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Save or pay off DEBT?
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Author: Anderson, JessicaKountze, Elizabeth
STARTING OUT
Actually, twenty somethings need to do a little of both.
AT 25, Andrew Wagner
has a bright future. He just got a master's decree in international
relations, and he has a job with the World Bank.
But Wagner is
worried. He has accumulated $40,000 in student loans and expects to
pile on more debt for law school. Once he gets his law degree, he knows
he'll face a financial conundrum. "I'm looking at being 28 with a lot
of loans and no savings for retirement," says Wagner. "Should I pay off
the debt or start saving for retirement?"
Plenty of
twentysomethings are asking the same question. On average,
undergraduates who borrow leave school owing $18,900, and graduate
students owe an additional $31,700, according to a recent study by
Nellie Mae, the student-loan marketer. Law and medical-school students
borrow twice as much.
Still, when you're
squeezing the most out of a starting salary, don't rush to pay off all
your student loans. Set priorities by identifying "good" versus "bad"
debt and determining where you can earn the biggest return.
When you take on
"good" debt, you borrow to help build future wealth, says Bob Schumann,
a financial adviser in Gahanna, Ohio. Student loans fit this definition
because the asset you're buying will last longer than the debt. "Your
college education paves the way for you to make more money throughout
your lifetime," says Schumann.
On the flip side is
"bad" debt--loans for cars, furniture, clothes or anything that loses
its value over time. Creditcard debt is the leading culprit here.
Paying oft a
credit-card balance on which you're being charged 18% interest is the
equivalent of earning 18% on your money. That's tough to beat, so
getting rid of high-priced credit-card debt should be your top
priority--with one exception, if your employer offers a 401(k) or
similar retirement plan, contribute as much as you can to take
advantage of any employer match. If your employer kicks in 50 cents for
every dollar you contribute, for instance, that's a guaranteed 50%
return.
Open an IRA.
Even if you don't have access to a 401(k) plan, it's smart to start
saving for retirement with a Roth IRA, which gives you tax-free income
in retirement plus limited access to your money if you need it earlier.
"People think they have years to save for retirement, but there really
is no substitute for time," says Marnie Aznar, a financial planner in
Morris Plains, N.J. "The earlier you start, the more time your money
has to grow."
What's more, you get
the psychological satisfaction of having a cushion, whether it's for
retirement, next summer's vacation or a house in a few years. And
paying off debt versus saving doesn't have to be all or nothing. On an
entry-level salary, you could contribute $50 per paycheck to your
401(k) (or set up an automatic deposit in a Roth IRA), and put $50
toward paying oft credit-card debt--or saving for a house if you're
debt-free.
Stop fretting.
And what about those student loans? Don't agonize over them, says
Aznar. They almost certainly carry a lower interest rate than any of
your other debt. You could consolidate your undergraduate and graduate
Stafford loans at the current low rate of 3.37%. Once you've done that,
paying them off is equivalent to earning just over 3% on your
money--and you can get higher returns elsewhere.
You can also deduct
$2,500 in student-loan interest each year as long as your income is
less than $50,000 as a single filer or less than $105,000 as a joint
filer. The deduction phases out as income rises between $50,000 and
$65,000 (or between $105.000 and $135,000 for joint filers).
If you don't have
expensive consumer debt, it's fine to pay ahead on your student loans
just to get that monkey off your back. But don't pay them off at the
expense of saving for retirement, says Aznar. Your priorities should be
repaying credit-card debt and putting as much as you can into a 401(k)
or a Roth IRA.
PHOTO (COLOR): Andrew Wagner is concerned about repaying student loans.
~~~~~~~~ By Jessica Anderson
Research by Elizabeth Kountze
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