How Student Loan Default Can Hurt Your Retirement Strategy

A mother and daugher calculting retirement portfolio balance

PeopleImages / Getty Images

Defaulting on student loan debt can be damaging to your credit score, but it can also have serious consequences for your retirement plans. If you're still paying on student loans, it's important to understand how a default could put your long-term financial health at risk. 

Student Loan Default Can Shrink Your Social Security Benefits 

Social Security is an important part of the retirement picture for millions of Americans. According to the Social Security Administration, 45.8 million retirees and 3.1 million of their dependents received Social Security retirement benefits in 2020. On average, they collected a monthly benefit of $1,514.

Overall, Social Security represents about 33% of elderly Americans' income, according to the SSA. If you're banking on being able to claim Social Security benefits in retirement, there's a very important reason to make sure you're staying on top of your student loan debt. When you fall behind on payments to federal student loans, the government can make up what you owe by garnishing your Social Security benefits

Between 2005 and 2015, the number Americans who had their Social Security benefits garnished because of student loan default rose from 8,700 to 40,000. Approximately $171 million in defaulted student loan debt was collected through Social Security offsets. On average, a 2016 report by the Government Accountability Office found, the typical borrower had 15% of their monthly benefits withheld, the maximum amount allowed by the Debt Collection Improvement Act of 1996. 

Using the $1,369 monthly after benefit as a guide, that's $205 a month deducted off the top to repay defaulted student loans, bringing your Social Security income down to $1,164 a month. If you haven't saved as much as you would have liked in a 401(k) or an individual retirement account, you may not be able to afford to have a bite taken out of your Social Security benefits. 

How to Keep Student Loan Default From Wrecking Your Retirement

Student loan default is becoming more commonplace among seniors. According to the Consumer Financial Protection Bureau, nearly 40% of federal student loan borrowers age 65 and older are in default. Between 2005 and 2015, the number of older Americans who had their Social Security benefits garnished because of student loan default rose from 8,700 to 40,000. 

If preserving your Social Security outlook is a priority, you need a plan for keeping student loan debt in check. A good place to start is by assessing your student loan default risk. 

Take a look at your monthly budget. How much are you paying towards your student loans each month? How manageable are the payments? Would you still be able to afford them in retirement if your housing costs increase or you find yourself paying more for medical care in retirement? 

If you're already feeling the pinch from student loan payments and retirement is still a few years away, there are a couple of things you can do to downplay the possibility of default. First, you can focus on scaling back your expenses. If you're spending less, your student loan payments may not be as hard to manage. 

If you've cut everything you possibly can, you may need to think about changing up your payment plan. Income-driven repayment plans take your income into account when setting your monthly payment. The catch is that moving to an income-driven plan to get a lower payment could mean paying on your loans longer. But, that may be more appealing than worrying about whether your Social Security's going to be cut because you defaulted on your loans.

And if you do slip into default, don't panic yet. You could still avoid losing any of your benefits by rehabilitating your loans. Rehabilitation allows you to restructure your payments so you can back on and track and get out of default. You agree to make nine on-time monthly payments over a 10-month period. Once you've done that, you're no longer in default and any Social Security garnishment stops. You may also be able to consolidate your federal loans, which could reduce the odds of landing in default again. 

Keep the Lines of Communication Open With Your Loan Servicer

If you're worried about defaulting on your student loans—or what that might mean for your retirement—the worst thing you can do is nothing. If you think you may be in danger of falling seriously behind on your loans, reach out to your loan servicer sooner rather than later. They may be able to offer options for managing your loans in the short- or long-term so you can enjoy your later years without sacrificing your Social Security benefits.