your earning power is greatly diminished.