Overview of student debt reform proposals

Most discussion on student debt involves debates over the desirability of free college and large-scale debt discharge programs. The proposals listed here involve a wider range of policy levers.

Student Debt Proposal #1: Eliminate First-Year Debt

The reduction of student debt taken on by first-year students through a combination of additional first-year financial assistance and restrictions on first-year loans would be an effective way to reduce total debt incurred by student borrowers.  This policy would also provide large benefits to students susceptible to payment problems because they did not finish their degree.  Go to this post for a more thorough discussion of a proposal to eliminate or substantially reduce debt incurred during the first year of college.

Student Debt Proposal #2:  Potential modifications to student loans

Existing programs designed to provide student borrowers debt relief are ineffective. Proposed reforms including — a relatively quick partial discharge of federal student loans, the elimination of interest charges on the maturity date of the loan, and the conversion of outstanding student debt at loan maturity to a tax liability collected by the IRS — would benefit both student borrowers and taxpayers.  Go here for a description of problems with existing student debt relief programs and my proposed reforms.

Student Debt Proposal #3: Facilitating on-time graduation

Students who fail to graduate on time take on high levels of student loans; hence, policies that improve on-time graduation rates would reduce student debt burdens.  There are multiple reasons why students fail to graduate on time and multiple ways to increase on-time graduation rates including — improvements in education prior to college, changes in college academic policies, and efforts to assist students dealing with hardships. Go herefor a description of polices designed to facilitate on-time graduation.

Student Debt Proposal #4: Reducing tradeoff between retirement savings & student debt repayment

Reforms centered on enhancing Roth IRAs and increasing incentives for the use of Roth IRAs would better balance saving for retirement and student debt repayment than the Secure Act 2.0 reforms that center on use of 401(k) plans. A first draft of a paper opposing the Wall Street view and suggesting new incentives can be found here

Coming Attractions: Forthcoming work on student debt includes — discussions of problems with public service loan programs and income based replacement loan programs, evaluation of potential regulation of private loans, the use of PLUS and parental PLUS loans, and treatment of student debt in bankruptcy.

Student Debt Proposal #1: Eliminate First-Year Debt

A combination of increased financial assistance for first-year students and restrictions on the use of student loans by first-year students would substantially reduce financial burdens associated with student debt.

Specific Proposed Policy Changes:

  • Design and provide funding and incentives for creation of financial assistance packages leading to a debt-free or tuition-free first year at both community colleges and four-year institutions.
  • Eliminate federal student loans until students have 9 credit hours of college credit from AP courses, community colleges or accredited on-line programs.
  • Provide federal, state, and private funds for programs that increase college-level work prior to college.
  • Increased incentives for quick transfers from community colleges to four-year institutions.


  • Students who take out loans and do not complete college are around 3 times more likely to default on their loan than student borrowers who get a degree.   The reduction of first-year debt will reduce the debt burdens of people who leave school early and are most likely to experience payment problems.
  • The stipulation that people complete some college level courses prior to full-time college will reduce initial access to higher education by low-income and minority students.  However, these groups with higher student debt burdens would gain the most reduction of first-year debt.
  • The stipulation for some college level experience prior to full-time college would better prepare people for college and would reduce dropout rates.
  • The elimination or reduction in debt among people who leave college after a year or two could facilitate reentry to college after people get some job experience.
  • Low-income and minority students also stand to benefit the most from new programs that increase access to and use of higher education courses prior to full-time college.  For some students, access to a community college or high-quality on-line course would be preferable to access to an AP course with a high fail rate.
  • Universities would be encouraged to increase off-semester admissions to facilitate the admission of more students after a single semester at a community college.
  • The proposed increase in financial assistance at both four-year and two-year institutions will allow more qualified students to choose a four-year alternative.  By contrast, the Biden Administration free-community college proposal would encourage some qualified applicants to delay or forego four-year options.
  • Private schools and historically black colleges could also benefit from changes in financial assistance packages depending in part on the incentives tied to use of federal funds.
  • The changes in financial assistance programs could differ across institutions depending on the level of tuition and the level of state or private support.

Concluding Remarks:  Many people are unprepared for full time college and the burdens of student debt immediately after graduating college.   The proposals outlined here would help many young adults become better prepared for higher education before taking on any debt. 

Student Debt Proposal #4: Creation of incentives for more rapid student loan repayment

Financial incentives favoring contributions to 401(k) plan over rapid repayment of student loans make many households worse off financially. Programs and incentives encouraging the rapid repayment of student debt would lower future borrowing costs, facilitate the purchase of homes, and allow many households to increase saving for retirement.

Introduction:   Tax and financial incentives are more generous for contributions to 401(k) plans than for the repayment of student debt.

  • Workers are allowed to to save untaxed dollars in a firm-sponsored retirement plan or an individual retirement account.
  • Firms can match employee contributions to the 401(k) plan. Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary. 

The subsidies for 401(k) contributions are substantially higher than the subsidies for student debt repayments.

  • Student borrowers can deduct up to $2,500 of interest on student loans.  
  • The student loan tax deduction pertains exclusively to interest while the entire 401(k) or IRA contribution is exempt from taxes.
  • There is no matching contribution for student loan repayment.

The decision to prioritize 401(k) contributions over student debt repayment does not always work out well as discussed in a previous post.  Potential consequences include:

  • Higher total loan payments associated with selection of longer loan maturities.
  • Higher borrowing costs stemming from higher debt levels and lower credit ratings.
  • Early disbursements of 401(k) funds leading to penalty and tax payments.
  • Increased likelihood of having debt obligations in retirement.

Student borrowers who quickly repay their loans would increase saving for retirement, realize lower borrowing costs, start the process of paying off their mortgage and would basically be much better off.  

There is general agreement that student debt significantly impedes saving for retirement by young households.  There is, however, no real consensus on how to fix this problem.

A Congressional Proposal:

Wall Street favors and greatly benefits from incentives for 401(k) investing.   Current proposals to assist student borrowers favored by Wall Street and financial advisors maintain incentives for 401(k) contributions over rapid repayment of student loans.

The Secure Act 2.0 would expand incentives for 401(k) contributions.  One provision would allow student borrowers who are enrolled in a firm-sponsored retirement plan to receive a matching 401(k) contribution for funds used to pay off their student loan.  

It is not clear an act of Congress is needed to implement this proposal because of a previous IRS ruling.

The proposal should allow the employer to contribute an employer match to the employee’s 401(k) plan up to the smaller of the student loan payment and the maximum allowable match on the 401(k) plan.   The student borrower repaying her loan would receive the employer match even if the student borrower did not contribute to the 401(k) plan.

The proposal only benefits student borrowers at firms with 401(k) plans, workers at firms with plans offering matching contributions, and workers eligible for the 401(k) plan.

Many student borrowers will not benefit from this provision in Secure Act 2.0 including:

  • People at firms with 401(k) plans that do not match employer contributions. Around 49 percent of all firms do not offer an employer match.
  • Employees who are ineligible for the firms-sponsored 401(k) plan.  Around 24 percent of firms require one year of service for entry to the firm-sponsored 401(k) plan.

This proposal and other aspects of Secure Act 2.0 favor higher-cost 401(k) plans over low-cost IRAS.  People who rely on high-cost 401(k) plans end up paying a substantial portion of their savings to Wall Street. Go herefor a discussion of the impact of 401(k) fees on retirement.

Moreover, the use of traditional 401(k) plans instead of Roth IRAs substantially increases tax burdens in retirement. A strong case can be made that workers should maximize the use of Roth IRAs instead of contributing to traditional plans.  

A more equitable and efficient approach might provide additional retirement subsidies for people without access to 401(k) plans or might provide additional incentives for the more rapid reduction of student loans.

An Alternative Proposal

The current system, which incentivizes saving for retirement over rapid repayment of student loans, does not work for many households.  This is evidenced by a CNBC article that found that nearly 60 percent of young adults have taken funds out of their 401(k) plan.

The alternative proposal presented here incentivizes the more rapid repayment of student loans over saving for retirement.  Under the alternative approach, the government would discharge 25 percent of the original balance of the federal student loan after the student borrower made 36 full-time payments on a 10-year loan and 60 full-time payments on a 20-year loan.

The alternative approach levels the incentives for rapid repayment of student debt and saving for retirement. Students who delay making full payments on their student loan would also delay receipt of the partial discharge on the student loan.  

The more rapid repayment of student loans and the partial discharge of the student loan frees up monthly payments and allows student borrowers to increase savings for other objectives including saving for retirement and a home purchase.

The alternative proposal would benefit all student borrowers including borrowers working at firms that do not have a 401(k) plan, borrowers with at firms with 401(K) plans that do not have employer matches and workers ineligible for their firm-sponsored retirement plan.

The alternative proposal does not favor high-fee 401(k) plans over low-fee IRAs.

The alternative plan does not encourage workers to stay at a job where they might be unproductive and unhappy to claim matching funds.

The partial discharge on student debt reduces demand for Income Based Replacement IBR loans and Public Service Forgiveness Loans (PSFL), both costly programs for taxpayers.

Concluding Remarks:  Wall Street and financial advisors consistently advise their clients to prioritize 401(k) contributions over rapid repayment of student debt.  This approach is not leading to a secure financial life for many student borrowers who are paying more on student debt over their lifetime, incurring high borrowing costs on other loans, having trouble qualifying for a mortgage and raiding their 401(k) plan prior to retirement.   A quick partial discharge of student debt would allow highly leveraged students to increase saving for retirement.

Student Debt Proposal #3: Facilitating on-time graduation

Policies that improve on-time graduation rates outlined here will substantially reduce lifetime student debt burdens.


Most of the focus of the discussion on student debt burdens is on proposals to make college debt free and proposals to forgive student debt.  The previous work on student debt published by this blog looked at the possibility of eliminating student debt for first-year students and potential modifications to student loan contracts that would offer limited debt relief. 

The discussion in this post examines whether student debt burdens could be improved through improvements in on-time graduation rates.

This CNBC article states that only around 41 percent of undergraduate students graduate within four years and 59 percent of undergraduate students graduate within six years.  On-time graduation rates are lower for people who start college at a community college and then transfer to a four-year institution.   

People who graduate on time tend to borrow less because of annual limits on student debt.

  • A dependent undergraduate student graduating in four years can take out a maximum of $27,000 in Stafford loans.  
  • The maximum Stafford student debt for dependent undergraduates is $31,000.
  • The overall Stafford debt limit for independent students is $57,500.  People who take longer to graduate are more likely to become independent students and qualify for the higher limit.
  • People who spend a longer amount of time in school may be more likely to take out a private student loan.

A couple of years ago I examined data from NCES on the relationship between amount of time it took for undergraduate to graduate and student debt outcomes for students graduating in 2012. 

  • 73.3 percent of students taking five or more years to graduate incurred debt compared to 62.6% for students who graduated in four or fewer years.
  • Average student debt for students with debt was $31,639 for students taking five or more years to graduate compared to $25,528 for students taking four or fewer years.

These figures understate the impact of duration in school on debt totals because everyone in the sample graduated and the debt totals do not include private loans or PLUS loans.

Improving on-time graduation rates:

Three policy levers designed to improve on-time graduation rates are considered.  The first set of policies involves programs attempting to better prepare students for college.  The second set of policies involves programs and rules impacting students in college.  The third set of policies involves attempts to mitigate the impact of unanticipated events and circumstances, including economic hardships and sexual assault.

Improving preparedness of students prior to college:

Some students are better prepared to succeed in college and graduate on time. The need for remedial courses often increases the amount of time spent in school and the total debt incurred.  

Costs associated with remedial education are not exclusively incurred by low-income or community college students.  One study reveals 45 percent of student taking remedial college work are from middle-income or upper income households and that nearly half are enrolled in four-year public or private colleges.

Several programs are proposed to better prepare students for college including:

  • Efforts to improve early education outcomes: Go here for a study on the importance of early education programs.
  • Efforts to increase access to AP courses and improve AP scores.  The programs discussed heretarget communities with low AP participation rates and attempt to improve both access and performance.
  • Increased access to community college courses while still in high school: The California Dual Enrollment program is an example of a program that allows high school student obtain college credit in high school.
  • Increased early access to camps and courses related to computer programming and coding:  It would be useful to survey people obtaining a CS or STEM degree to more fully evaluate the impact of early access to CS and success in the field.

Polices adopted by colleges:   

Colleges differ substantially in their on-time graduation rate.  Part of the difference is explained competitiveness of the college. Part of the difference is explained by college-specific policies, starting with transparency about on-time graduation rate and other performance metrics.

  • Greater transparency on on-time graduation rates for the university by area of study:  Some information on on-time graduation rates, debt totals, and starting income for universities can be obtained from the College Scorecard.  It would be useful to have more information for schools and for different departments in schools along with an overall rating.   
  • Better monitoring and Increased incentives for students to maintain on-track for on-time graduation:  Some students often enroll in fewer than the 15 credits per semester needed to graduate on time. Go here for a Cal-State article on why students should take 15 hours per semester. A policy requiring students who are behind schedule complete some on-line or summer course work before receipt of additional student loans might be useful.
  • Standardizing AP credit policies:  Some schools and some departments do not give credit for students who pass some AP exams.  Any student who gets a 4 or above on an AP test should get some credit if the institutions is processing federal student loans. The academic issues created by this change could be mitigated by having the department create a new course that overlaps but builds on the AP course. 
  • Reduce loss of credit by transfer students:  This article points out that student lose around 40 percent of their credits by transferring and argues for the acceptance of more transfer credits.  It would also be useful for students to transfer earlier in their career when fewer credits are at stake.
  • Increase access to courses for people needing certain credits for graduation or completion of a major:  Some students fail to graduate on time because they cannot enroll in a course needed for their major or for graduation.  Colleges need to rectify these types of problems and evidence should be reported to the College Scorecard or other Internet sites.
  • Increased Use of on-line courses:  The increases use of on-line courses can be an efficient approach when students are falling behind track for on-time graduation and when students need only a few courses to complete their degree.

Unanticipated Events that could lead to reduce on-time graduation rates:

Economic hardships and sexual assault undermine academic performance and delay the completion of academic programs.

  • On-time graduation would improve if more resources were available to assist students with housing and food.  This study found that economic hardships including lack of stable housing and lack of sufficient food impacts the ability of students to do well in food.
  • On-time graduation would improve if sexual assault was reduced and if resources were used to assist victims.  One study here discusses retaliation by perpetrators and institutional response.  This studyfound evidence that victims of sexual assault were more likely to experience a decrease in GPA and/or quit school. 

Concluding Remarks:  The ability to graduate on-time is a major determinant of the amount of debt a student takes on.  Policies and programs that better prepare people for college, that create incentives for colleges to helps students graduate on time and programs that assist students in difficult circumstances, would improve on-time graduation and reduce lifetime student debt burdens.

Student Debt Proposal #2: Potential modifications to student loans

Proposal considers partial discharge of loans after 4 years and complete elimination of interest charges at or near the maturity date of the loan. Future work will show these proposals are more effective an equitable than existing programs and proposals.


The current cohort of students is entering the workforce with substantially more debt than the previous cohorts of student and the growth of both the number of people with student debt and the average debt level have been consistently upwards. High student debt burdens are leading many student borrowers to forgo saving for retirement, delay starting a family, or put off purchasing a home.  

Some Democrats have urged President Biden to cancel up to $50,000 in student debt for all people with student loans.  Most economists believe that a widespread cancellation of student debt would be an inefficient and regressive subsidy.  Many student borrowers with debt could repay their loan without financial assistance and an indiscriminate loan relief program would allocate resources away from other pressing concerns. Most economic analysis supports the view that indiscriminate student debt cancellation programs would do very little to stimulate the economy.

Several papers including one by the New America Foundation one discussed in Inside Higher Education and my own work published by NASFAA have focused on reforming Income Driven Repayment Plans.  Current Income Driven Repayment (IDR) programs offering debt relief and linking debt payments to income have many problems.

  • The programs may incentivize some students to increase the amount they borrow.
  • Some students that commit themselves to an income linked loan may have been better off with a traditional loan.
  • Some student borrowers enrolled in IDR programs struggle to meet other financial priorities despite the benefits of the programs.
  • A large portion of applications for loan discharge have been rejected by the Department of Education as discussed in this CNBC article.

The memo presented here discusses ways to provide meaningful debt relief through modification of standard loan agreements instead of expansion of IDR loans or the creation of indiscriminate loan discharges.

A Proposal:

  • Discharge 40 percent of the initial loan balance after receipt of 60 monthly payments on 10-year loans and 72 monthly payments on 20-year loans.
  • Encourage partial interest payments for people in economic hardship rather than total payment forbearance.
  • Eliminate Interest charges on all loans on the scheduled loan maturity date.
  • Allow and facilitate collection of outstanding student loans after maturity of the loan by the IRs through federal tax returns.

Benefits of the Proposal:

The proposal presented here eliminates many of the uncertainties and problems associated with current programs offering student borrowers debt relief.    It offers students some assistance early in their careers allowing households to save for other priorities.   It does not create an incentive for students to increase the amount they borrow and contains incentives to facilitate quicker repayment of student debt.  The partial discharge of debt and the elimination of interest charges should reduce the number of people entering retirement with outstanding student debt.

  • The current system does not provide any loan forgiveness for 10 or 20 years.  The earlier debt relief in this proposal allows borrowers to pursue other financial objectives and may facilitate refinancing to lower-interest rate loans.
  • Many borrowers are unaware of any problems with their loan for 10 or 20 years when they apply for loan forgiveness.  The revised program will uncover problems with loan forgiveness applications after 60 months of payments for 10-year loans and 72 months of payments for 20-year loans.
  • The current system incentivizes many borrowers to pick the IDR program as soon as they leave school even though this choice can lead to higher lifetime loan payments if circumstances change.   The revised program assists borrowers with standard loans reducing reliance on IDR loans.
  • IDR plans create an incentive for some people to borrow more than they otherwise would because they anticipate low life-time loan payments and complete loan forgiveness. The alternative loan forgiveness terms presented here will always result in higher repayments for people who borrow more.
  • The loan discharge offered in this program occurs earlier for people making all payments on time, creating an incentive for student borrowers to prioritize student loan payments early in their career.
  • The existence of financial assistance for student borrowers with 10-year loans will reduce an incentive for borrowers to take out long-term loans and will speed repayment to the Treasury.
  • One study found the number of American over 60 with outstanding student debt quadrupled between 2005 and 2015. The elimination of interest charges at loan maturity proposed here should reverse this trend.
  • The elimination of all interest at the loan maturity creates an incentive for borrowers to allocate payments to other debts charging interest.  This problem is mitigated by requiring a minimum payment on student debt outstanding after the loan matures collected by the IRS through the federal tax return.

Concluding Thoughts:

Student debt is creating financial hardships for many borrowers and existing IDR programs often fail to provide meaningful debt relief.  Problems associated with student debt will worsen because of the growth of debt.  Most student borrowers can repay and manage their student debt with limited financial assistance.  An indiscriminate large discharge of student debt would impose costs on taxpayers and divert funds from other pressing priorities.

The program outlined here provides limited quick and efficient debt relief to student borrowers without the distortions caused by existing programs or proposed large-scale debt discharge proposals.

Lessons from the fall of ARKK

ARK funds are in free fall. Is there a better way to invest in high-risk startups?

Introduction:  ARKK, the ARK innovation ETF had fallen 58 percent from its all-time high by late January 2022.    The fund is experiencing massive outflows.  

What could Cathie Woods have done differently? 

Is there a way to create a fund that targets the most innovative companies but takes on less risk and does not experience this type of massive decline in value when things turn south?

Analysis:  Two Problems with the ARKK Investment Approach:

There are two problems with the ARKK investment model that led to this debacle.

The first problem involves an incorrect perception of the extent of diversification of the ARKK fund.

The ARKK fund, despite having 153 holdings, is not highly diversified.  The ARKK holdings have similar characteristics.  The firms are young, innovative, and risky. 

When risk appetites fall, as they are currently these firms fall in tandem.   

A portfolio manager could have a reasonably diversified portfolio based on either 153 randomly selected firms or 153 firms selected from different sectors of the economy. Much less diversification is obtained from a 153 similarly situated firms.

(It is sort of analogous to a person applying to all IVY league schools thinking one acceptance is in the bag because of the law of large numbers. The number of applications is not determinative when all institutions have similar decision rules.)

The tech fund could increase diversification of its holdings by holding 20 percent to 40 percent of its assets in a market portfolio perhaps through a Vanguard S&P 500 fund like VOO.   Alternatively, the tech fund could consider putting 20 percent to 40 percent of its assets in more stable value stocks, live VOOV, a fund that is uncorrelated with the startup sector.

A fund investing in high-tech startups needs to hold substantial funds in the general market or better yet invest substantial funds in the market that is not high tech.  A fund that invests 50 percent in innovative firms and 50 percent in startups would be able to reallocate assets when tech prices are elevated and make additional purchases during market downturns.

This approach is similar to the approach used by FBALX, a fund that balances stocks and bonds to provide more stable income in one fund.  The FBALX fund did well during the 2008 market downturn.

An ETF with both a tech portfolio and a market or value portfolio creates a better risk-return tradeoff than a pure tech startup portfolio.   The professional portfolio manager would reallocate assets from the tech component to the value component when tech was high and purchase tech assets when prices crash.

The person managing a combined tech/value ETF would probably be picking tech stocks at bargain prices right now rather than dealing with panic-driven withdrawals.

The second problem Impacting the risk of ARKK involves the existence of some very large positions inside several companies and a general lack of transparency exhibited by most ETFs (not just ARKK) on overall risk.

It is not accidental that Michael Burry, famous for the Big Short, was the first investor to highlight potential problems with ARRK.   Michael Burry is famous for looking at the quality of investments inside an ETF. 

I quickly looked at some of ARKK holdings.  My analysis for this post was limited to 10 holding found on the third tab of a listing by ZACKS.  The 10 holdings I looked at were – Fate Theraputics, 10 X Genomics, Docusign, Robinhood, Pacific Bioscience, Pager Duty, Iridium Communications, Tusimple Holdings, Gingko Bioworks, and Twist Bioscience.

My quick analysis found many ARKK ventures were highly speculative and were in the red.

Furthermore, ARKK had extremely large positions in some firms.

  • None of the 10 funds had positive earnings; hence, the PE ratio is undefined for all 10 firms.
  • The ARK management group was the largest shareholder for 4 of the 10 firms, was the second largest shareholder in one firm, was the third largest shareholder in two firms, was the fifth largest shareholder in one firm and the seventh largest shareholder in another.

ARK is a relatively small fund manager compared to firms like Vanguard, Fidelity, Blackstone, and T Rowe Price. ARKK is a relatively small fund compared to other tach and small-firm growth funds offered by larger firms.

Withdrawals from ARKK leading to the sale of company stock could exacerbate downward pressure on stocks when ARKK had an oversized position.

The recent withdrawals from ARKK and other ARK funds could have and likely did result in additional selling and downward pressure on stocks where ARK had a large position.

In a rational market the fundamentals of the stock prices determine the value of the ETF.  My concern is that selling by a risky ETF could spill over and impact the price of certain stocks.

Concluding Remarks:   The ARK funds allow investors to get exposure to innovative firms without taking on single-stock risk.  However, the amount of diversification offered by ARKK is not as large as some investors believe. The high stakes held by ARK funds likely exacerbated selling and downward price of some tech firms and the innovative company sector. 

One additional lesson from this post is that just as one should not judge a book by its cover one should not judge a fund by its profile.

Financial Tip #12: Impact of mortgage debt on longevity risk

The existence of mortgage debt in retirement is shown to substantially increase the likelihood a person will totally deplete their retirement account and will have to rely exclusively on Social Security and Medicare for all expenses.

The Situation:  Consider a person who took out a 30-year mortgage, 15 years prior to retirement.   The initial balance on the mortgage was $600,000 and the interest rate on the mortgage was 3.6 percent.

The person retires with $1,000,000 in her 401(k) plan but the retiree also has an outstanding mortgage of $378,975 and an ongoing monthly mortgage payment of $2,728.  

The retiree plans to spend $40,000 per year $3,333 per month to cover non-housing consumption in retirement. 

  • The total annual disbursement from a 401(k) plan for a person with a mortgage is $72,735.
  • The total annual disbursement from a 401(k) plan for a person without a mortgage is $40,000.

Question One:  What are the outstanding balances of the retirement plan after 15 years for a person with a mortgage and a person without a mortgage if the rate of return on investments in the retirement plan is 6.0 percent per year?


  • The outstanding 401(k) balance after 15 years for the person with a mortgage is $691,380.
  • The outstanding 401(k) balance after 15 years for the person without a mortgage is $1,484,698.

Question Two:  What are the 401(k) outstanding balances after 15 years if the person started retirement with $900,000 in 401(k) assets.


  • The person with the mortgage has a 401(k) balance of $445,971 after 15 years.
  • The person without a mortgage has a 401(k) balance of $1,239,290 after 15 years. 

Implications for longevity risk:

The existence of a mortgage payment substantially increases the depletion rate of the 401(k) plan. The mortgage payment cannot be avoided during market fluctuations.  The existence of a mortgage during a market downturn at the beginning of retirement can have an especially adverse impact on retirement wealth.

The discussion presented here does not explicitly consider taxes.

  • All traditional 401(k) assets are fully taxed as ordinary income.   
  • The person with higher spending due to a mortgage will have also have higher taxes.
  • This person may increase spending to have adequate non-housing consumption.

More on these issues will follow.

Technical Note:  Discussion of Financial Calculations

The most straight forward way to obtain the 401(k) balance is to set up a spreadsheet where the loan payment is subtracted from the balance each month and the balance minus the loan payment earns a monthly return.   

A second approach involves the use of the FV function.  

The arguments of the FV function are

  • Rate 0.06/12 or 0.005.
  • NPER 12*15 or 180.
  • PMT 6061.21 for person with a mortgage and $3,333.33 for person without the mortgage.
  • PV -1,000,000. Negative because PV is cash in and must be the opposite sign of the PMT function.

The FV function is set up to analyze loans, so be careful with the sign of answer.

The logic of the spreadsheet approach is easier to follow.

Financial Tip #11: Roth Conversions Early in Retirement

People entering retirement with liquid assets outside of their retirement account should delay claiming Social Security benefits, delay disbursement from traditional retirement plans and convert traditional retirement assets to Roth assets. This strategy requires substantial liquid assets outside of a retirement account

previous post explored the potential gains from converting traditional retirement assets to Roth assets whenever taxable income was low.  This post explores a specific situation, the conversion of traditional retirement assets to Roth assets early in retirement prior to a person claiming Social Security benefits. 


Many financial advisors recognize the benefits from delaying claims in Social Security benefits.

Social Security benefits are reduced by 30 percent for workers born 1960 or later who claim retirement benefits at age 62 instead of 67. In addition, each month delay in claiming retirement benefits after reaching the full retirement up to age 70 age, increases benefits by 2/3 of 1 percent.  Go here to the SSA site for a discussion of advantages of waiting until the full retirement age to claim Social Security benefits.  Go here for a discussion of the advantage to claiming Social Security at age 70.

The potential gains from delaying 401(k) disbursements and delaying claiming Social Security benefits while converting traditional retirement assets to Roth assets have not been fully publicized.   

The strategy of converting traditional retirement assets to Roth assets early in retirement can be profitably implemented if the household has substantial financial assets outside of a retirement account to fund current consumption.  In some cases, these liquid assets can be obtained by a household downsizing to a smaller home and using the house equity to fund consumption.  

The cost of converting traditional retirement assets is the additional tax paid on the increased income stemming from the conversion.  A household in retirement not claiming Social Security benefits and not disbursing 401(k) funds will have a low marginal tax rate and low conversion costs.  

The benefits of the conversion of the traditional assets to Roth assets are the reduction in tax during the year Roth assets are disbursed instead of traditional assets. The amount of Social Security benefits subject to federal and state income tax is linked to modified adjusted gross income.  Since Roth disbursements are not taxed and not included in modified adjusted gross income the disbursement from a Roth instead of traditional retirement plan can have a substantial impact on taxes.  

Go here for a discussion of the taxation of Social Security benefits.

Funds obtained from investment returns on the conversion of conventional assets to Roth assets cannot be disbursed without penalty or tax for five years starting January 1 of the year of the disbursement.   The five-year rule pertains to investment returns on all conversions, even those that occur after age 59 ½. 

An example of returns from converting traditional assets to Roth assets in retirement:

This example of the potential advantages of converting traditional retirement assets to Roth assets early in retirement was published in this Tax Notes article.

A married couple — filing a joint return with $10,000 in investment income — converting $34,550 in traditional assets to Roth assets would have taxable income of $19,750 and would pay $1,975 in tax.  The cost of conversion in this instance is $1,975, the difference in tax paid with the conversion and the tax paid without a conversion. 

The investment of $34,550 in a Roth account that earns a 6 percent annual return would be slightly more than $46,000 in five years. The one- year conversion would, in this instance, pay for the $39,000 distribution and would leave $7,000 for future distribution. 

A household distributing $50,000 from a traditional retirement account would pay around $7,072 in tax.  The household that distributes $39,000 from a Roth account and $11,000 from a traditional account would pay approximately $400 in tax.  

The total tax savings from the conversion, assuming a 6 percent return on converted assets is around $7,700.

The rate of return on the conversion is estimated a 30.7 percent.

Concluding Remark:  People entering retirement can extend the longevity of their retirement savings by initially using non-retirement assets to fund consumption, by delaying claiming Social Security benefits and 401(K) disbursements, and by converting traditional retirement assets to Roth assets.

Health Policy Memos: Fixing Disparities in Health Insurance Premiums and Outcomes

Several disparities in health insurance outcomes in the United States could be resolved by combining employer-based and state exchange insurance markets, by modification of the premium tax credit for state exchange insurance, and through the creation of new low-cost insurance options.


Nearly 12 years after enactment of the Affordable Care Act (ACA), substantial disparities in the cost of health insurance still exist. Some middle-income young workers without access to employer health insurance receive no premium subsidies and cannot afford state-exchange premium payments.  Some low-income households with an offer of “affordable” employer-based health insurance are precluded from claiming the premium tax credit for state exchange insurance.  This post discusses potential changes to ACA rules that would address these problems.


The Affordable Care Act (ACA) created state exchange health insurance markets for people without employer-based health insurance.  The creation of a viable state-exchange market created an incentive for some firms to eliminate employer-based insurance.

The ACA maintained a dominant employer-based health insurance system through the inclusion of two rules.

The first rule described here disallows the premium tax credit for any person working at a firm that offers “affordable” employer-based health insurance.  Affordable insurance was defined as self-only insurance costing less than 9.61% of household income.  

The second rule, commonly called the employer mandate, described here, is a fine applied to large employers that do not provide affordable comprehensive insurance to 95 percent of full time employees.  

These two rules have limited the size of state-exchange marketplaces.   Currently, around 12 million people obtain their health insurance from state exchange compared to around 156 million people obtaining health insurance from their employer.  

The American Rescue Plan (ARP) enacted by Congress and the Biden Administration includes provisionsmaking health insurance on state exchanges more affordable.  The ARP increased the generosity of the premium tax credit for lower-income households, capped benefits at 8.5 percent of household income, and eliminated the rule denying any benefits to households with income exceeding 400 percent of the federal poverty line FPL.

These provisions of the ARP expire after 2022 unless extended by Congress.   The Biden Administration has not altered the affordability rule, or the employer mandate and employers are still the source of health insurance for most working-age people and their dependents.

Analysis of Disparities in Health Insurance Premiums:

The existence of a large employer-based insurance market coupled with a fringe market for households without offers of employer-based insurance has caused disparities in health insurance premiums and outcomes.

State-exchange subsidies fail to assist young middle-income people seeking self-only coverage:

The premium tax credit provides a generous benefit to older households seeking expensive family-plan policies.  However, the premium tax benefit often provides very little or even no assistance to young adults seeking self-only coverage. 

The premium tax credit is not available to employees at firms offering employer-based insurance. Management of firms that decide to end offers of employer-based insurance to assist older workers seeking family coverage often substantially increase health insurance costs for young workers seeking self-only coverage.

The impact of the decision to offer employer-based coverage on two workers is illustrated with data from the Kaiser Family Foundation state exchange market-place calculator and data on the cost of employer-based coverage from the Kaiser Family Foundation annual survey.

  • The KFF state exchange premium tax calculator reveals a 30-year-old individual making $80,000 per year seeking self-only coverage would pay $4,664 for health insurance on a state exchange.  This worker would not receive any premium tax credit.  The average annual premium paid by a worker with employer-based insurance with self-only coverage is $1,299.  
  • The KFF state-exchange premium tax calculator was used to find the premium and support provided to a family making $80,000 a year with two adults aged 50 and two children one age 12 and one age 15.    The estimated financial help from the government in the form of a premium tax credit was $16,406 per year.   The average cost to the family was $4,840 per year.  The average cost to the worker for the family plan policy is $5,969 per year.

Many firms that offer employer-based health insurance subsidize all or part of the premium.   The average subsidy in 2021 was $6,440 for single coverage and $16,253 for family coverage.  

Small firms not subject to the employer mandate can avoid these costs by eliminating employer-based insurance.  The decision to eliminate employer-based coverage helps older workers with families and creates additional costs for young adults seeking self-only coverage.

Health insurance issues for people who cannot afford their share of premiums of employer-based insurance:

Many people with an offer of employer-based insurance are ineligible for the premium tax subsidy for state exchange insurance even if the state exchange marketplace offers more affordable and more comprehensive health insurance options.

People with an offer of affordable health insurance from their employer are precluded from claiming the premium tax credit because of the affordability rule. The definition of affordable health insurance is based on the affordability of self-only health insurance leaves employer-based family coverage unaffordable for over 5 million families.   These five million families are ineligible for premium tax credits but cannot afford a health insurance plan covering their entire family offered through their employer.

Many people believed the IRS incorrectly interpreted the affordability definition in the ACA because the original law contained an individual mandate.  The repeal of the individual mandate may make this argument harder to make since people are no longer fined for lack of coverage.  

The Biden Administration has not altered the employer mandate or the affordability rule.  The definition of “affordable” in the affordability rule continues to be based on the cost of self-only insurance leaving around 5 million households unable to afford a family option.

The alteration of the affordability rule could cause some small firms to eliminate offers of employer-based insurance, could cause some large employers to pay fines under the employer mandate and could increase insurance costs for some firms. 

The decision by the Biden Administration to leave the “affordability” rule and the employer mandate in place limited the impact of the more generous premium tax credit on the size of state exchange markets.

Reforms to health insurance markets designed to reduce the disparities in health insurance premiums:

Many disparities in health insurance premiums can be addressed by combining the employer and state exchange markets, by modifying the premium tax credit and through the creation of new low-cost but comprehensive health insurance options.   

The proposed health insurance marketplace has the following rules.

  • All employers would be allowed to purchase health insurance for their employees on state exchanges rather than sponsor an employer-based policy exclusively for their own employees. 
  • The employer subsidy for state exchange insurance would be a deductible business expense and would not be subject to personal income tax, as with the current treatment of employer expenditures on employee health insurance.
  • Employees would be allowed to use the employer subsidy for the purchase of any health insurance plan on a state exchange.
  • The state exchange would offer a public option or a new low-cost copper option. 
  • Large employers choosing the new premium subsidy would be required to provide a subsidy equal to 60 percent of the cost of the state-exchange policy for every full-time employee.  
  • Employers providing a subsidy on state exchanges would be required to provide the subsidy to all full-time workers.
  • Firms could make tax free subsidies up to 100 percent of the cost of a gold plan on state exchanges.
  • Self-employed people and people without an employer-based subsidy would receive a premium tax credit.
  • The new premium subsidy would have a floor of 40 percent of the cost of a silver plan and a ceiling like the existing premium tax credit based on household income.
  • The state exchange will offer a public option already offered in some states or a low-cost private option, patterned after the copper plans considered by Alexander and Murray.

Comments on the proposal:

Comment One:  Businesses and workers could continue with employer-specific plans if insurance companies continue to provide the product.  It is likely that workers and firms would prefer state-exchange subsidies because workers could choose any plan on the state exchange best meeting their needs.

Comment Two:   Unions would negotiate the size of the health insurance premium and workers at firms with generous premium subsidy offers could purchase the most expensive state-exchange health plan.

Comment Three:   The smallest permissible subsidy from employers and from the revised premium tax credit should be enough to cover the cost of the copper plan or the public option.

Comment Four:  The floor of 40 percent of the cost of health insurance of a silver plan on the premium tax credit is less generous than the floor on employer-based insurance but it assures that a young adult seeking self-only coverage would obtain some support and does not dissuade companies from offering a more generous subsidy to attract talent in a competitive job market.

Comment Five:    The public option proposed here is not free.  The person could choose to spend its subsidy for a low-cost private or public option or could choose to purchase a more expensive private plan.    The new system puts private insurance on a relatively even footing with the government option. 

Comment Six:   The new low-cost private and public options would be superior to short-term health plans that leave people with substantial financial exposure and do not protect people with pre-existing conditions.

Comment Seven: The existence of private high deductible health plans with tax-preferred health savings accounts could induce many households to select a private plan over the public option to take advantage of the tax savings from contributing to private health savings accounts.  This tax savings would not be available for public insurance plans or for private comprehensive insurance plans.

Comment Eight:   Some aspect of this proposal could be enacted through the tax reconciliation process by majority vote as described here.

Concluding Remarks

Many disparities in health insurance outcomes could be resolved by having firms subsidize the purchase of state exchange health plans, through the modification of the existing premium tax credit and the creation of low-cost but comprehensive health public and private health insurance options.

Financial Tip #10: Convert traditional 401(k) funds to a Roth when income is low

The cost of converting a traditional IRA to a Roth IRA, the additional tax paid on the amount of the conversion, is generally low in years where a person leaves the workforce. The potential tax savings in retirement is considerable.


Often people leaving the workforce raid their retirement plans to fund current consumption.  A departure from the workforce creates an opportunity for people to convert traditional retirement assets to Roth assets at low cost.  The low-cost conversion to Roth assets can substantially improve financial outcomes in retirement. Households are only able to make this low-cost conversion if they have a decent ratio of liquid assets to debts.


  • A previous post, financial tip #6, found that people leaving a firm with a high-cost 401(k) plan should roll over funds from the high-cost 401(K) to a low-cost IRA to increase wealth at retirement.   The rollover is often a prerequisite to converting traditional 401(k) assets to a Roth.
  • The tax code allows for the conversion of traditional IRAs to Roth IRAs. Distributions from a Roth account in retirement are not taxed and do not count towards the amount of Social Security subject to tax. The person converting previously untaxed funds in an IRA pays income tax on the converted funds in the year of a conversion.   The cost of converting traditional assets to Roth assets, the additional tax paid stemming from the conversion, is low when households have marginal tax rates.   
  • Marginal tax rates are lowest when a worker or a spouse leaves the workforce.  This can happen when a person returns to school, decides to care for a family member, becomes unemployed or retires.  
    • Conversion costs are $0 if AGI including the amount converted is less than the standard deduction ($12,950 for a single filer).
    • Conversion costs for single people filing an individual return are 10 percent of taxable income AGI minus the standard deduction for taxable income between $0s and $14,200.  Increases in taxable income up to $54,200 increase conversion costs by 12 percent, the marginal tax rate.
  • The potential gains from converting traditional retirement assets to Roth assets early in a career perhaps when returning to school are tremendous.   
  • A person leaving the workforce for school for a couple of years at around age 28 might convert $20,000 from a traditional IRA to a Roth at a cost of around $2,000.
  • The balance of the Roth account from this conversion after 30 years assuming a 6.0 percent return is $114,870. 
  • The direct tax savings from the conversion assuming a tax rate of 10 percent would be $11,487.  An indirect tax savings from the omission of tax on Social Security, assuming around $50,000 in Social Security payments spread over a couple of years, would be around another $5,000.  The conversion can be thought of as an investment of $2,000 leading to a return of around $16,000 in around 30 years.  The rate of return for an investment of $2,000 and a return of $16,000 in around 30 years is around 7.2%.
  • A person in a low tax bracket because she is young and single and returning to school and only working for the part of the year could be in a much higher tax bracket in retirement, especially if married and both spouses worked and claimed Social Security.  In many cases, the returns from converting a traditional IRA to a Roth will be much higher than the one reported by the simple example in the above bullet. A person living 100 percent on Roth distributions and Social Security could easily pay $0 in annual tax after accounting for the standard deduction.
  • A person returning to school full time with no reported earnings could convert an amount equal to the standard deduction to a Roth and pay no additional tax.  It would be irrational for a person with a 0 percent marginal tax rate to fail to make a conversion.
  • Workers leaving the workforce are often more concerned about meeting immediate needs than for planning for retirement.  However, conversion costs are small during a year a person leaves the workforce.
  • Workers leaving the workforce with debt or with 401(k) loans often distribute funds from their 401(k) plan, pay a penalty and tax, and are unable to rollover or convert funds to a Roth.
  • The five-year rule imposes tax and penalty on funds disbursed from a Roth IRA funded through a conversion from a traditional IRA within five years from January 1 of the year of the conversion.  A separate five-year waiting period is applied to each conversion.     The five-year rule applies for conversions after age 59 ½ even though all funds in Roth accounts funded by contributions can be withdrawn without penalty and tax at that age.  The purpose of the five-year rule for conversions and its implementation even after age 59 ½ is to prevent immediate access to funds in a traditional retirement account.  The five-year rule for conversions appears to apply to disbursements from both contributions and earnings for both pre-tax and after-tax IRAs. 

Concluding Remarks:   The cost of converting a traditional IRA to a Roth IRA, the additional tax paid on the amount of the conversion, is generally low in years where a person leaves the workforce.  The potential tax savings in retirement is considerable.

Several additional posts on IRA conversions are planned.  One post considers issues related to conversions of non-deductible IRAs in a procedure called a backdoor IRA.  A second post considers the advantages of converting pre-tax IRAs during retirement.