How to budget for retirement and student loan payments

You recently left college and started working at your dream job. Your new employer offers a retirement plan, but you still have student loan debt. Should you wait to start making contributions until you pay off your student loans? Or is it better to start saving for retirement?

While it's tempting to begin paying down your debt, you also want to prepare financially for the future. Saving for retirement early has many benefits, so instead of directing all of your money toward debt, look for creative ways to do both. Here are some tips to help get you started.

Get financially organized

Finding room in your budget for retirement savings and student loan payments is sometimes challenging, but it gets easier once you understand your financial picture.

To do this, Brooke Napiwocki, a certified financial planner and financial wellness speaker at Crescendo Wealth Management in Grafton, Wisconsin, suggests putting together a personal balance sheet.

"When you are first starting out, your net worth might be a negative number but over time it can be less negative and eventually positive with consistent loan payments and regular saving," says Napiwocki.

Your monthly cash flow is ideally around 10% to 20% of your income, says Napiwocki. If you have negative cash flow, evaluate options to cut your expenses or add some side hustle income. From here, you can decide how to prioritize debt payoff and retirement savings.

Don't wait to start saving

When you have a large student loan balance, it's tempting to use all of your available cash flow to pay off your debt. But if you're not leaving room in your budget for retirement, you could be missing out on thousands of dollars in lost investment earnings.

"If a 22-year-old starts saving $5,000 per year and invests expecting a 6% average annual rate of return, they would be projected to have just under $1,064,000 by age 67," says Napiwocki, "This in contrast to if they started 10 years later at age 32 they would have just over $557,000 by age 67 assuming a 6% annual rate of return."

You could be leaving even more money on the table if you're not taking advantage of an employer match for 401(k) contributions.

"Most company sponsored retirement plans have a matching component, typically $0.50 per dollar of the employee's contribution up to around 3% or 4% of their salary, but you have to participate to get it," says Lawrence Solomon, a certified financial planner and client advisor at Mercer Advisors in Vienna, Virginia. "Even if the investment they select in the plan returns nothing, they still make 50% on their money."

If your employer doesn't offer a retirement plan, you can contribute to a tax-advantaged Individual Retirement Arrangement (IRA) or, if you qualify, a Roth IRA.

"For most individuals, the Roth IRA is a great option because you can take out contributions tax-free at any time (after the 5-year holding period). It also grows tax-free and will be withdrawn tax-free in retirement (i.e., beginning at age 59 ½)," says Napiwocki.

Saving for retirement early gives you an advantage over those who wait, Solomon added. He advises recent college graduates to save as much as they can as soon as they can in a retirement plan. If you're new to investing, you may want to consider a target date fund, which is an account designed to maximize returns based on your selected retirement date.

Include debt payments and retirement savings in your budget

When creating your budget, consider how to best use your leftover cash flow. Napiwocki suggests prioritizing in the following order.

1. Make your student loan payments: By making on-time payments, you'll start to build credit worthiness while paying down your balance. If you miss a student loan payment, you risk hurting your credit score and being subject to late fees or loan default.
2. Contribute to a retirement plan: Whether you are saving on your own or in an employer-sponsored retirement plan, your ultimate goal should be to save 10% to 15% of your gross income, says Napiwocki. Since this might be a stretch if you're just out of college trying to pay off debts and save money too, try saving at least enough to maximize your retirement plan benefits. If your employer plan offers a 401(k) match, contribute at least up to the match amount. If you are saving in an IRA or Roth IRA, try making the maximum contribution each year that will qualify for tax benefits.
3. Contribute to your Health Savings Account (HSA): An HSA is a tax-advantaged account that allows you to save and pay for qualified medical expenses when you have a high deductible insurance plan. Contributions to an HSA are pretax through your employer's payroll system. Interest earned on your investment will also grow tax-free and won't be taxed when you use the funds to pay for qualified medical expenses. If your employer offers an HSA, contribute at least up to the amount you expect to pay out of pocket that year, with a goal of maxing out the annual contribution.
4. Move money to your emergency fund: Napiwocki suggests aiming to save 5% to 10% of your gross income in a separate emergency fund. Start by saving at least one month of expenses, with a goal to eventually have six months' worth of expenses saved.
5. Use any leftover funds to make additional debt payments: Once you've completed the steps above, you're ready to get aggressive with your student loan debt. Some people prefer the snowball method—paying off the smallest balances first—and others may choose to tackle their loans with the highest interest rates first. Napiwocki suggests thinking through what motivates you to pay off your debt and what will save you the most money in interest.

Consider refinancing student loans

If your monthly loan obligation is taking up too much of your budget, it might make sense to refinance your student loans. You may be able to get a lower interest rate and/or reduce your monthly payments.

There are some things to consider first. While a lower monthly payment may free up cash flow in the short-term, you could end up paying more in interest over the long run if you extend your repayment term, says Peter Faust, certified financial planner and wealth advisor at Tanglewood Total Wealth Management in Houston.

When it comes to tax benefits, if your student loans were eligible for the student loan interest deduction, they should remain eligible even if you refinance. However, if you refinance them with other debt not used for higher education, then you will lose this deduction.

"Everyone's situation is unique," he says. "You have to look at each situation on its own merit and each refinance option on its own merit, and how that plays into someone's short-term cash flow as well as long-term planning."

Set yourself up for success

It's never too early to start building your financial future. The best approach is to strike a balance between paying down debt and building your nest egg. Focus on making your required student loan payments as well as meeting your retirement savings goals. If you need help creating a budget, you can take a DIY approach with financial planning software like Quicken or Mint. For questions about taxes, retirement plans, or investment strategies, please see IRS.gov or consult a certified financial planner or a tax professional.