Must clients choose retirement savings or paying student debt?
Young clients shouldn’t have to decide between paying off student loans and saving for retirement.
“It isn’t about doing one over another but prioritizing,” says Davon Barrett, an advisor at the firm Francis Financial in New York. He says he tells clients they should contribute the percentage of their income that will generate the maximum employer match on their 401(k) or similar plan.
“Otherwise,” he says, “You are essentially leaving free money on the table.”
The $1 trillion student debt load in the U.S. can threaten the future financial security of millennial clients. Over 42% of millennials between the ages of 18 and 29 report that they or someone in their household has student debt, according to a 2017 poll conducted by Harvard IOP at the Kennedy School.
Helping clients understand compound interest is one vital role advisors can play.
“Many college students don’t save for retirement because they don’t think they have enough money to make a difference, but one major key is maximizing compound interest,” Barrett says. “Over decades, original contributions will grow exponentially because of compound interest.”
If a client contributes just $25 per month to a retirement account earning 7% interest, they’ll have $59,890.53 after 40 years, says Barrett.
“Nearly $48,000 of that growth can be attributed to compound interest,” he says. “The longer a student waits, the less that impact is felt.”
The average class of 2016 graduate has $37,172 in student debt, up 6% from last year, according to Student Loan Hero, an online tool for helping millennials understand and repay student debt.
Younger clients, who are decades away from retirement, often focus on eliminating this debt rather than saving for later life, but advisors agree this isn’t the best approach.
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Advisor Erin Deopel Wikstrom, who works with millennial clients, has developed a hybrid approach to help her clients live in the moment while preparing for their financial future.
Wikstrom , a planner with the Doepel Group at Raymond James, says her strategy begins with a cash flow analysis, taking into account current income and liabilities. Because her millennial clients haven’t had much time to accumulate assets, their greatest asset is their earning potential.
“We start quantitatively: How much do I make? How much do I need to live? This area requires, perhaps, some sacrifices,” Wikstrom says. “It may require forgoing little luxuries; this is where we complete an assessment of what truly brings us fulfillment.”
The framework for Wikstrom’s hybrid strategy is built with what’s left after she and the client determine what funds are available for basic needs and some wants.
“Whatever is remaining is then split between debt reduction and retirement savings. This is where our discussion becomes more qualitative rather than quantitative,” she says.
THE DIY GENERATION
A growing number of older Americans have defaulted on their federal student loans, according to a GAO report. As a result a portion of their Social Security retirement or disability benefits is withheld above a minimum benefit threshold to repay the debt.
Since Social Security is the primary source of income for many older Americans, it’s paramount to make sure clients understand they need a retirement plan. Otherwise they could find themselves in a situation where their Social Security is being garnished to pay back decades-old debt.
“Millennials are such a do-it-yourself generation,” Wikstrom explains. “But now more than ever they need an advisor because they’re just Googling and researching on their own accord what the best philosophy is, and they’re coming back with old-school theories.”