Benefits June 24, 2014

Linking Student Debt and Retirement Savings

June 24, 2014 (PLANSPONSOR.com) -- One lesson Stuart Ritter, of T. Rowe Price Investment Services, strives to impress on the public is that $25,000 saved and $25,000 borrowed are far from equivalent.
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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. 

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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 PLANSPONSOR. “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 PLANSPONSOR. “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.

Benefits June 24, 2014

How PBGC Premium Increases Would Impact DB System

June 24, 2014 (PLANSPONSOR.com) – A new report finds that Pension Benefit Guaranty Corporation (PBGC) premium increases would negatively impact the defined benefit (DB) pension system.
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“Further PBGC Premium Increases Pose Greatest Threat to Pension System,” recently released by the American Benefits Council, finds that PBGC premiums are disproportionately high already and that further increases could force employers out of the DB plan system and erode the PBGC’s premium base.

The report’s authors point out that premiums have increased substantially over the past decade or so. Specifically, between 2005 and 2016, the flat rate or per-participant premium is expected to more than triple, from $19 to $64 per participant. In addition, the variable rate premium is expected to more than triple, from $9 per participant per $1,000 of unfunded vested benefits to at least $29 per participant, during the 2012 to 2016 time period.

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The increases translate to “real and significant liabilities for employers and ultimately for employees,” according to the report. While the rationale given for these premium increases, by Congress, is to avoid short-run liquidity problems, the report finds that the PBGC holds enough assets to pay all benefits to participants in terminated single-employer defined benefit pension plans for many years into the future.

In addition, the report finds that proposed premium increases would impose an estimated $2 billion per year of additional costs on employers in the single-employer DB plan system by fiscal year 2024. Over the short run, employers may address these costs by reducing capital investments or reducing dividends paid to shareholders.

“All available data refutes the notion that the PBGC’s single-employer guarantee program needs additional premium revenue,” contends American Benefits Council President James A. Klein, based in Washington, D.C. “The agency’s self-reported deficit belies the fact that PBGC’s assets and income far exceed its foreseeable payouts.”

The report also finds that:

  • Artificially low interest rates inflate purported underfunding of pension plans and the PBGC’s self-reported deficit. More than 96% of PBGC’s own reported deficit estimates relate to plans that have already exited the DB plan system. So, current sponsors of plans that pose no risk to the PBGC are forced to pay for the actions of employers who long ago terminated their plans.
  • Double counting of PBGC premium increases perpetuates long-term deficit spending. Policymakers perpetuate long-term deficit spending by, in effect, “double counting” premium increases (which can legally only be used by the PBGC) for general revenue purposes, thereby offsetting spending for completely unrelated matters.
  • The mandatory nature of the PBGC program effectively gives employers only one choice to avoid burdensome premiums, which is to exit the system by de-risking. Employers lack a competitive market for the service provided by the PBGC. The only options available to plan sponsors to reduce the burden of PBGC premiums are to reduce risk through buyouts and other measures, or exit the DB plan system completely.
  • The PBGC premiums represent taxes on employees. While employers face the statutory incidence of these taxes, the impact is ultimately felt by employees if the result is to compel employers to freeze or terminate the DB plan.

Klein adds, “The same abnormally and artificially low interest rates that are inadvertently punishing pension plan sponsors are also distorting the true financial position of the PBGC. We urge lawmakers to avoid a third consecutive year of premium hikes and focus instead on making it easier for employers to stay in the system.”

Revised figures about participant longevity, when combined with potential premium increases, could also negatively affect the DB plan system, according to the report. New mortality tables generated by the Society of Actuaries show that plan participants are living longer. Once the Internal Revenue Service approves these new tables, pension liabilities will significantly increase. As a result, the funding levels of DB plans will decrease, resulting in substantially increased funding requirements and higher PBGC variable rate premiums.

The full text of the report can be downloaded here. The American Benefits Council is a national trade association for companies concerned about federal legislation and regulations affecting all aspects of the employee benefits system.

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