Can Workers Tackle Student Loans and Retirement?

Student loan debt has become much more prevalent than it once was, with aggregate debt increasing by 400% from 2001 to 2016, according to the U.S. Federal Reserve. This reality coincides with the rapid transition away from defined-benefit plans to defined-contribution plans, particularly for younger workers, and it appears to be a drag on workers' ability to save for retirement. Aware of the reality, employers are beginning to deploy programs that allow workers to receive their 401(k) match by paying off their loans--which could help those with student loans simultaneously save for the future.

Researchers who have studied student loan debt find a strong association between higher levels of student debt and lower retirement savings. For example, the Employee Benefit Research Institute found that median defined-contribution retirement account balances were almost 40% lower for people who had student debt than those who did not. (This statistic only compares people with college degrees to each other; the gap narrows slightly as overall balances fall among those with some college but no degree.)

Of course, correlation does not mean causation, and students without student loan debt are probably different from students with it for a variety of reasons. Nonetheless, these differences are meaningful and likely due to workers directing more money to student loans at the expense of savings.

So, what can employers do about this problem? At least one employer asked (and got) permission from the IRS to treat workers' payments on their student loan debt as a contribution to a retirement plan for the purposes of determining whether an employee is eligible for a matching contribution. So, a worker could pay of his or her student debt while still getting an employer contribution into a 401(k) plan.

At least for now, the IRS permission only applies to one company, but many others have expressed interest as well. Furthermore, there is a bill sponsored by Senators Ben Cardin and Rob Portman that would codify this guidance into law, paving the way for every employer to offer such a plan.

There seem to be two obvious benefits from this policy. First, it would allow workers to get their employer match by just paying off their student loans. Workers who are unable to contribute to a plan at all because of their student loan payments are forgoing a guaranteed return of their employer's match rate. These programs would help obviate that problem.

Second, on some level it probably makes sense for workers to be paying off student loan debt rather than contributing to a retirement plan. After all, federal student loan interest rates range from 5.05% to 7.60%, with most direct loans clocking in at 6.60%. A guaranteed 6.60% return is pretty good, even if a defined-contribution plan investment might eclipse those returns. Allowing people to focus on their debt without completely staying out of the financial markets by continuing to collect a match inside their defined-contribution plans makes sense.

The downside is that tax policies conspire to make this opportunity to pay loans while getting a match less appealing. By forgoing a contribution to a 401(k) and directing it to student loan debt, these workers miss out on an immediate tax benefit (or a deferred one if they use a Roth 401(k) vehicle). Not only that, within interest and income limitations, student loan interest can be deducted from taxable income as well. (This benefit is "above the line" and can be taken along with the standard deduction.) So, if this policy results in people paying their student loans down more quickly, they lose tax benefits on both sides.

Finally, no one has conducted analysis of the distributional effects of this policy. My intuition is that it will probably mostly benefit higher-income workers, since people must have attended college to even have college loans, and those college-educated workers generally earn more to begin with. College-educated workers are also more likely than others to work for an employer that sponsors a defined-contribution plan. Moreover, workers with other forms of debt might resent workers getting an extra benefit for going to college and taking out loans to do so.

Despite these potential drawbacks, making it easier for employers to help workers save for retirement and manage their debt is worthwhile and timely. Hopefully, the policy is opened up and there is widespread interest among employers in offering this option.