Can Your Student Loans Hurt Your Retirement? Yes.

March 30, 2016

Photo credit: Comstock-Stockbyte-Thinkstock

Student loan payments take a serious bite out of your monthly income and restrict your ability to save for retirement. Everyone with student loans faces the dilemma of deciding whether to make extra loan payments now to reduce their debt burden or make contributions into their retirement savings plans to build a better nest-egg for retirement.

How will this dilemma affect your retirement individually and the aggregate retirement security of the nation?

First let’s look at student loans.
The amount of student loans outstanding has grown by a trillion dollars over the past decade. That’s trillion with a “T”. Currently there are over $1.2 trillion in outstanding student loans. That is more than 30 percent of total consumer debt and it’s even greater than all of the outstanding credit card debt. What’s worse is that student loans are not escapable and cannot be erased in a personal bankruptcy. Under government plans, you can have your payments deferred but eventually, unless you qualify for special programs, you will have to pay the money back. Currently the average recent college graduate carries $28,900 in student loans. Of all the student loans outstanding more than one in five is delinquent.

How will this effect long term retirement savings?
For the individual, every dollar that is used to pay down loans could have been used to increase retirement savings. At the current rate of interest, the recent grad would be paying $297 a month for 10 years just to pay down their student loans. What would the individual be able to save if they made these payments into their 401(K) plan?

Let’s say the loan payments go into retirement savings for 10 years and then not another contribution is made until the person retires after a 30 year career. Assuming a 6 percent return across the entire period, there would be $161,114 in their account to help fund their retirement. Paying back the $29,000 loan has reduced their retirement savings by about $161,000.

What is the aggregate effect across all working age households of this huge student loan debt?
The Center for Retirement Research (CRR) has just released a report on how student loans will affect retirement savings. The CRR calculates the National Retirement Risk Index (NRRI) which measures a household’s ability to replace income in retirement at a level sufficient to maintain their standard of living. The CRR projects that most households would like to retire with a retirement income that allows consumption expenditures no less than 10 percent lower than their pre-retirement levels. Currently, their 2013 survey showed that 51.6 percent of households are at risk of falling below this level. Including the effects of student loan repayments increases this risk by 4.6 percent. That means 56.2 percent of households will face insufficient income levels in retirement.

Now at this point you could argue that this is a high class problem that will resolve itself over time. Those folks with student loans will graduate and get high paying jobs and will become very wealthy by the time they retire. As these graduates progress in their careers the loans will be quickly paid off and their enhanced earning ability will allow them to catch up quickly. In some cases that is true but for many, the student loans will become a significant impairment that will handicap them for the rest of their lives.

  1. A total of 24 percent of student loans are held by young households making less than $30,000.
  2. Almost 20 percent of student loan debt is held by folks who did not graduate and are therefore unlikely to see large increases in their income. This puts a large group of people at serious risk.

The CRR calculated that the risk of falling short in retirement grows to 67.1 percent for those that failed to complete college but are still paying back student loans. Likewise for households who are carrying student loans but are still in low income jobs their risk of falling short in retirement is 65.8 percent. So, you could conclude that student loans are not a big issue… as long as you graduate and work in a field where your lifetime earnings are high.

It’s hard to measure how this will affect folks in Colorado in the future but we can guess that it will be a significant issue. Although statistics on wages of Colorado graduates are not readily available, the US Department of Education follows graduation rates for every state. Here in Colorado, graduation rates are 54 percent for public, 62 percent for private, and just 24 percent for for-profit colleges with an overall average of 50 percent. That’s worse than the national average at 55 percent. If this large number of non-graduates carries student loan debt, they will fall into the growing low-wage earners who have their future saving impaired.

This may seem like a small problem today, but consider the effect on society in 30 years. If we are currently seeing  52 percent of households with insufficient retirement savings to support their current pre-retirement consumption, what will happen when this grows to 56 percent or higher just because of the recent student loan binge? What will retirement be like for the folks who took out student loans and either didn’t graduate or didn’t get a high paying job?