It was a whirlwind week with lots of different client
scenarios that I’ve been asked about, but they all have some common themes.
First, let’s take the story of a local high school senior
who didn’t have enough savings to pay for college. I had the opportunity to
meet this young woman, and she is simply amazing in pursuing the money for
college. She resorted to unconventional means to raise money. That, in turn,
attracted world wide attention on the news and social media.
Her story and fundraising page are here.
Personally, I’m glad to have been a small part of this, trying to help her achieve her college goals.
Take a step back, and think about what happened here. How
did this happen? Both of her parents have professional jobs and an otherwise
comfortable existence. For whatever reason, her parents didn’t plan for her
college and were in no position to help her in substantive way.
That lack of foresight and planning when she was younger have
now limited her flexibility regarding school choices and ultimate ability to go
to college.
Please note that I am not judging her or her parents in
any way. Rather, they are facing the results of their actions (or lack
thereof). Not every parent feels the need to help pay for college, so the fact
that this girl’s parents aren’t in a position to help really isn’t that unusual
in my experience.
What this means is that this girl is likely to take on much
more student debt to help pay her way through school.
In an article that likely surprised absolutely nobody, Morningstar
wrote an article about their subsidiary HelloWallet and a study conducted
looking at the relationship between student debt and retirement savings.
The bottom line here – people who are saddled with student
debt save less for retirement than people who don’t have student debt. This
revelation is like predicting yesterday’s weather!
The article does make an interesting point in that by not
prioritizing debt payments, and instead saving, a person’s long term net worth
is much higher than if the debt was paid off first.
Why is this? Compound interest.
Compound interest simply means that interest earns interest,
so does so as long as the money is left in an account.
When you pay off debt, interest doesn’t compound
(thankfully). If you have a credit card balance and pay off that balance,
there’s no more interest. And zero interest paid results in zero additional
interest!
Personal finance articles often state that by paying off
your debt gives you a guaranteed return of whatever interest rate was on the
loan. True enough, but that doesn’t consider that the return is only one time.
Instead, saving the money earns a return that can compound for many years!
Hopefully, the graduating high school student will
understand this article and save for her long term wealth – and health!
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| Not the type of flexibility I'm talking about, but impressive given that I can't even touch my own toes! |
What the article doesn’t talk about is what types of
vehicles to use for retirement savings, and that lack of planning can reduce
flexibility.
This brings me to the other type of client I saw this past
week - the recent retirees.
Two couples recently asked me about their retirement
savings. Both couples were high earners, appeared to have plenty in savings,
and enjoyed a comfortable lifestyle. The combination of Social Security and
retirement withdrawals allowed each couple to travel, buy gifts for grand kids,
and otherwise do what they wanted.
Their questions though dealt with a topic one would not
normally associate with retirees – taxes! Because they had saved diligently in
their work 401ks and IRAs, they now have to take “required minimum
distributions” from those accounts per IRS regulations. Those withdrawals, plus
their Social Security, were leading to higher taxes and higher Medicare
premiums.
Why higher taxes? No more kids in the house so fewer tax
exemptions. Mortgage paid off so no more interest deductions. And no more tax
deductible 401k contributions. The net result is that income may have dropped
from their final working years, but taxable income has gone up!
Because they didn’t have the flexibility of adjusting, or
even stopping their withdrawals, they had to take out more money than they
wanted to cover taxes. In turn, that is now leading to worries that they might
outlive their money.
Instead, had they diversified the types of accounts used for
retirement savings based on tax treatment, they could vary the timing and tax
impact of their withdrawals to make their money last longer – and pay less in
taxes!
Their lack of planning limited their flexibility. And
their lack of flexibility is limiting their freedom because they’re worried
about making the money last.
This brings us back to the high school girl.
It is impossible to say that her life would follow a pattern
suggested here, but it’s not unreasonable to think that it would.
She’s going to have to take on extra debt to pay for school.
She’s likely to save less for retirement because of that
debt.
She’ll have less money in retirement, or unknowingly limit
her own flexibility to help make the money last.
What’s my point with this?
People often think of money and goals in silos. One doesn’t
affect the other. But they really do. If I told this 18 year old girl and her
parents that by not planning properly for college, it was going to hurt her
retirement, do you think they would have believed me? Of course not!
Ask yourself this question – based on what you know now,
what would you have told your younger self about finances that would have led
to better results today?
What do you think the 65 year old future self would tell the
18 year old of today?
Leave your answers, comments below!
