Ritter is a research-oriented financial planner and vice president at the firm. He says the role is like that of a research physician at a big teaching hospital. He spends less time planning with individuals and more time “working with math Ph.D.’s and investing experts to craft answers to the financial dilemmas that people face.”
There’s no shortage of dilemmas to confront, Ritter says, but one of the most common questions he fields from financial advisers and human resources staffers alike is how to help individuals meet the challenge of achieving adequate retirement savings while also planning for nearer-term expenses, especially higher education costs for children.
According to recent analysis from the Chronicle of Higher Education, nearly 20 million Americans attend college each year. Of that 20 million, close to 12 million (about 60%) borrow to help cover at least some of the costs. And according to the Federal Reserve Board of New York, there are approximately 37 million student loan borrowers with outstanding student loans today. Ritter says it’s common to hear from individuals who feel borrowing for college is simply a necessity—saving enough in advance is impossible, they say.
“These individuals often feel that, if they can’t save in advance, they’ll just borrow the money later,” Ritter tells PLANADVISER. “They think about it as a one-for-one tradeoff, save a dollar now or borrow a dollar later, it’s all the same in the end. But that’s not the case, not even close.”
Ritter points to an analysis on his firm’s college saving education site (www.collegesavingschillout.com) that explores the implications of borrowing $25,000 versus saving $25,000—an amount of money close to what the College Board says it takes to fund a single year of education at a “moderately expensive” in-state public college for the 2013–2014 academic year.
It takes about $70 a month in savings for 18 years to reach $25,000 as a down payment towards school, Ritter explains. “If you wait to borrow that money, it will be something like $300 a month for 10 or 12 years afterwards before you pay back the whole debt. That’s a huge incentive to save the money in advance. In the end, you can pay several times more to finance education when using borrowed money.”
The important principle for individuals to consider, Ritter says, is that saving money in advance puts the force of interest and earnings to work for the individual—whereas borrowing money puts the force of interest in opposition to the individual. Ritter says there are already powerful, tax-advantaged tools to help workers save and invest for future education costs, namely the 529 college savings plan. But even the basic association of 529 plans with education expenses remains tenuous, he says. Only about a quarter of the investing public can pin a 529 plan directly to the idea of college savings when asked, and recognition is actually declining (see “Awareness Around 529 Plans Backtracks”).
Ritter admits that in today’s environment of stagnant wages and ballooning education costs, many people would still be unable to save enough for college even with better understanding of 529s. So borrowing does, in fact, remain a necessity. In these cases, Ritter explains, it’s absolutely critical for long-term financial health to ensure that the student debt payment schedule does not cut into retirement savings, either for the parent or the student-children after graduation.
“One thing we want people to learn about loans, and student debt in particular, is that in a lot of cases there is not a huge benefit to paying the debt off any faster than you have to once you have decided to take the money,” Ritter says. “That’s because the interest rates tend to be lower on student debt.”
Ritter says current thinking suggests that it’s better to pay off the student loans “as you’re supposed to,” and then take any extra money and put it first into an emergency fund. Once an emergency fund is in place that can ideally cover about six months of expenses, then retirement savings become the priority, Ritter says.
“Very often there is a match that you’re giving up if you prioritize debt above everything else and start paying that back faster than the terms of the loan at the expense of retirement plan contributions,” Ritter says. “If it takes you a decade to do pay off the student debt, that’s a decade of lost returns on top of what you paid back for the loans. If you can afford to put money into the retirement plan while still paying back student debt, that’s an extra 10 years of compounding you can earn.
“We have put together some guidelines for folks in terms of what that hierarchy should be,” Ritter adds. “The first two things to focus on are starting to save for retirement and building an emergency fund. Then after that, you can start looking at other things, whether that’s paying down student loans or, more importantly, paying down high interest debt.”
Sue Fulshaw, managing director of retirement plan product management at TIAA-CREF, says it’s important for sponsors and advisers to understand that the effort to rank or prioritize debts and retirement savings is daunting and stressful for individuals. The situation is made more difficult by the fact that personal situations can vary widely—making general advice ineffective in this context.
“It’s a very individualized decision about how you want to manage your debt and how you are going to relate that to the retirement savings picture,” Fulshaw tells PLANADVISER. “Being that it is a very individualized decision, the important thing for employers to do is to provide appropriate education and advice to the employee base on what the factors are going into these decisions.”
The most effective support for participants entails one-on-one meetings with professional financial advisers and having a conversation on all the factors, she says, from income considerations and questions of the levels and types of debt to assessing the individual’s long-term aspirations for retirement.
“Part of the good news is that we’ve found employees are very open to advice provided through their employer,” she explains. “Really the opportunity here for us is to help educate the employees and connect them with an adviser though the workplace who is knowledgeable on these issues. Their gut may be telling them to pay the debt down as soon as possible, but the adviser will be able to bring rationality to the process and really maximize retirement readiness as well.
“Hopefully that will make them be able to make borrowing decisions that they are happy with in the long run,” Fulshaw adds.