401k Assets To Pay Student Loans?

Student debt is a legitimate obstacle, what's the best way to tackle it?

Rand Paul has a plan to help people pay off their student loans with limited access to 401k or IRA assets. You don't need me to tell you that due to the exorbitant increases in tuition, many people are choking on their student loans, this problem also encompasses people in their 60's who've helped family members go to school. The plan in its current form would limit withdrawals to $5250 per year. My guess is that if this ever comes to be, it will look much different than the initial draft so for this post I will zoom out a little bit.

Pretending for a minute there were no limits to how much could be taken from a retirement account to pay for student debt, if someone had $100,000 in their 401k and owed $100,000 in student debt, I would not empty out my account to zero out my debt. I did something like that once with my first large paycheck out of college and the credit card debt I'd accumulated while in college. The numbers were very small but the short period of essentially no money and no debt was not ideal. I am not saying it is wrong, just sharing a personal anecdote and my sentiment after the fact.

If it ever comes to be that you could access qualified assets to pay down, as opposed to pay off, student debt, then in terms of dollars and cents, it would make sense to do because you were able to get the tax deduction going in and can then access it without paying tax coming out.

While there is no way to know whether Paul's plan will ever come to pass so maybe a good question is whether or not younger workers should pay down debt at the expense of saving for retirement or figure out some sort of balance and what that balance might be.

Obviously there will be some sort of minimum payment for student debt and for anyone caring about maintaining their credit rating (a form of optionality) they will have to pay it. In the typical 401k plan some amount of the employee contribution is matched by the employer along the lines of 50 cents on the dollar for the first 5% contributed (that's just an example, there are many permutations). You are turning down free money if you don't contribute enough to get the full benefit of the employer match. There is no such dynamic with IRA accounts. Anyone with access to an employer match should take advantage of that...

...at least when they are starting out. We've all seen the articles that say putting $1000 into an IRA at 18 will grow to be $100 million at age 65. While I may exaggerating slightly, the compounding effect of putting, say, $5000 into a 401k every year in your 20's will go a long way to having enough for retirement. All the more so with an employer match. Doing a little spreadsheet work, putting $5000 per year into a 401k from age 23-30 while getting a $1250 match (50 cents on the dollar on the first 5%) would grow to $60185 at age 30 assuming very modest growth. Assuming no other retirement savings ever again, that $60185, assuming a very modest 12% per year (I am making fun of Suze Orman, I actually assumed 4%) would compound up to $228,360 at age 65. While I concede the flaw of assuming linear returns, that is still going to be a big chunk of this persons retirement assets assuming that they actually do save more for retirement along the way.

One point I have made repeatedly is that it is never too late to start saving for retirement. The later you start, the more difficult it will be of course and the greater the odds that something will have to give (like working longer or substantial downsizing). Doing similar spreadsheet work as above, and starting at 50, saving $15,000 per year, presumably you're making more at 50 and might even have your house paid off, and getting a $2500 employer match, at age 65 it would compound out to $275,213.

That's not great but combined with the money saved from 23-30, would be at just over $500,000 a decent amount able to generate $20,000 a year assuming the 4% rule. This probably doesn't equate to a lavish retirement but combined with Social Security and the option to downsize a free and clear home (extracting cash from the swap) probably gets the job done.

This scenario then lays out a 20 year window to pay off student debt. Would it take that long paying more than the minimum, paying as much as you can? I graduated in 1989 with $3000 in student debt that I was able to pay off long before 30, so I don't have a sense of how easy or difficult it would be to pay off all student debt between 30 and 50 but my sense is that as a worst case scenario, someone could get the vast majority of it paid if they were disciplined and didn't have bad luck on some other front.

If you're reading that and think, it wouldn't take anywhere near 20 years, then all the better for accumulating more for retirement. Giving up the employer match for that period of time, any period of time, is clearly suboptimal, I am not making the case otherwise but in terms of having a serious student debt burden, something has to give.

Pulling from the 401k in the manner Paul is proposing would allow for the debt to be paid faster at the expense of a smaller retirement balance now but maybe the ability to put more in later like if the 20 year window I framed above was just ten years.

There is a balance to this and tradeoffs to be considered. The above is plausible but there are many plausible strategies. Figure out the tradeoffs and proceed with what makes the most sense for you. No one will care more about whether you get your student debt paid off more than you.

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