Sen. Rand Paul (R-KY) this week unveiled his plan to fix the student debt crisis by allowing borrowers to dip into their retirement accounts to pay off education loans and expenses.
But experts say the effort is misguided and, at worst, detrimental to Americans’ future security.
“It’s not like Americans are flush with retirement savings where they have money to spare to repay student debt,” Greg McBride, Bankrate’s chief financial analyst, told Yahoo Finance. “Taking withdrawals from retirement accounts will rob Americans of years of valuable compounding that is critical to accumulating a sufficient retirement nest egg.“
The Higher Education Loan Payment and Enhanced Retirement (HELPER) Act, which Paul introduced on Monday, proposes to allow Americans to withdraw up to $5,250 from their 401(k) or IRA accounts – tax- and penalty-free – to pay back their student loans or tuition expenses. The funds can also be used to pay for tuition or expenses for their spouse or dependents.
“Instead of empowering the federal government to increase its involvement in education, which will only raise costs even higher and further lower the value of our dollars to cover them, we can empower the American people to reduce the burden of debt, realize the dreams they studied hard to achieve, and grow their retirement savings,” Paul said in a press release.
Kicking ‘the can down the road’
But many households are already behind on saving for retirement, many experts point out. More than 3 in 5 Americans say they need to catch up, while half of workers have already raided their retirement savings for unexpected expenses, down payments on houses, and tuition.
“Most families do not save enough for either retirement or college,” Mark Kantrowitz, publisher of Savingforcollege.com and an expert on student debt, told Yahoo Finance. “This could kick the can down the road because contributions to retirement plans are limited, potentially leaving workers with less money for retirement.”
There could be a silver lining, though, Kantrowitz said. Paul’s bill may encourage larger contributions to retirement plans. Currently, only 1 in 5 Americans max out their 401(k) or IRA contributions, according to TD Ameritrade.
On Twitter, users also panned the senator’s proposal.
Let me get this right, you’re gonna let us use our entire 401K the first x number of years of our career to pay for our student debt, so we start actual retirement savings 6-10 years later than expected AND we aren’t getting social security after it runs out in 2035!!! https://t.co/IrkrZwWI2w— Zach Tallevast (@CardHard11in11) December 5, 2019
So, rather than middle-aged and in debt, we’ll leave you old and desititute.— And other duties as assigned (@FredPoling1) December 4, 2019
Don't forget to raise the age or retirement and cut social security benefits before you use your 401k...— James Moriarty (@prof_jmoriarty) December 5, 2019
Coming up next: you can pay your student loans with your organs.
One kidney for 40% of your student loan debt.
What could possibly go wrong?
Who benefits from this plan?
Americans currently owe around $1.5 trillion in student debt, out of which 11% is more than 90 days delinquent or in default as of the third quarter, according to the Federal Reserve Bank of New York.
This “suggests that they are not earning enough to repay their loans,” Deborah Goldstein, executive vice president at the Center for Responsible Lending, told Yahoo Finance. “So I am not sure that this proposal, which focuses on people who are putting aside retirement savings out of their incomes, really gets at the heart of the problem, which is that there are a lot of students who are not earning enough to be able to make payments.”
But if the bill does go through, it would help wealthier people who have the capacity to save for retirement, Goldstein said.
“It would mean they could use those retirement accounts,” she said, “and make payments on loans.”
The legislation could also benefit parents who aren’t sure if their child will go to college, Kantrowitz said. Instead of saving in a 529 plan – funds that must be used for education expenses to avoid penalty – parents can save through their retirement plans.
“If the child does not go to college, they get a head start on retirement,” Kantrowitz said. “If they go to college, they can use the money after college to pay down their student loan debt.”
Paul also wrote an op-ed in the Lexington Herald-Leader, arguing that choosing to invest $5,250 in student loan repayment instead of a low-yielding U.S. bond through a 401(k) is “more advantageous to workers, as 95 percent of the student loan payment goes to principle.”
But McBride noted that 401(k)s should be heavily tilted towards stocks, not bonds, when a person is young. Using retirement funds to pay off student debt also means you miss out on a critical compounding effect, he said.
“Time is your biggest ally in long-term savings, whether that is for retirement or education,” he said. “Delaying saving until paying off debt can leave a big hole in your future financial security, and taking early withdrawals to pay off debt has the same detrimental effect.”
Tax-free employee contribution a ‘promising idea’
Experts applauded other aspects of the bill, though.
The legislation allows for employer-sponsored student loan and tuition payment plans to be tax-free, up to $5,250. It would also repeal the cap on deducting student loan interest.
“That seems like a very useful, promising idea,” Goldstein said.
Kantrowitz agreed: “It will have a small, but positive impact on borrowers, saving them hundreds or thousands of dollars a year.”
That portion of the bill is similar to another bill floating around in Congress, the Employer Participation in Repayment Act of 2019, which also would make employer contributions to workers’ student loans tax-free.
Aarthi is a writer for Yahoo Finance. She can be reached at firstname.lastname@example.org. Follow her on Twitter @aarthiswami.