May 29th is “529 Day,” which serves as a reminder for families and young people to begin planning for higher education and how to pay for it.
Financial planners always encourage both parents (who are willing) and students to save for college expenses. While it is important to choose the right school for the right reasons, it’s also important to maximize college savings without sacrificing retirement savings or basic lifestyle needs in advance of and during the college years. For many college students, this means taking out student loans to help with the cost of tuition.
Paying off student loans following graduation can be a tricky journey to navigate, but as long as you avoid making the below planning and payment mistakes, you’ll set yourself on the right track.
- Taking out student loans before emptying a 529 plan - Hopefully the 529 College Savings Plan has been exhausted to pay for qualified education expenses before you started taking out student loans. If not, withdrawals need to be taken for the equivalent amount of all tuition paid and scholarships received over the four years. You can declare the exception to income tax and the exception to penalty on your 1040 tax forms.
- Delaying employment after graduation - This is not the time to “start your own business” or “try to discover yourself.” Get a new job that pays well enough to begin making payments or continue your education and apply to defer your student loan payments. Unemployment deferment is usually difficult to qualify for and has time limitations. You need to be employed, qualified for community service, or continuing your education.
- Not budgeting for future lifestyle expenses before graduation Create a budget before you graduate that includes small savings goals and all living expenses in order to realistically map out how much you can afford in lifestyle expenses before you start your new job, shop for an apartment or buy anything. Avoid unnecessary purchases and consider saving money by living with a roommate or two. As you pay the monthly minimum payment on your student loan, plan to use any surplus cash to build up an emergency savings account of at least six months of expenses (including loan payments). Also, contribute to a 401(k) plan, at least to the employer matching amount.
- Not taking advantage of optional repayment schedules - There are options to pursue a repayment schedule that is more proportional to your income. These minimum payments provide flexibility, but the interest can continue to capitalize. You must always make the minimum payments on your student loan – there is no loan forgiveness via bankruptcy
- Failure to negotiate assistance with an employer - Many employers offer financial assistance towards school expenses or making student loan payments. Ask about this tax-free benefit. It may be more beneficial than the typical bonus pool or moving expense reimbursement.
- Draining a retirement plan or borrow against your 401(k) plan to pay off/reduce the balance of a student loan - Too often, because the student is tired of making payments, they decide to drain their retirement savings to pay off their loans. However, this is an expensive way to do so, especially with penalties and income taxes on the withdraw. As your income increases over time, the payments will not feel so constraining. Just be mindful of living within your budget and paying the loan off over time.
- Holding off on important life events and experiences because of debt Don’t let student debt put your life on pause. Keep your life on schedule; it is important to date, marry, have kids, buy a home and seek career advancement, if you so desire. Having student loans simply means that you have to live within your means. Your “significant other” needs to know your personal goals and any financial issues, and should that person become your future spouse, he or she needs to know that marriage will have times of being “richer and poorer.” Most married couples will tell you that the those first few years of marriage are the financially poorest years. So, don’t live with your parents because you think that will allow you to pay off the loan faster (you may or may not). Move forward with your chosen plans so that you will not miss out on important life events. For those married or single, continue to have fun, socialize, and focus on career development and experiences that make you more valuable to your employer. If someone asks why you work so hard and are so smart, tell them it is “because you have student loans to pay.”
- Opening credit cards and floating balances to help pay student loans When you have significant student loan debt, where the payment exceeds 15 percent of your monthly take-home pay, do not use a credit card to help pay it down. Also, do not borrow against credit cards to help pay student loans – the cash-advance interest is often way too high. Credit cards make it far too easy to spend beyond your means. Instead, link a debit card to your checking account(s) and an emergency fund. I recommend using two checking accounts: one for monthly bills and one for daily spending. The only card you carry with you is the one for daily spending, which is linked to an account whose balance is used for discretionary spending only. The other checking account is used for monthly bill payments, and the emergency fund is strictly for emergencies, not vacation or other fun money. Eliminating the use of a credit card will not prevent you from building a positive credit score; your student loan payment history will do that for you, as long as you make the payments on time.
A CERTIFIED FINANCIAL PLANNER™ professional can answer any questions you may have or provide you with more actionable advice and guidance when paying down your student loan debt.