Lowering Financial Barriers to Education

This is the final post in a series that examines the history of student loans and the disconnect between the cost of education and how it is rewarded. This post proposes measures we can take to improve how we serve and price higher education.

Lowering the financial barriers to education requires a rebalancing of the cost and reward of higher education with adjustments to each layer of the system. These are our recommendations:

1. Share the burden
2. Service better
3. Lend less

We focus on changes driving immediate impact for the person burdened by student debt. Certainly, the way we price and deliver higher education requires long term efforts. We have to begin by reducing the burden on the debt holder.

Share the burden

Student loan repayment benefits are the most sought after benefits following medical and paid time off. The number of businesses offering some form of student loan repayment assistance has doubled since 2017. This is the market speaking and demanding a solution to a very real pain. The unfortunate truth is that most of the small to medium businesses that are the lifeblood of our economy, hiring more than 52% of the workforce, cannot afford to offer repayment assistance. These businesses already struggle to attract and retain talent and should be empowered to participate in repayment assistance programs.

Student loan repayment assistance offers employers an avenue to reduce financial stress among their employees, improve engagement, improve talent acquisition, and improve talent retention. 86 percent of employees ages 22 to 33 would commit five years to a company in exchange for student loan repayment assistance. These outcomes make a measurable impact on employers’ bottom lines.

Since taxpayer money funds federally guaranteed student loans it would only make sense to give the taxpayers a break and allow businesses to participate in tax incentivized student loan repayment assistance programs. We recommend two ways to do this.

1. Permanently include student loan repayment as a qualified deduction and increase the incentive to be current with inflation

Recently, the Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded the definition of "educational assistance" in Section 127(c) of the Internal Revenue Code (IRC) to include payments made towards employees’ student loans as tax deductible for the employer and not part of adjustable gross income (AGI) for the employee. The $5,250 cap that applies to education assistance programs holds true for student loan repayments made by employers, but the provision will sunset on December 31, 2025 if supplemental bills are not passed. To build on this progress, legislators should permanently consider student loan repayment as part of education assistance and increase the cap on contributions from $5,250 to bring the incentive current with inflation. The cap on contributions was last evaluated in 1986, which adjusts to $12,348.85 after inflation (as of June 2020). Tax incentives should be provided in real dollars and provisions should be considered for automatic increases of caps every 5 years. Educational assistance deductions are one of the most underutilized deductions. It’s time the government took action to create better incentives for employers to activate these deductions.

This simple extension could have a massive impact for borrowers. The average graduate owes $33,000 and makes a monthly payment of $357. An additional $5,250 annually from their employer, disbursed monthly, would get them out of debt 5 years earlier and save $2,748 in interest. At $12,348 a year, they’re out of debt 8 years earlier and save $3,465 in interest.

Given the current default rate is 12%, extending and expanding incentives for employer participation in student loan repayment would result in savings for the federal government from improved collection rates:

• Estimating this incentive reduces the default rate to 8% in five years
• Assuming the loan portfolio maintains an average annual growth rate of 5.33% (AAGR of federal portfolio from 1970 to 2019) over that time
• The federal government would save $71 billion in uncollected loan balances.
• That is equivalent to the total federally backed loans issued in 2019.
• It would take over 17 million Americans at $5,250 (or 7 million at $12,348) receiving this benefit from their employers to nullify these savings from loss of employer income tax due to the incentive

2. Expand the contingent benefits restrictions on 401K plans

In 2018, the IRS issued a private letter ruling (PLR) to allow an employer to provide 401(k) matching contributions when their employees make payments towards their student loans. Previously, the primary source of contention was whether such an arrangement would violate the provision for restrictions on contingent benefits described in section 401(k)(4)(A) and section 1.401 (k)-1 (e)(6) mandated for 401K plan design. These restrictions exist to deter employers from creating unfair incentives for employees to participate in company sponsored programs. The IRS concluded that the mechanism by which the employer was proposing to implement the student loan benefit program would, in fact, not violate the restrictions. In doing so, the IRS opened a floodgate of similar requests. Inundated with requests for PLRs and recognizing the popularity of the innovation, the IRS promised to provide general guidance by June 2020. That date has come and gone by leaving many hopeful businesses stalled.

How much additional 401K saving would such an incentive influence?

• 25% of millennials with access to a 401K are not making contributions.
• On average, those that do contribute, put away about 7.3% and earn an average employer matching contribution of 4.1%. That totals to an 11.4% savings rate.
• The median income for households headed by millenials with at least a Bachelor’s degree was $105,000 in 2018.
• If 90% of those millennials currently not contributing to their retirement as the result of student debt (13.5 million people) start earning a 401(k) match from their employer when they pay their student loans, they’d be getting $4,317 in annual matches.
• That's an additional $70 billion in tax deductible 401(k) contributions by employers and increases in retirement savings per year by over $70 billion.

Given the Center for Retirement Research has projected student loan debt to increase the number of households at risk at time of retirement by 4.6%, how would this extra $70 billion impact retirement savings (and risk) for the recipients? A quick example:

• A 30 year old, retiring at 67
• Earning a 5% average real rate of return
• Yields an extra $438,759 at retirement.

Across the group, using 30 as the median age of millennials, that compounds to over $7.1 trillion in real dollars by 2057.

What does this tax incentive cost the government?

• Note the estimated $70 billion in tax deductible 401(k) contributions by employers when employees can earn a 401k match when they pay their student loans
• At a 20% corporate tax rate, that is a potential loss of $14 billion in tax revenue for the government.
• Over 37 years, that adds up to almost $1 trillion if corporate incomes grow at 3% in line with inflation.
• However, the net gain in savings on social security payouts would still sit at almost $6.1 trillion. By passing these incentives the government can address both the student debt and social security crises.

Service better

The repayment experience loan servicers give borrowers is a major source of pain for the borrowers. We need to address deficiencies in servicing and open up the space to allow financial companies to innovate and evolve the legacy processes borrowers struggle with today.

1. Address deficiencies in loan servicing

Given the many barriers to student loan repayment, there is simply no room for an ineffective collection (loan servicing) process for those that are able to make payments. It’s clear that repaying student loans can be made a more effective and joyful experience.

A 2015 Consumer Financial Protection Bureau (CFPB) report assessed that current servicing practices may not meet the needs of borrowers or loan holders. The report calls out deficiencies in access to borrower benefits, the servicing of transfers, customer service, error resolution, and payment processing.

2. Mandate support for 3rd party payments companies

Outside of correcting deficiencies in loan servicing experiences, there is immense room for innovation in how borrowers experience repaying a student loan. Growth in financial technologies has led to advances in how consumers manage and interact with their finances digitally. Financial products, like Dolr, are now being tailored to fit users’ lifestyles to incentivize consistent, positive behavior in a way that brings delight to maintaining a healthy financial life.

For example, at Dolr we are:

• Allowing daily, weekly, and bi-weekly payment schedules to help borrowers align repayment with the timing of income and expense events within their month.
• Providing simple tools for borrowers to better understand their debt picture and see how decisions regarding payment plan selection, increased payments, and interest capitalization impact their specific repayment journey in terms of time and money saved.

Understanding the current deficiencies in loan servicing come from a historic lack of innovation in these areas, it may not be feasible or practical to expect loan servicers to independently spend resources developing innovative and user-friendly loan repayment experiences. For this reason, the government must mandate support for 3rd party payments companies that are innovating on behalf of loan services.

Loan servicers should provide an Open Data style access to borrowers loans by providing standardized API access that third parties can build innovative products on top of to maximize the borrower experience.

Lend less

In general, college dropouts bear the heavy burden of having all the risk but none of the returns associated with earning a degree. Pressured by society, lenders seeking to expand their serviceable addressable market, and institutions focused more on profits than education, the qualifications required to attend a 4 year public college have significantly diminished.  Couple this with an increase in one or two year diploma programs being rebranded as 4 year college majors and the quality of a college education has also diminished.  College is not for everyone and that is ok.

Short Term

Ban interest capitalization on future loans and forgive as much accumulated debt that is a result of capitalization as possible. This is a grossly unfair practice and must be abolished.

Medium/Long Term

The government should create incentives for lenders and educational institutions to raise their bars. First, students qualifying below a threshold should be directed to the local community colleges for a minimum of 1 year so they have a chance to cheaply explore both the degree and vocational career options available. Secondly, the profitability should be diminished for private lenders. Rates should be the yield rate for 10 year treasury bonds + 0.25% maximum. That’s it. Nothing more. Lending to college goers should be the safest investment available to funds looking for consistent long term returns. We should turn to investment trusts and retirement funds to fund the loans.

For loans not funded by such vehicles we need to  create capped schedules on the loan amounts guaranteed by the government and tie these to the year of college. Year 1 having the lowest guarantee - year 4 fully guaranteed. When lenders have to assess their own risks and returns are capped we can start restoring balance. No, this does not diminish the opportunity - community colleges are a cheap alternative to wasting 2 years of hands on experience and the 10+ years required to pay that back. Many people are realizing they don’t need to take the college risk to be able to build and enjoy their lives. Yes, college goers are rewarded with higher mean earnings. As a society we have to be honest with ourselves and accept that college is not for everyone.

Conclusion

We examined the historical context for the student loan crisis we are faced with today, presented the issues both with how education is priced and how society rewards it, then presented clear and attainable recommendations to start the process for recovery. Our combined recommendations would save the borrower both time and money while creating a more sustainable federally funded student loan program.

Our recommendations are focused on shorter term horizon that impact the borrower the most. This should represent just the beginning of a wider reform of how we price and reward higher education. We cannot continue to put our future generations at risk. Instead, let us invest in our future and create the ongoing culture of learning that has made this great country what it is today.