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Will Student Debt Crush Recent Grads’ Retirement?

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If today’s working-age households had the same level of student debt as those recently leaving college, what kind of effect would that have on their retirement?

New research from the Center for Retirement Research at Boston College aims to assess the impact of growing student debt on retirement security.

“Student loan debt has been growing at a rapid clip over the past decade, prompting widespread concerns about its impact on the financial futures of young Americans,” authors Alicia Munnell, Wenliang Hou and Anthony Webb wrote in a February report titled “Will The Explosion Of Student Debt Widen The Retirement Security Gap?”

According to data from the Federal Reserve Bank of New York, student loan debt was $1.2 trillion in 2015 — compared with just $200 billion in 2003. This data shows that student loan debt now accounts for more than 30% of total household non-mortgage debt, having surpassed credit card debt in 2011.

“The question is whether starting out $31,000 in the hole could have a big impact on households’ retirement preparedness,” the report stated.

What the report found is that, yes, it does have an impact.

“This impact occurs through two channels: directly, by reducing saving in retirement plans; and indirectly, by reducing the rate of home ownership and home values,” the trio wrote.

The report found that households with student debt are 6.7% less likely to own a home, and that the homes they do own will have a 5.4% lower value.

“With student debt and particularly delinquent student debt, it can be harder to get a mortgage,” the report stated. “Thus, in addition to getting a late start on saving in a 401(k) plan, those with student debt may also delay buying a house, a potential source of income in retirement.”

To assess the impact of growing student debt on the retirement security of today’s working-age households, the report used the National Retirement Risk Index (NRRI). The NRRI measures the percentage of working-age households that are at risk of being unable to maintain their pre-retirement standard of living in retirement.

As of 2013, the NRRI showed that even if households worked to age 65 and annuitized all their financial assets (including receipts from reverse mortgages), 51.6% of households were at risk of being unable to maintain their pre-retirement levels of consumption once they stopped working.

The NRRI has increased over time due to longer life expectancies, reduced Social Security replacement rates and very low interest rates, the report noted.

How will this percentage be affected by the growth in student loans?

The report gave the households in the NRRI the same student loans when they were in their 20s as recent college students.

Using the Federal Reserve’s 2013 Survey of Consumer Finances data for people aged 21 to 29 as an approximation for recent college students, the report found that among this age group, 55% of households had student debt, with an average amount of $31,000.

If today’s working-age households had this same level of student debt, the additional 4.6% of households would be at risk of having inadequate income in retirement.

“This change represents a substantial increase in the already alarming rate of households at risk — from 51.6% to 56.2%,” the report concluded.

The report then asked, “Is 4.6 percentage points a big increase?”

To put this number into context, the report compared it to a very dramatic policy change — a 19.6% across-the-board benefit cut in Social Security (exempting current retirees) to eliminate the program’s long-term financing shortfall. The report said that such a cut would raise the NRRI by 10.7 percentage points.

“So, extrapolating the effects of the growth in student debt into the future has an impact that is roughly half as large as a huge and unprecedented cut in the nation’s main source of retirement income,” the report said.

The report suggested that college costs should be included in broader policy discussions over how to improve lifelong financial security.

“The bottom line is that student loans definitely have a meaningful adverse effect on retirement security,” the report said.

— Read “Americans Making Modest Progress in Savings Goals” on ThinkAdvisor.