As millennials rack up increasingly large amounts of debt to finance their educations, the necessity of paying back the hefty sums often overshadows the need to fund retirement accounts.
Seventy-seven percent of millennials — the cohort of Americans born between 1980 and the mid-2000s — cite debt reduction as the No. 1 step they are taking to actively plan for retirement, according to a joint study conducted by the Insured Retirement Institute and the Center for Generational Kinetics.
Advisers say they often see millennial clients anxious about their student debt, but indicate it's important to develop a financial plan that doesn't neglect retirement savings.
“I feel like it's our job as planners to balance the two,” said Allen Kozel, wealth coach at Stewardship Wealth.
At the same time that
college enrollment has reached historic highs, debt from student loans is on the rise. About 60% of students who earned bachelor's degrees in 2012-13
graduated with debt, according to College Board, a nonprofit organization in the higher education sector. These students borrowed an average of $27,300, an increase of 13% from five years ago and 19% over a decade ago.
One of Mr. Kozel's millennial clients, a man in his mid-30s, is one such younger person saddled with student loan debt to the tune of $80,000. That debt presents a barrier to achieving some of his life goals, such as getting married (he needed money for a ring), buying a house, raising a family and saving for an eventual retirement.
“You could tell he hated having the student loans looming over him,” Mr. Kozel said. Further, the interest rate on his student loans was high, around 6% to 7%.
Mr. Kozel set up a financial plan for the client first targeting consumer debt, which was $2,000 at an initial interest rate of zero but which ramped up to a very high rate after 12 months. After that was paid off, Mr. Kozel had the client allocate $500 per month to a combination of an emergency fund, Roth individual retirement account (the client wasn't yet eligible for his company's 401(k) plan, and the plan didn't offer a company match), and student loan payments exceeding the requisite monthly sums. Allocations were $100, $100 and $300, respectively.
CASH FLOW
Andrew Sivertsen, part owner of The Planning Center, Inc., said his focus is on cash flow. His millennial clients are mainly young professionals coming out of medical or dental school, and are usually anxious to pay down their staggering debt, sometimes in the range of $500,000 or more.
“I think they're keenly aware that they're carrying a negative net worth,” Mr. Sivertsen said.
Ultimately, it's too burdensome if 60% to 80% of take-home pay goes toward fixed expenses, such as debts, insurance, utilities, property taxes and rent; bringing it under 50% is ideal, Mr. Sivertsen said. He looks to free up additional cash flow for clients first by reducing commercial debt, which is usually higher-interest, and then student debt. That doesn't mean eliminating the debt, but getting it under control so that monthly fixed expenses are reduced.
Once cash flow is manageable, then clients should take advantage of the company match in a 401(k) plan; then, if there's additional money, paying down debt more quickly is a good option, Mr. Sivertsen said.
ALL ABOUT THE MATCH
“It's going to be better for you to place that dollar in the plan up to company match” than pay down debt at an accelerated level, said Katherine Roy, chief retirement strategist and head of individual retirement at J.P. Morgan Asset Management.
Ms. Roy advocates a total savings level of 15% in a 401(k) plan for people of all income levels, so that savings are high enough to be able to overcome unforeseen complications in retirement, such as illness, taking care of parents or losing a job. A
recent J.P. Morgan report on millennials makes the point that they will face more job uncertainty than prior generations. For example, millennials with college degrees face the prospect of their jobs, especially those in manufacturing and services, being computerized, which could interrupt long-term savings goals.
However, people should consider redirecting some funds to pay down student loans if there's an interest rate of 5% or higher, Ms. Roy said. J.P. Morgan's capital market assumptions point to a 6% return on a 60/40 stock-bond portfolio over the next 10 to 15 years; using that assumption, the interest rate could outpace 401(k) returns.
“You're losing ground, unfortunately,” she said.
A client's emotions could be the deciding factor, though, when having a conversation about debt and retirement savings, said Eric Roberge, founder of Beyond Your Hammock, a firm specializing in 20- and 30-year-olds. Mr. Roberge tries to sway clients' decisions based on what makes the most financial sense for them, but if a client feels strongly, it could damage the client relationship to push too hard in one direction, he said.
“There's a fine balance,” Mr. Roberge said.
