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Ask Bob: What's Better? Pay Down a Student Loan or Invest in a Roth IRA?

Financial planner Jay Abolofia, CFP, recommends that our reader pay down student loan versus investing in a Roth IRA.

Question

My 27-year-old son, who is employed, is faced with a dilemma. His student loan is in forbearance until Sept. 30, 2020 because, I think, of the CARES Act. So, he could either keep paying down the principal on that loan, it's about $1,000 per month, or he could invest that $1,000 per month into a Roth IRA until the forbearance ends. My thought is that it would be better to pay down the student loan since it will reduce the balance and perhaps improve his credit score. He will be more than able to make up the lost investment, about $4,000 total, in the Roth IRA. Thoughts?

Answer

Federal student loan payments, including interest, are currently suspended through September 30 due to the CARES Act, according to Jay Abolofia, PhD, CFP, the founder of Lyon Financial Planning

This means, says Abolofia, that your son is not required to make any payments on his Federal loans at this time. 

"However, assuming he has stable income, now is an excellent time to continue making payments," he says. "With interest being equivalent to 0%, every dollar he pays will go directly towards paying down the balance on the loan."

What's more, Abolofia says prepaying the loan in this way is akin to buying a risk-free bond with a guaranteed rate of return equal to the rate on the Federal loan (likely 6-7%). "With equivalent government bonds currently earning less than 1%, continuing to make payments on his Federal loans is an excellent strategy," he says. "Investing the money in the stock market, possibly in a Roth IRA, offers no such guarantees." 

Read https://studentaid.gov/announcements-events/coronavirus.

Got Questions? Get Answers. 

Got questions about Social Security, Medicare, retirement, investments, or money in general? Get answers. Email Robert.Powell@Maven.io. Kim McSheridan assisted with this report.