Rising student loan debt may be hampering young people's
ability to buy homes or even move out of their parents' basements. But that
does not mean student loan borrowers always should be in a hurry to pay off
this debt. In fact, young borrowers could wind up poorer in the long run if
they prioritize rapid debt repayment over saving for retirement.
That's because retirement contributions typically offer tax
breaks, company matches and future compounding that are worth far more than the
interest saved by accelerated student loan repayment. As more young people
incur student loan debt in ever-increasing amounts, it's essential that they
understand the costs of prioritizing debt repayment over retirement savings,
planners said.
A recent TransUnion study of "credit active"
consumers — people with at least one credit account or loan — found that 51
percent of those aged 20 to 29 now have student loan debt, compared to 31
percent in 2005.
Balances have soared as well, the study found. The average
balance for a 20-something borrower in 2014 was $25,525, compared to $15,853 in
2007. That's a 60 percent increase.
An Experian study found an even greater rise in student loan
debt when the rest of the population was counted in. Experian's study of its
own credit reports found student loan debt had risen 84 percent between 2008
and 2014 and that the average balance for borrowers of all ages was $29,000.
Bachelor's degree recipients who graduated in 2014 with debt
owe an average $33,000, according to financial aid expert Mark Kantrowitz,
publisher of EdVisors.com, a college finance resource site. But even that
amount of debt isn't prohibitive as long as the graduate lands a job with an
annual salary that tops that amount - something college graduates typically do,
Kantrowitz said.
Census Bureau data shows that for people aged 25 to 34 in
2012, the median earnings for
those with a bachelor's degree was $46,900, while the median for high school
graduates without a college degree was $30,000.
Meanwhile, saving for retirement often gets harder, not
easier, as people age and incur other financial responsibilities, planners
said.
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.
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