Why We Need a 401(k) Plan for Student Loans
June 24, 2015

Why we need a “401(k) for student loans.”

Today’s recent college graduates – the people you’re trying to hire – have a problem: The cost of education has ballooned far faster than their ability to earn money to pay for it – both during and after college. Many of them are graduating with student debt levels nearly unheard of just a generation ago.

Consider: The average debt carried by last year’s class of four-year non-profit college graduates was $28,400 — roughly 50 percent higher than it was a decade ago, according to The Project on Student Debt. At the same time, a recent report from the U.K.-based research firm Mintel found that “almost a quarter of respondents believe that their student loan payments will get in the way of them applying for a credit card or a mortgage, which may further dampen the sluggish economic recovery.

That’s a problem indeed.

When you graduate with a year’s worth of your entry-level income or more in student debt, it’s like coming to the plate with two strikes against you. When that happens, it’s hard to swing for the long ball. These younger workers are simply trying to get on base.

And here’s the challenge for employers: The traditional 401(k), SIMPLE IRA and 403(b)-type retirement savings products that were so beloved of the Baby Boomers and Generation X no longer adequately incentivize workers struggling with student loans.

Think about it: Your 401(k) plan has a vesting schedule, correct? You might have a great match, but employees don’t get to keep it unless they’ve been in service a certain number of years.

Why is it employers routinely vest employer contributions over a period of several years instead of granting them up front? To encourage good employees to stay, of course! Historically, a substantial match and intelligent vesting schedule has been a powerful incentive to stay in the company.

But that was a while back – when students were graduating with half the debt loads they have now, and when they had strong economies that made it easier for them to contribute at least enough to pick up the company matching contributions.

Things are different now.

Students today know that paying down a student loan provides a known, guaranteed, risk-free rate of return. They may not know much about mutual funds. But they know that a bird in the hand is worth two in the bush.

They also know that student loan debt is not dischargeable in bankruptcy. They all have to go to exit briefings before they graduate explaining this in brutal detail.

What’s the message they get from lenders? It’s like Ray Liotta’s character’s now iconic line in that scene from Goodfellas: “F*** you, pay me.”

The lawyers are enforcing the deal, and the media is reinforcing the message.

They are actively asking themselves whether it’s better to contribute to a 401(k) plan or pay down student loan debt.

And so from the point of view of the younger, debt-saddled employee, that 401(k) plan, or SIMPLE IRA or 403(b) as the case may be, isn’t that compelling an option.

Let’s take it a step further: For a young employee – and for many who aren’t that young anymore – they have shorter-term goals than retirement that are more immediate and pressing:

They want to get a car loan for an affordable and reliable car – or save up cash to get it. (Cash for clunkers took a lot of cheap beaters off the road! It’s tougher to find an inexpensive car that youngsters can work on themselves than it used to be!).

They want to get an apartment in a nicer neighborhood, but now they need to qualify with at least 3 times the rent in income. But rents are rising faster than income – up 14 percent since 2010, and even more in some markets.

They want to qualify for a mortgage but need a minimum debt-to-income ratio – currently 43 percent, in most cases, for a conventional mortgage acceptable to Fannie Mae. For VA loans, there’s no down payment required, but the back end ratio required is even lower – 41 percent.

Debt on the balance sheet hurts their chances of obtaining credit, and the sooner they can pay off their student loans – or at least refinance down to a lower payment – the more easily they can meet these life milestones.

How does the standard 401(k) help them? Answer: It doesn’t. The more they contribute, the lower income they show on a credit, rental or mortgage application, the less apartment they qualify for and the harder it is for them to purchase a home.

There’s a fundamental mismatch, then, between the priorities of senior management and older HR professionals and those of younger college graduates struggling under debt loads amounting to $1 trillion nationwide.

The Solution

From a public policy perspective, it’s a tough nut to crack. But there’s a pressing need for some kind of relief for millions of these younger workers who are having trouble launching – and therein lies an opportunity for employers to add substantially to their own value package while differentiating themselves from other employers competing for the same talent: Offer a student loan repayment program as an employee benefit.

Offer it as an alternative right alongside your 401(k) plan, perhaps

as a bridge program designed to get these workers into your retirement plan. A kind of “student loan repayment 401(k),” if you will.

And because such a plan would not be a qualified plan under ERISA (or much of anything else!), the employer has a great deal of flexibility in how they set it up.

You could create a matching plan, where your employee contributes a certain amount each month (after taxes) to pay down the loan and you contribute a sustainable match.

You could create a seniority-based program, or provide a sweetener for various service milestones.

You could create an additional incentive for promotion to a level of seniority that qualifies for the program.

Additionally, this program could be offered in conjunction with an education assistance program. Those seeking to complete degrees would be incentivized to become eligible for the company EAP. If they already have degrees, they’ll want to work hard to become eligible for your student loan repayment assistance program.

Advantages to Employers

The advantages to the worker are obvious. But there are a number of advantages to the employer as well:

  • Employer payments to education creditors made on a workers’ behalf are fully deductible as compensation expenses (though taxable to the employee.
  • Increased employee loyalty
  • Lower turnover, with attendant savings in recruiting and bonus costs
  • Less risk of losing a promising worker to government or military opportunities – both of which offer substantial student loan repayment or forgiveness programs
  • Referrals. Workers who benefit from student loan repayment programs generally know many other equally talented people in a similar position. In a competitive market for skilled and educated employees, this is an important edge.

The 401(k) is a fine program, and together with its cousin the SIMPLE IRA is an essential part of retaining quality workers in today’s market – after a certain point. But in a changing economy, with a new generation of workers now entering the work force, employers must match their incentives with the reality that today’s younger college-educated workers face.