Wealth Accumulation and Student Debt

Wealth accumulation refers to the process of building up assets and financial resources over time, often through saving, investing, and earning income. However, student debt can significantly hinder this process for many individuals. As higher education costs continue to rise, a growing number of graduates are entering the workforce with substantial debt, which can limit their financial flexibility and ability to save for future goals, such as home ownership or retirement. The burden of student loans may also impact career choices, as graduates may opt for higher-paying jobs to manage their debt rather than pursuing their passions. This situation creates a tension between the pursuit of education and the long-term financial well-being of individuals. Moreover, disparities in income and debt levels can exacerbate existing inequalities, affecting diverse communities differently. Understanding the implications of student debt on wealth accumulation is crucial for both individuals and policymakers as they navigate the complexities of education financing and economic stability.

Published in: 2021

By: Zimmer, Scott

Subject Terms

Wealth Accumulation and Student Debt

Abstract

Rising levels of student student loan debt may have an effect on the ability of people to amass sufficient resources in the form of savings, investments, and real property to be able to retire and live comfortably during the latter part of their lives. Millenials have taken on large amounts of debt in the course of their education, only to enter a job market in which jobs are relatively scarce and often do not provide the expected returns on the investment made in acquiring a university degree. Many millennials, and in some cases parents who have taken on loans to help their children, have begun to wonder whether they will be able to ever pay off the debt.

Overview

While the proportion of people in the United States attending college has increased, the long-held assumption that each generation will enjoy a greater level of prosperity than their parents has reversed. Millenials as of 2016 had not achieved corresponding levels of prosperity as compared with people in the same age group a quarter century previous, though this is not attributable to a diminishment of the "wage premium" that accompanies a college degree. Rather, a limited job market has resulted in longer term unemployment or underemployment, even for college graduates. Further, since 1990, student loans have surpassed credit cards by a substantial margin as the largest source of debt among U.S. consumers.

Wealth Accumulation. The concept of wealth accumulation has both a conventional and a specific meaning. In conventional terms, it means just what its says: the gathering together of assets in any form, including cash, real estate, investments in the form of savings, stocks, bonds and so forth, and personal property such as jewelry and cars. The specific meaning of "wealth accumulation" comes from the fields of finance and estate planning. In this context, wealth accumulation occurs as a distinct phase within the overall life cycle of personal finance. This life cycle attempts to describe people's needs and attitudes regarding money at various points in their lives. Although there are different models for the life cycle of personal wealth, a common one includes four stages: wealth accumulation, pre-retirement, retirement, and legacy. In theory, people have a different set of tasks to perform at each stage if they hope to be able to retire and live comfortably without having to work in their later years.

The general pattern of wealth management during these phases, that is, the type of behavior that is expected or recommended according to personal investment experts at each stage, changes because each stage is part of a process the ultimate goal of which is to prepare one for a comfortable retirement. During the wealth accumulation stage, which begins when one enters the workforce (usually in one's mid-twenties) and lasts until ten years before one intends to retire, the goal recommended is to acquire valuable assets and to save as much money as possible for either unforeseen expenses, emergencies, or future use in retirement.

Part of wealth accumulation involves the use of a variety of investment strategies at different levels of risk, and it is common for investors to use higher risk strategies earlier in the wealth accumulation period, because if the investment does not perform well, the investor will still have time to recoup any losses. The advantage of higher risk investments is that they generally yield correspondingly higher returns. Even small amounts consistently invested in high-yield accounts will rapidly accrue to substantial savings, which are foundational to later financial security.

After the wealth accumulation phase comes the pre-retirement phase, which typically lasts about ten years. During this period, investors move their investments into lower risk instruments in order to make sure that the assets will be available for use in retirement. At the end of pre-retirement comes the actual retirement phase, when one ceases to earn income and instead lives off of savings and the proceeds of investments made at earlier phases of wealth management. Most investors in the retirement phase concentrate on living within their established budget and avoiding undue risks that might produce expenses that have not been planned for. The final phase involves the creation of wills, trusts, and similar instruments to ensure that all assets are allocated according to one's wishes after death.

These patterns and models have been called into question, with an increasing number of people expressing skepticism that they will ever be able to retire. Some of this doubt began with the economic crisis of 2008, in which many people's investments for the future were wiped out or severely diminished. A large aging workforce unable to retire and massive job cuts coupled to generate bleak unemployment numbers and fewer opportunities for an expanding number of new college graduates, many of whom were forced to return to the parental home or pursue further degrees in order to avoid imminent student loan repayments. Additionally, many parents assumed debt to pay educational expenses for their children, thus undercutting their own ability to save. The burden of debt on former students is seen as an impediment to wealth accumulation for younger members of the workforce and a drain on finances for parents and others who have taken on debt at a life stage when personal capital should be conserved for retirement.

Further Insights

By 2014 total student loan debt in the United States had risen to more than a trillion dollars, an increase of 300 percent over eight years (Beauchamp & Cooper, 2014). That number only continued to increase in subsequent years. Not all people with student debt are college graduates, however. Many former students attended college with the assistance of student loans but left before completing their degree. Others took advantage of loans to attend non-degree programs, and still others assumed debt on behalf of family members. Total student debt continued to rise into 2016, and according to the Consumer Financial Bureau, more than $1.4 trillion in debt was spread between approximately forty-four million Americans by that year.

Debt Burden on New Workers. Student loan debt hangs over the heads of many college graduates. For many years the annual costs of higher education have risen steadily and at a rate much higher than the rate of inflation. Of all U.S. adults between the ages of nineteen and forty—the life stage in which people generally enter the workforce and are best situated to accumulate assets (such as real estate) and save aggressively—35 percent have some student debt (Ratcliffe & McKernan, 2015). The average student debt for students in the class of 2015 was estimated at $35,000, the greatest amount of student debt for a graduating class up to that date (Sparshott, 2015). According to a 2014 Gallup poll, people who held student debt some years out from graduation did not enjoy the same level of financial well-being as people without student loan debt in the same cohort. The gap in financial well-being widened with the amount of debt and was accompanied by deficits in other measures of well-being (Dugan, & Kafka, 2014).

While private student loans are available and relatively easy to obtain, they frequently have a very high interest rate. Federal student loans are available based on financial need and come in the form of low-cost subsidized loans and higher cost unsubsidized loans. Financial need is generally reflective of family wealth, and families in which older generations have accumulated wealth often confer large gifts on children and grandchildren attending college. According to a 2015 report from the Urban Institute, African Americans are more likely to carry student loan debt (42 percent) compared with whites (28 percent), based on data from 2013 (Konczal, 2015). Anxiety about repaying student loan debt is greater in lower income families, couples with dependent children, and individuals who are underemployed (Ratcliffe & McKernan, 2015).

Several programs exist to help people with student loan debt who find repayment difficult. The Income Based Repayment (IBR) program, for example, allows those with student loans to make smaller payments on their loans, because loan payments under IBR have maximums set at a percentage of the borrower's income. The goal of programs like IBR is not to make the debt go away, but to make paying it off less painful for the borrower, who may struggle for a time at the outset of his or her career before starting to earn enough to make higher payments on the debt.

Debt Burden on Other Borrowers. An increasingly common scenario is for would-be retirees to have acquired student debt as a result not of their own educational expenses, but of their children's. Traditionally, students who needed assistance paying for college would apply for scholarships and grants, and take out student loans in their own names. It can also be challenging, however, for students to obtain enough financial aid, and an increasing number of parents are finding it necessary to help their children afford the education they need to enter the workforce with the wage premium that comes with attending college.

Assuming debt on behalf of their children makes it difficult for many parents to accumulate wealth for their own future needs. Age of retirement may be extended and additional streams of income, such as from a second, part-time job, may become necessary the additional financial obligation. Presumably, the child who receives parental assistance will help pay off the debt once his or her education has been completed, but unforeseen circumstances, such as death, illness, family discord, or long-term unemployment, may interfere with the child's ability to pay.

The worst case scenario for the juxtaposition of student loan debt and retirement planning occurs when student loans have not been paid off before the borrower approaches retirement age. This is because retirement marks the point at which a person stops working and thus no longer has a salary to use when making student loan payments. Living expenses, including loan payments, must be drawn from investment income, savings, pension or Social Security benefits, or some combination of these. When a person enters retirement with outstanding student loans due, the ability to make loan payments and meet the normal expenses of everyday life may become extremely challenging.

Most of the student loan repayment measures that have been implemented are targeted toward young people who are just beginning their professional lives and have many years of repayment before them. Most programs, like IBR, are not designed to work retroactively on older debt, and neither private student loans nor Parent PLUS loans are eligible for the IBR program.

No Relief through Bankruptcy. Students are required to begin making payments on the student loans within months of leaving school. The typical student loan payment schedule is based on the assumption that the student will enter the workforce soon after graduation or disenrolling. One effect of the 2008 recession and the sluggish recovery that followed is the relatively few number of jobs available for people entering the workforce, including slots for qualified college graduates. For those who did not complete a degree, diminished income opportunity can be exacerbated by the burden of student loan debt. Widespread unemployment and lack of opportunity has led to an upsurge in defaults on student loan debt. Unfortunately for those struggling to make a living, let alone acculumate assets, student loan debt is almost never dischargeable through bankruptcy.

Student loans are different from many other forms of consumer debt, such as credit card debt or mortgages. Under certain circumstances, debts can be discharged through bankruptcy, thereby allowing a debtor unable to meet his or her obligations, to renegotiate loans or sometimes have certain debts forgiven altogether. While the bankrupt party's credit temporarily suffers, ability to pay creditors and begin wealth accumulation is established. Student loan debt is specifically excluded from bankruptcy consideration in most cases. Most student debt originates with the federal government, and the exclusion is rooted in the fear that easily obtained student borrowing would lead to widespread abuse. For those hit hard by the tepid job market and carrying student debt, the bankruptcy exclusion has imposed an inexorable impediment to wealth acculumation (Beauchamp & Cooper, 2014).

For families with student debt, where one or both parents become unemployed or otherwise undergo an income reduction, the shock of new loan payments upon a child leaving school can be devastating. Repayment may require penalty-laden withdrawals from retirement accounts or the sale or refinancing of the family home. What is more, even though Social Security income may not be touched by most creditors seeking repayment, with student loans the government is able to withhold up to 15 percent of each Social Security payment if there is outstanding student loan debt in the name of the Social Security recipient. This can mean that elderly debtors may see the income they were expecting to live off of reduced by garnishment of a portion of their Social Security. As the cost of living has continued to rise alongside the amount of student debt, concerns also grew that an increased number of older Americans still struggling with student debt and paying for children's debt could be facing a retirement marked by poverty due to their reliance upon Social Security. The US Government Accountability Office (GOA) was therefore asked in 2015 to look into the trend in which the Social Security benefits of older Americans were being garnished to pay off student loan debt to determine how well they were able to live on what they had left. The GOA reported in 2016 that in fiscal year 2015, $171 million of the $4.5 billion collected on defaulted student loan debt was collected through Social Security offsets. Almost 114,000 people over the age of fifty had Social Security offsets in 2015 (US Government Accountability Office, 2016).

Viewpoints

Students who are unable to find employment after leaving school or are able to find only low wage work that barely pays enough to live on are hard pressed to make their student loan payments. Some students are thus faced with the prospect of devoting all of their disposable income to student loan repayments throughout the initial period of wealth accumulation in which they would ideally purchase a home and begin contributing to their retirement. Balancing the priorities of wealth accumulation and student loan repayment can require extremely difficult decisions. Many are uncertain whether they should focus on paying off their student loans and put off saving for retirement until the loans are paid, or if they should make their priority into retirement savings and avoid confronting the issue of student loans. Most financial advisers state that neither of these options is wise, since they can both have unfortunate consequences. Unpaid student loans can injure one's credit rating and result in garnishment, while retiring debt free but without any savings would leave one with little or no money to live on.

The most common advice given by financial planners is to first minimize student loan payments as much as possible, by consolidating several loans into a smaller number of loans, hopefully at a lower interest rate, and then to make these (hopefully smaller) payments on schedule every month. Then, at the same time, devote as much of what remains to saving for the future. Some borrowers explore alternative courses of action, such as using home equity to pay all or part of their student loans, effectively consolidating their student loan and mortgage debt, though at the cost of asset accumulation in the form of home equity.

Terms & Concepts

Disposable income: The portion of a person's earnings over which they have discretion; in other words, what is left over after expenses such as rent, utilities, and other bills have been deducted from income. Some student loan repayment assistance programs base the maximum monthly payment a person may be required to pay on a fixed percentage of the difference between the poverty level and that person's discretionary income.

Four phases of wealth: Financial managers often advise their clients that most people go through four stages in relation to money: wealth accumulation, pre-retirement, retirement, and legacy.

Garnishment: Garnishment is a process through which a person's earnings can be forcibly withheld from payments owed to the person as wages or as earned benefits such as Social Security. Garnishment is not available for all types of debt, and when it is available it is usually limited to a statutorily set percentage of the person's income.

Graduated repayment plans: A student loan repayment assistance program that begins with lower monthly payments when the borrower begins to repay the loan, and increases the size of these payments every two years.

Income Based Repayment (IBR): IBR is a program implemented by the federal government to assist those having difficulty repaying their student loans. Under IBR, the monthly repayment amount due from a student is capped at a percentage of the person's monthly income. The IBR amount also factors in the the number of dependents being supported by the person's income, in an effort to help people repay their debt without excessive financial suffering.

Optimal portfolio: An optimal portfolio includes a range of investments in various instruments, and is able to maximize returns on these investments while minimizing risk. This allows the investor to earn more while reducing the chances of losing money.

Parent PLUS loan: A Parent PLUS loan is a loan from the federal government that a parent of a college student can take out in order to help the student pay for his or her education. The Parent PLUS loan differs from traditional student loans in the fact that it is taken out in the name of the parent rather than in the name of the student attending college.

Bibliography

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Sparshott, J. (2015, May 8). Congratulations, class of 2015. You're the most indebted ever (for now). The Wall Street Journal. Retrieved December 28, 2016 from http://blogs.wsj.com/economics/2015/05/08/congratulations-class-of-2015-youre-the-most-indebted-ever-for-now/

US Government Accountability Office. (2016, December 19). Social security offsets: Improvements to program design could better assist older student loan borrowers obtaining permitted relief. US Government Accountability Office. Retrieved December 28, 2016 from http://www.gao.gov/products/GAO-17-45

Wealth Accumulation and Student Debt

On this Page

Subject Terms

Wealth Accumulation and Student Debt

Abstract

Overview

Further Insights

Viewpoints

Terms & Concepts

Bibliography

Suggested Reading