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The long-term consequences of student loans

You have heard the message for years: A college education will give you vastly expanded career opportunities and dramatically higher income for the rest of your life. Easy as pie, right?

Not if you have to take out student loans. New data from LIMRA, an association providing research and consulting to insurers, shows that just $30,000 in student debt can cut as much as $325,000 from your 401(k) balance by the time you retire.

That is hardly an outlandish amount to borrow. As of 2014, the average student graduating with debt had borrowed $28,950, up from $18,550 a decade earlier, according to The Institute for College Access and Success. And some 69 percent of the class of 2014 borrowed for college.

If millennials had access to defined benefit retirement plans, where employers made contributions on their behalf, their retirement would be more secure. But only 10 percent of workers under age 30 have access to a defined benefit plan, according to LIMRA's Secure Retirement Institute. That means the onus for retirement saving is almost entirely on them, and those paying down debt are at a clear disadvantage.

"With Gen Y being in defined contribution plans, the time for them to really get ahead is in their 20s and early 30s, but if they have a huge student loan, they really can't do that," said Michael Ericson, research analyst for the institute.

The institute used the Federal Reserve's 2013 Survey of Consumer Finances to calculate the long-term effect of student loans. They assumed a typical millennial would start work with a salary of $35,000, and about 15 percent of that would be available for retirement savings, debt repayment or a combination. Using the federal student loan interest rate of 4.6 percent and assuming 2 percent income growth annually and investment returns of 5 percent a year, they could see how much millennials could save.

"We knew that it was obviously going to be less money" for the millennials with student loans, Ericson said. "But the compounding really makes it a large difference for the 22-year-old."

It is not only the 22-year-olds feeling the effects of student debt. The institute also examined the amount of education debt held by those close to retirement, and found a sharp increase over 25 years. In 1989, just 4 percent of people aged 55 to 64 had education debt, but by 2013, that figure had grown to 30 percent.

Other researchers have also studied the impact of student debt on long-term financial health and reached similarly troubling conclusions.

The current system of financial aid and widespread student indebtedness "has reduced the ability of our educational system to be a force for upward mobility," said Melinda Lewis, associate professor of practice in the School of Social Welfare at the University of Kansas who has studied our current system of financing college. "It is still true that you are better positioned if you go to college, but you are not as much better positioned if you have to go to college with debt."

Other research by Demos, a public policy think tank, found that home ownership is significantly lower among among 20-something households: 52.3 percent of those households with student loan debt own homes, compared to 58.8 percent of households without student loans.

Student Loan debt
Kirby Hamilton | Getty Images

Clearly, student debt has long-term ramifications for millennials' finances. Students who want to minimize their student loan burden can consider moves like spending their first two years at a community college, where tuition is generally lower, or working during college to reduce borrowing needs.

But Ericson cautioned against reflexively paying off loans as quickly as possible. True, a private sector loan can come with an interest rate of 10 percent or more, he said, and "you can't often expect that in your defined contribution account. In that case it makes sense to pay down the debt as fast as possible."

But saving cash on hand in a 401(k) account, if you expect to earn 5 percent or more, can make more sense than using the money to pay off a loan with interest at 4.6 percent.

Student loans can be the key to a college education and a life of expanded career and earning prospects. But it is worth boning up on the potential effects of student debt to make sure you do not hamstring your finances in the process.