Capital Ideas^™ 
Investment insights from Capital Group

While there is extensive media coverage regarding Americans’ lack of retirement savings, a much less discussed topic is the growing amount of debt that Americans carry into retirement. Larger mortgages, higher student loans and a greater overall comfort with debt than displayed by earlier generations has increased the average debt for households approaching retirement by nearly 160% from 1989 to 2010, according to AARP.

Making payments on this increasing amount of debt can force people to retire later than they’d like or borrow more after they stop working, when household income generally falls.

U.S. consumer debt timeline

Credit innovations since World War II have helped fund the rise in the U.S. standard of living by providing financing for home mortgages, credit card spending and education costs.

 

When you retire might depend on when you were born

The rise in debt affects age groups differently. For current retirees, who are generally of the so-called silent generation born before the mid-1940s, debt is much less of a problem. They have borrowed less and owe less than their generational counterparts.

Those approaching retirement, the baby boomers, are far more indebted and as a result are, on average, 15% less confident about their financial security and preparedness than the silent generation, according to a recent Pew Charitable Trusts report.

But boomers can instruct on the importance of retirement saving. The younger generations are borrowing even more.

Generation X’ers are the most heavily indebted generation in U.S. history, although millennials top the list in terms of student loan debt, as education costs continue to increase much faster than household income.

With different generational experiences of debt, it’s no surprise the generations have different levels of confidence in their retirement security. According to the Employee Benefit Research Institute’s (EBRI) 2015 Retirement Confidence Survey, current retirees actually retired earlier than current workers expect to retire. Only 14% of current retirees actually retired at age 66 or older, while almost half of current workers 55 or older expect to retire at 66 or older. Moreover, 11% of current workers 55 or younger never expect to retire, according to the survey.

What is the impact of higher student loan debt on retirement savings?

The rapid increase in student loan debt has led some to wonder if younger generations will face more hurdles to retirement preparedness than their parents did. If today’s working households had started out with the student loan balances facing recent college graduates, the number of households at risk of not being able to maintain their pre-retirement standard of living would increase from 45.3% to 51.6% (for the group aged 50-59). That’s the conclusion of “Will the Explosion of Student Debt Widen the Retirement Security Gap,” by Munnell, Hou and Webb, a paper published in 2016.

In a more positive light, a recent Center for Retirement Research (CRR) paper, “How Does Student Debt Affect Early-Career Retirement Saving,” concludes the relationship between student debt and participation in a retirement plan is small and not statistically significant. “Though young workers’ balance sheets are clearly hurt by student debt,” authors Rutledge, Sanzenbacher and Vitagliano argue, “they do not substantially reduce retirement saving to compensate.”

How to bring debt into balance

For better or worse, debt has become a key method by which American households increase their lifetime earning power. Easier access to credit and greater debt availability have helped many Americans afford major purchases such as homes, which have strengthened the asset side of their balance sheets, as well as college degrees, which have become increasingly necessary in the competitive labor market.

The loans and credit cards that expanded opportunities during the working years can constrict flexibility in retirement. A proper financial plan should include paying down as much debt as possible while you are still working.

5 ways to reduce the impact of debt in retirement

1. Budget during your working years, so that as many major and emergency expenses can be managed through savings as possible.
2. Stick to the budget, so dollar limits are enforced on entertainment, food, clothes and holiday items you want but may not need.
3. Optimize the amount saved for retirement through consistent contributions to IRA and/or 401(k) accounts.
4. Contribute to 529 plans to help plan for college expenses and potentially unburden the next generation from large amounts of student loan debt.
5. Educate yourself on the costs of debt, which far outweigh the costs of the item financed (even with today’s low interest rates).