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Have you ever heard the phrase “sometimes the cure is worse than the disease”? This may be one of those cures.
Even the most casual observer will no doubt have noticed the attention paid to the rising student debt. This has inevitably led to creative ideas aimed at eradicating that liability.
“There is a viral narrative about burdensome student loan debt hamstringing people financially,” says Robert R. Johnson, Professor of Finance, Heider College of Business at Creighton University in Omaha. “The narrative leads to paying off debt in any way possible.”
It’s only natural, then, that you are now seeing solutions involving the use of retirement savings to pay off student loans. This is similar to the way 401(k) savings can be used to pay “hardship” events.
“Student loans are one of the largest monthly expenses for many college graduates, and 401(k)s are very likely their largest savings account,” says Matt Hylland, Partner at Arnold and Mote Wealth Management in Cedar Rapids, Iowa. “When times are tough and bills are due, it is hard to not think about using this relatively big account to help make ends meet.”
Recently proposed legislation would allow people to use their 401(k) accounts to reduce college debt. “Kentucky Senator Rand Paul’s new bill, the Higher Education Loan Payment and Enhanced Retirement (HELPER) Act, was introduced on December 3rd, allowing individuals to take out up to $5,250 from their retirement accounts,” says Mike Hennessy, Founder & CEO of Harbor Crest Wealth Advisors in Fort Lauderdale, Florida.
Using your 401(k) savings to pay down debt incurred for past education may be a cure that’s worse than the disease. “This doesn’t solve the problem,” says Greg McBride, Chief Financial Analyst at Bankrate.com in West Palm Beach, Florida. “Rather, it just trades one problem—student loan debt—for another—a shortfall in retirement savings.”
“This is a bad idea because it leaves Americans even less prepared for retirement, which is another pending crisis,” says Joshua Brockwell, Investment Communications Director at Azzad Asset Management in Falls Church, Virginia. “Of course, Paul and others assume that Americans have retirement savings to begin with. Sometimes they don’t. And sometimes that’s because those individuals are laser-focused on paying down their college debt.”
The data suggests more problems with this concept. Even those that do save for retirement may have savings too meager to use for student loans. “The Report on the Economic Well-Being of U.S. Households revealed that only 36% of non-retired adults think their retirement savings are on track,” says Stephen H. Akin of Akin Investments, LLC in Biloxi, Mississippi. “The report went on to say that about one third of middle-class adults can’t afford to cover a $400 emergency.”
One cannot simply address the issues of debt and saving as if they occur in a vacuum. As with many things in life, you will find you will need to weigh one objective against the other. It can be a zero-sum game. When you prioritize one, you diminish the other.
“Financial goals are not singular, i.e., one needs to balance a plethora of financial goals through one’s life,” says Johnson. “Specifically, robbing your retirement funds to pay off student loans is a bad idea for two reasons. First, you dramatically reduce the funds accumulated for retirement. Secondly, there are negative tax consequences. Funding a 401(k) reduces taxable income.”
At the very least, taking funds out of your 401(k) removes one of the primary advantages of long term investing. “You lose out on compound interest and the momentum you start to build early on in your working years,” says Melissa Brock, Money editor of Benzinga in Detroit. “You’ll have the most money when you retire if you invest early and let your money grow.”
Because of this “rule,” financial professionals tend to want you to avoid taking money out of your 401(k) until you actually need it in retirement.
“Generally speaking, 401(k) assets should never be touched for anything other than retirement,” says Andy Panko, Owner & Financial Planner at Tenon Financial LLC in Iselin, New Jersey. “As pensions become increasingly rare and Social Security becomes increasingly strained, people will continue to bear more of the burden of funding their retirements. Typically, workplace retirement plans like 401(k)s are peoples’ only source of retirement savings. Tapping those savings for something other than retirement can significantly impact a person’s ability to retire.”
There’s also an unintended consequence to Rand’s proposal. It may be the same unintended consequence you’ve seen arise when it became easier to take on college debt. “Increasing the availability of funds to pay for college can only serve to artificially boost demand and thus the price of college, which is already sky-high,” says Hennessy.
Using your 401(k) to pay down college debt hurts you in multiple ways. “In the long run you’re giving up all the wealth you’ve worked so hard to accumulate, and will be starting over without the benefit of time that you had in your 20s,” says Allison Bishop, a financial coach in Portland, Maine.
The cost might alarm you. “Taking $10,000 dollars and earning 5% annualized for 25 years gives you $33,864 dollars in the future,” says Hennessy. “If that $10,000 is gone today to pay for loans, you lost all that growth to fund your future you.”
The numbers can get ugly fast if you assume a 10% annualized return (which is closer to the average stock market return over the long run). Using $10,000 to pay off a student loan will cost you $108,347 over 25 years. Considering typical outstanding student loan balances are $50,000 or more, you can quickly see how using your retirement savings to pay down student debt can cost you more than half a million dollars!
But there’s more than the financial pain. “If one hasn’t accumulated enough retirement savings, upon retirement one is faced with two options — work longer or experience a lower standard of living,” says Johnson. “Often the work longer option is unavailable due to health reasons, either one’s own health or the necessity to serve as a caregiver for a loved one.”
Imagine what society will look like if people rely on using their retirement savings to pay student loans. “More people will be unable to retire or expect more from the government in retirement,” says Matthew W. Burr, HR Consultant at Burr Consulting, LLC in Elmira, New York. “Social Security is dead; people should not rely on anything in my generation for retirement. You will have folks working into their 80’s.”
If you think Millennials hate Baby Boomers now, here’s what “working into their 80’s” will mean. “The most significant impact is that individuals will not be able to retire on time, meaning they will work longer,” says Adam Marlowe, Principal Market Development Officer for Georgia’s Own Credit Union in Atlanta. “This has a larger impact on society because younger individuals will be unable to move up the ladder at the same rate and many will not be able to acquire jobs, because those that should be retiring will not be leaving the workforce.”
The broader implications of this don’t get any better. Aaron Freedman, a financial adviser for Mass Mutual Financial Group in Boise, Idaho, says, “More people will end up on government programs and have less disposable income later in life, which puts a financial drain on our economy as a whole.”
“Our country is already facing a retirement crisis due to people living longer and there being less and less sources of steady secure income such as pensions and Social Security,” says Panko. “Therefore, without people adequately saving for their own retirements, society will be burdened by an increasing number of elders in destitution. If people start withdrawing from their 401(k)s en masse, the risk of major societal financial problems is amplified.”
By encouraging retirement savers to pay down their college debt with their 401(k) assets, society as a whole will be faced with the “you can pay me now or you can pay me later” dilemma. “Others around you will end up covering portions of your retirement plan,” says Scott McKnight, a financial adviser at NM Wealth Management Company in Hoover, Alabama. “Think children, grandchildren, society at large.”