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Sen. Rand Paul says taking money out of your retirement accounts to pay down student loans will create a ‘more secure retirement’ — but many financial advisers strongly disagree.
Paul, a Republican senator from Kentucky, proposed the HELPER Act — short for “Higher Education Loan Payment & Enhanced Retirement Act” — this week, which would allow Americans to either pay for college or pay down student debt using money in their 401(k) or individual retirement account.
Under this proposal, employees would rely on their own contributions as well as employer matches to pay off student loans quicker, Paul said. The senator tweeted a scenario where a recent college graduate earning $46,000 at a company that matches up to 6% of her salary would be able to pay off her loan with less interest in fewer than seven years, as opposed to 15 years if she didn’t have access to this plan. He suggested that in the remaining eight years, the employee would have amassed $46,000 in retirement account contributions (or $57,000, with a 5% annual return). (The worker had $30,000 in student loans with a 4.54% interest rate).
Individuals would be allowed to take up to $5,250 out of their retirement accounts penalty- and tax-free, as could their parents to help with these college expenses.
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But financial advisers say the proposal could be devastating to retirement savings, and potential nest eggs. “There are already too many reasons (or excuses) to draw from retirement plans,” said John Power, a financial adviser and principal of Power Plans in Walpole, Mass. “College loans can be paid over time.”
Not only would the bill squash a young employee’s chance of saving small amounts of money over a longer period of time, but it could derail a parent’s retirement plans. “It’s a quick fix to eliminate student debt that will cause a much larger retirement crisis years from now,” said William Parrott, a financial adviser and president of Parrott Wealth in Austin, Texas. “Also, people who have student loan debt have little money saved for retirement.”
In Paul’s example, the employee was either putting $230 a month toward student loans, to pay off the total balance in 15 years, without saving for retirement, or paying $437.50 (by also using employer contributions) toward student loans, then starting to save for retirement six years and nine months later. But this scenario, which factors in a 6% employer match, assumes a more generous company contribution than is common. Comparatively, the average match is 4.2% and it could come with strings attached.
The proposal also strips young adults of one of the greatest benefits they get to starting to save for retirement early: compound interest. Putting away $5 or $10 a month may not seem like much, but even those contributions, along with interest and investment returns, add up to a sizable amount of money in a portfolio later in life. (It also builds the habit of investing for the future, and as income increases, so too could the size of contributions.) “It destroys the compounding effect of qualified retirement plans, and puts the person even further away from their retirement goal,” said George Gagliardi, a financial adviser at Coromandel Wealth Management in Lexington, Mass.
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Some proponents said there are benefits to Paul’s proposals, though. The bill would allow individuals to use pretax dollars to pay for college expenses and student loans, and money would come out of a retirement account instead of a 529 plan, thereby being considered an excluded asset on the FAFSA application, said Timothy Neuville, a financial adviser at Marcum Financial Services in Irvine, Calif.
IRA participants can already use distributions for higher education without a penalty, though that money is still taxed, said Monica Dwyer, vice president of Harvest Financial Advisors in West Chester, Ohio. “I suppose it would be nice to offer no penalty on distributions from 401(k) accounts, but remember that this law benefits the government by encouraging withdrawals.”
The proposal also assumes Americans have access to a 401(k) plan, or one with an employer match, or they have the financial means to pay up to the match. It also raises a thorny issue of whether parents can — or should — channel some of their retirement assets on a child’s tuition or student debt.
Using retirement funds to pay for student debt or college could make the current struggle Americans have with saving for retirement worse, said Kevin Mahoney, a financial adviser and founder of Illumint in Washington, D.C. “The solution to a significant, systematic problem does not involve creating or exacerbating another problem,” he said.
