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The $1.2 Trillion Problem Hurting Americans’ Savings

By Kelly Isom, Kenneth Megan, Mark White

Wednesday, June 10, 2015

In 2014, the Bipartisan Policy Center (BPC) launched the Commission on Retirement Security and Personal Savings, led by former Senator Kent Conrad and WL Ross & Co. Vice Chairman Jim Lockhart. The commission will consider and make recommendations regarding Social Security, pensions, defined contribution (DC) savings vehicles, strategies to generate lifetime income and other factors that affect retirement security.

This BPC-staff authored post is the 11th in a series that will outline the state of retirement in America and provide a sense of the challenges that the commission seeks to address in its 2015 report.

For more information on the topics below and in the rest of this series, see our staff paper, A Diversity of Risks: The Challenge of Retirement Preparedness in America.

Student loans have an adverse effect on the savings of young Americans. Almost one-third (6.7 million borrowers) of those with federal student loans in repayment are more than 90 days delinquent, and recent trends point to delayed homeownership and retirement savings.

Relationship of Student Loan Debt to Retirement Savings and Household Formation

The cost of a four-year college degree has risen by 150 percent since 1980.1 This sharp increase in the cost of college has led to a similarly drastic rise in student debt, with total outstanding loan balances (federal plus private) now approaching $1.2 trillion. Average loan balances among 25 year-olds almost doubled between 2003 and 2012.2 In 2013, 69 percent of graduating college seniors from public and private nonprofit colleges had student loan debt, with an average burden of $28,400. This debt is impacting the savings ability and behavior of many Americans early in their careers.

For those who owe sizable interest payments on their large debt burdens, saving for retirement necessarily takes a backseat. A 2013 survey by the American Institute of Certified Public Accountants found that 41 percent of those with student loans postponed contributions to retirement plans.

The same survey found that 29 percent of those with student loans had put off buying a house. Researchers at the New York Fed have analyzed this trend towards delayed homeownership caused by student loans. Before the 2008 recession, young people with student loan debt were more likely to be homeowners—probably due to the higher earnings of those who benefit from higher education. But by 2012, people age 30 with student loan debt were actually less likely to be homeowners than those of the same age without student loan debt. Although likely in part driven by the Great Recession, this trend also seems to indicate that student debt is playing a role in young workers’ investment decisions—and that the burden of student loans may be more significant than the wage premium from earning a college degree, at least in the short term.

The situation for both household formation and retirement savings is almost certainly worse for the 41 percent of students who begin college but fail to graduate within six years. These individuals tend to take on more debt per credit than college completers, but fail to see the large wage gains enjoyed by college graduates.

Recent Reforms

Several reforms have been made to federal student loan programs in recent years. Starting in 2010, the federal government stopped issuing loans under the Federal Family Education Loan (FFEL) program—which offered privately funded, federally guaranteed loans—and began issuing these loans directly from the federal government via the already existing William D. Ford Federal Direct Student Loan Program (“Direct Loans”). At the time of enactment, the Congressional Budget Office (CBO) projected that this would save the federal government $56 billion over 10 years.3 As a result of this reform, along with the opportunity to refinance existing FFEL loans into Direct Loans, approximately 60 percent of the over $1 trillion in outstanding federal loans are now Direct Loans. Around 85 percent of all outstanding student loans are guaranteed by the federal government.

Another recent reform has been the creation of new repayment methods that limit monthly payments to a percentage of income—as opposed to requiring payment of a fixed dollar amount. For borrowers that elect income-based repayment, debt service is limited to 10 percent of income, with remaining balances forgiven after 10 years for those pursuing public service professions, and 20 years for workers in the private, for-profit sector. These changes could alleviate some of the longer-term impact of student debt on retirement savings, although some borrowers could also end up paying more in interest over the life of the loan.

Other policy changes to the program have included: stricter underwriting standards for parent loans; rules that hold institutions accountable for poor labor market outcomes; reduced subsidies to graduate students; and a new formula for calculating student loan interest rates (which will now be based on the 10-year Treasury note plus a margin). These reforms may impact the trajectory of the issuance of student loans and the total amount received in repayment.

The Obama administration has proposed additional reforms that would rate colleges based on metrics of institutional performance – such as graduation rates and student debt levels. Many in Congress have their own proposals. Thus, significant policy questions regarding student lending remain, and education indebtedness will likely continue to grow without additional reforms.

BPC’s Commission on Retirement Security and Personal Savings will consider the impact of student loans on retirement preparedness as it develops final recommendations to be released later this year.

Up Next in Retirement in America:
#12: One Big Asset: Homeownership
#13: Social Security and You

View all posts in BPC’s Retirement in America series under Related Stories below.


1 This figure is inflation-adjusted.

2 Inflation grew by about 25 percent over the same period.

3 BPC calculation based on http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/113xx/doc11379/amendreconprop.pdf

KEYWORDS: CONGRESSIONAL BUDGET OFFICE, GREAT RECESSION, MILLENNIALS, STUDENT LOAN DEBT, STUDENT LOANS, RETIREMENT IN AMERICA