Prepaying Student Loans May Mean Less Money In Retirement

Meanwhile, saving for retirement often gets harder, not easier, as people age and incur other financial responsibilities, planners said.

"I wish I could get every single one of (clients in their 20s) to set aside 10 percent from the beginning of their careers," said financial planner Delia Fernandez of Los Alamitos, California. "Then I wouldn't have these 40- and 50-year-olds in my office struggling to catch up for their retirements."

Here's how the math works:

Company matches offer an instant, free return of up to 100 percent on worker contributions. The most common match, according to Aon Hewitt [ACLC.UL], is dollar for dollar up to a specified percentage of pay, typically 6 percent. The next most common match is 50 cents per dollar contributed up to 6 percent, the human resources consultant found.

Even plans without a match offer tax deductions, tax deferral and sometimes tax credits. The value of the deduction depends on the worker's tax bracket, which is typically 15 percent to 25 percent for federal taxes and is often higher when state and local taxes are included. Lower income workers can qualify for a tax credit of up to 50 percent of their contributions. Contributions and earnings grow tax free until withdrawn.

Thanks to compounding, contributions made when workers are in their 20s can be worth twice as contributions made later. That's because the money has longer to grow.

A $1,000 contribution made at age 25 would typically be worth $20,000 or more at retirement age, while the same contribution would be worth about $10,000 when made at age 35, assuming 8 percent average annual returns. Even if participants don't achieve 8 percent, which is the historical stock market average for periods over 30 years, the math still holds: contributions made earlier return dramatically more.

Those returns tend to dwarf the value of prepaying student loan debt, especially for recent graduates. Interest on student loans is typically tax deductible, which reduces its effective cost. Someone in the 15 percent bracket would have an effective cost of less than 4 percent on a Stafford loan with a 4.66 percent interest rate. A 25 percent tax bracket would lower the effective cost to about 3.5 percent.

Higher rates — such as those charged on older federal loans and on many private loans — are more problematic and may need to be paid off more rapidly. But that debt payment still shouldn't come at the expense of company matches, financial experts said.

"Borrowers should always make the required payments on their federal education loans, since the penalties for default are severe," Kantrowitz said. "But otherwise they should maximize the employer match on contributions to their retirement plans, since that is free money, before devoting extra money to accelerating repayment of their student loans."