Flawed Assumptions About Retirement Savings for Grad Students

Yes, grad students should save for retirement, but let's get the math right on how much they can earn from Roth IRAs.

August 25, 2021

To the editors:

In "Grad Students, Start Saving for Retirement Now," Fahad Sajid does well to make sure grad students are aware of the advantages of a Roth IRA, and makes a good point about the compounding effect of early investments.

However, there’s a serious mistake in this article, and some important omissions.

The biggest problem is that Sajid uses the nominal returns on the S&P 500 to estimate future value. Retirement planning should always be done in real (inflation-adjusted) dollars. The inflation-adjusted compound annual growth rate (CAGR) for the S&P 500 since 1926, including dividends, is about 7 percent, not 10 percent. This makes a big difference when talking about long periods of compounding. Using this average, that $6,000 invested for 42 years would actually become $103,000, not $329,000.

There are subtleties on top of this. Almost no one is 100 percent invested in stocks from age 25 to age 67, so for most people the actual rate of return will be lower than the S&P 500. Standard retirement planning might assume 5 percent returns, or even 4 percent. At 4 percent, that $6,000 invested for 42 years turns into $31,000, which isn’t shabby, but is less than 1/10th of what Sajid suggests you might have.

Also, none of this includes fund expense ratios, the money you pay to invest in a fund, which range from near zero to over 2 percent of assets annually. (You can’t buy into the S&P 500. The closest you can get is a mutual fund or ETF that approximates it, but you have to pay for that.) Many educational institutions use TIAA-CREF, but their target date funds have expense ratios over 0.5 percent, reducing what would be a 4 percent return to under a 3.5 percent return.

In one tiny throwaway line, Sajid acknowledges not all grad students will be able to put $6,000/year into an IRA, but this deserves more attention. Income varies noticeably between institutions (and can vary between disciplines as well), but exhorting people to save money they don’t have is not helpful. Most grad students will not be able to afford this, and a nontrivial number of grad students are going into debt to fund their schooling.

Bottom line, save for retirement as much and as early as is practicable. Use a Roth if you’re in a low income tax bracket. But it’s not realistic to expect your savings in grad school to fund your retirement, even if you’re lucky enough to be able to max your IRA contributions.

--David Syphers

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