Or, two pharmacists play out the magic of compounding.

It’s an oft-debated topic: I have loans at relatively high interest rates. When I have extra money, should I pay them off or invest instead? Many finance gurus always advise paying off loans–you have a guaranteed “return” because you eliminate a known interest rate. In general, I agree with that, especially if we’re talking anything besides education loans. Credit card debt and many private loans do not apply to the advice you’ll see below–if you have them, they need to be your top priority.

Being young and in training, with a mountain of education debt, presents some unique considerations. Here is why I pay myself first and my debts later.

-I max out tax-exempt retirement accounts and/or employer-matched accounts first. You can never reclaim your lost tax-exempt space: you get $5,500 per year for a Roth IRA, and when that tax year is over, it’s gone. See the example below to see why that is important. As for employer match (which my health center does not support), that’s free money. If your program or someone else on your tax return has a job that offers employer match in a 401(k) or 403(b), max it out. You won’t beat that immediate 100% return anywhere, unless you bought Bitcoin any time before 2017.

-Properly invested, retirement accounts compound. The most important factor in passively building wealth is how long your investments compound, so it is especially critical to begin investing while we’re young. If the market follows historical patterns (and there is a LOT of data that suggest that it will, in a big enough timeframe), anything you invest in your 20s will multiply by a factor of 8 by the time you hit retirement age (rule of 72, average appreciation of market = 7.7%). Your loans compound, too, once you enter repayment. While you are in school or in deferment (which can include some or all of residency), most loans will accrue interest but will not compound. This means you won’t pay interest on the interest until after you finish training. This is why it’s important to chop off a big chunk with a signing bonus, or if you sell a house after residency: chuck it before it capitalizes and becomes principal.

-We’re young enough to wait out swings in the market. Even if we’re unlucky and make all these investments just before a big downturn, we’ve got 35-40 years before we can start pulling from retirement accounts without penalty. Historically, even big downturns recover within 10 years, and that historical interest rate of 7.7% that I keep mentioning also includes catastrophic events like the Great Depression, the dot-com bubble, the subprime mortgage collapse, etc. You’re still likely to enjoy some major gains before you’re ready to use these savings.

-Our loans will not be at 6-8% forever. You will undoubtedly refinance soon after you finish training to get a better interest rate, often in the 3-5% range. If you’re trying to compare average market appreciation of an index fund to numbers like that, it isn’t even close.

-You can aggressively pay down your loans to prevent interest accumulation when you finish training and have a bomb salary. Many people pay off significant debt in 10 years. I have a plan to pay it off 2 years after I finish training. The tax protected space available to each person in the form of a Roth IRA is capped and you can never go back to add to it.

-Money you put into a retirement fund is still accessible to you in the event of an emergency. There are specific cases in which it can be withdrawn without penalty (penalty is usually 10%), and even if those don’t apply, if you really need a lifeline then you pay the penalty and get what you need. If you paid off your loans with this money you would need to borrow from someone else or a private bank. The loan fees and interest on this would be less than agreeable, and it would take awhile to obtain.

For example, consider the tale of two pharmacists:

Let’s say Karyn and Carey have $5,500 to spare when they’re 22 and just started pharmacy school. They both take out 6% interest federal loans. Karyn puts the extra cash into her Roth and never touches it. Carey uses it to pay off $5,500 in loans during their first year. They finish school and go on their merry ways, both planning to be debt free 10 years later, at 36. The $5,500 that Karyn put in a Roth at 22 is worth $15,538 at 36. Carey, who used his $5,500 to pay down debt in his first year of pharmacy school, has $12,214 less debt than Karyn does. He is debt-free a few months before his retirement-minded peer. As pharmacists they pay a 33% income tax rate, so Karyn has to use $18,229 of her earnings that year to pay off the last of her debt.

Let’s say Carey put that entire “saved” amount into retirement accounts after he made his last loan payment–which he will need to do with his income after taxes, taxed at 33%. To put that $12,214 into a retirement account, he actually had to make $18,229 to cover the taxes, just like Karyn. He can only put $5,500 of the amount into his backdoor Roth IRA this year; the rest ($6,147) is in a traditional IRA and will be taxed when he takes it out as a retiree. He will never be able to go back and reclaim his lost Roth IRA tax exempt space. They both have to make $18,229 at 36 to balance out this calculation– her to pay off the debt she still has, him to put his “debt savings” into retirement. (If we’re being really picky…his $6,714 IRA contribution results in a tax deduction when he contributes it, so it saves him at most $2,215.62 on his taxes, or 33% of $6,714). Phew. Depending on her income–tax gymnastics here–around $2000 of her last student loan payment interest will be tax deductible. We’ll even assume Carey invests the extra $216 in his traditional IRA, bringing it to $6,930).

When they’re still friends at 65, Karyn and Carey decide to compare the fate of their $5,500. Karyn never touched it again and now it’s worth $133,548, which she will never need to pay taxes on, since it’s in a tax sheltered account and she is of retirement age. Carey, who matched her investment at 36 by earning $18,229 and splitting it between his retirement accounts, has $47,274 in his Roth. That money is his, free and clear. The other account, which started with $6,930, has grown to $59,565, but he will need to pay income tax on it whenever he makes withdrawals, so its value is really around 80% of that: $47,652.

Total value of their $5500:

Karyn, who invested it at 22: $133,548

Carey, who put it towards a loan, after adjusting for taxes on withdrawals: $94,926

Don’t worry, they’re both fine.

*Why the big difference? The invested money compounded in school, while the loan interest simply accrued, and over a long enough timeframe–here their entire working lives–the market’s growth has always exceeded the 6.8% interest rate of their federal loans. This would be more pronounced if someone had loans with lower rates, or a medical specialty with a residency, where the loan interest would still not compound. Of course, previous market patterns do not guarantee future results. It is conceivable that a disastrous period could intervene and flip the see-saw in Carey’s favor.

Like I said, they’ll both be fine.