Much has been written about the cost of a college education and the debt burden being placed on our children. 2014 college graduates have the dubious distinction of carrying the highest student loan debt in history.
According to the Wall Street Journal, today’s grads are saddled with, on average, $33,000 in student loans — nearly twice the amount of just 20 years ago. Start factoring in advanced degrees or more expensive schools, and you can see how the cost can quickly spiral out of control.
I recently met with an attorney who has more than $300,000 in student loans. Wow!
What can you do to keep this from happening to your kids?
One obvious solution is to save early and save often, as my colleague Carmen Wu explains in an article in EBW’s Knowledge University. (See below for an excerpt.)
And, as Carmen will agree, saving alone sometimes isn’t enough.
- Perhaps your children are in high school, but if you start saving for college now, there just isn’t enough time.
- Maybe you have several children, and there’s no way to save enough to cover the college costs for all of them.
- Or maybe there just isn’t room in the budget to save for everything.
Sometimes we have to prioritize, right?
This can be difficult for parents; after all, a big part of being a parent is putting your child’s needs above your own. But the cold, hard fact is that there are times when you have to put yourself first.
So often, I find myself having this difficult conversation with parents, and my advice is always the same: Prioritize your retirement above your kids’ college.
There are plenty of ways for kids to borrow and finance their education, but there is no way for retirees to borrow for their retirement. Acting on this knowledge can be a tough pill for parents to swallow.
Sometimes even when parents have set aside a chunk of money for their children’s college costs, they later realize they will need that money for their own retirement.
Case in Point
Two of my clients, James and Marsha (of course those aren’t their real names), were referred to me by Marsha’s parents, long-time EBW clients. In our first meeting three years ago, James and Marsha told me they had twin 14-year old boys and that they wanted to fully pay for the boys’ college education.
They had set aside some money for this purpose, in addition to money James and Marsha had earmarked for retirement. After creating a comprehensive financial plan for them, it was clear to me that there just wasn’t enough money saved to fully meet both goals.
James and Marsha took the news well, but did not want to see their boys saddled with debt before they even got their first job after college. So together, we came up with a plan where they would pay for half the costs of college, and their boys would cover the other half. For the past three years, we have worked toward this goal.
Recently, as the boys were beginning the process of applying to colleges, the whole family joined me in the office to discuss college costs. I started by asking the boys if they knew the costs of their top-choice schools, and to my surprise, they were both very close to the actual costs.
I was impressed. Luckily for James and Marsha, both boys were eyeing in-state schools, which would be a great help in keeping costs down. Next, using my planning software, we reviewed the costs of several schools on their list, as well as the costs of some schools in which their friends were interested.
I also showed them the costs of Northern Virginia Community College, to give them a basis for comparison. This led to a discussion of the relative value of their “ideal” schools versus two years at a community college.
After some discussion, I explained how much their parents wanted to fully pay for their education expenses, but that due to the realities of life, it just wasn’t in the cards. I told them that I had recommended to their parents that they focus on their retirement first and, again to my surprise, the boys were fully supportive of this decision.
I explained the plan for their parents to cover one half of the costs of college, and that they themselves would cover the rest through loans. We talked about the value of the boys having a vested financial interest in their studies, which led them to recount stories of people they knew who had washed out of college because they hadn’t taken it seriously.
This turned into a great conversation about the value of an education relative to their future career tracks, and balancing the myriad priorities of having a family.
I showed the boys how expensive retirement will be for their parents, and I explained that ensuring that their parents are financially independent in their later years actually is in their own interests as well.
Only half-joking, I asked the boys if they would like their parents to come live with them at some point. This somehow turned into a conversation about one of them having to bathe their father. Not a pleasant thought for anyone! Our discussion helped to underscore the future importance of the decisions being made today.
The bottom line: Fully paying for college isn’t a realistic goal for many parents.
This is evident by the fact that 70 percent of today’s college graduates leave school with student debt. But this isn’t necessarily a bad thing. Sharing the costs of higher education with your kids can be a great way to teach them the value of money, the value of an education, and the importance of pursuing a career that will be fulfilling and rewarding — and will also pay the bills.
The key is to be honest with your kids and to work collaboratively with them to develop a realistic plan. This process can yield great mutual understanding. Even if you are paying the full tuition for your kids, include them in the process. Help them to understand how much this is costing you and what’s at stake. Have a conversation about the value of an education; don’t just assume they get it.
As I think about what I want for my own daughter, I certainly want her to have a solid education. But even more than that, I want her to be a good person who demonstrates understanding and kindness. It’s clear to me that James and Marsha have given this gift to their boys.
Questions? Send an email to Hope Katz Gibbs.
Planning Ahead for College: Carmen Wu Provides a Road Map to Help You Navigate the Path
By Carmen Wu
Egan, Berger & Weiner, LLC
How does an American family successfully address the challenges of saving for all of their financial needs — raising a family, educating their children, and retiring successfully?
Start by investigating the various college savings vehicles that you can invest in, including:
1. Uniform Gift to Minors Act (UGMA) / The Uniform Transfer to Minors Act (UTMA). Known as custodial accounts, these are the most common trusts for minors. In most states, minors do not have the right to enter into contracts and are unable to own stocks, bonds, mutual funds, annuities, and life insurance policies. Plus, parents cannot transfer assets to their minor children — they must transfer the assets to a trust. To establish a custodial account, the donor must appoint a custodian (trustee) and provide the name and Social Security number of the minor. Then, the donor irrevocably gifts the money to the trust. The money now belongs to the minor, but is controlled by the custodian until the minor reaches the age of majority (18-21). Depending on the state, most UGMAs end at age 18; most UTMAs end at age 21.
Note: Earnings will be taxed annually, and UGMAs/UTMAs do not have the tax-deferred benefits that other saving vehicles enjoy. If the student is applying for financial aid, these are assessed at 20 percent to 25 percent. So if a student has an extra $1,000 saved before applying for financial aid, the aid will be $200-$250 lower.
2. US Saving Bonds Series EE Bonds and Series I Bonds. These provide a modest return for your child’s college education and are a low-risk investment. Series EE Bonds issued after 12/31/1989, and All Series I bonds, offer a tax-free benefit when redeemed to pay for qualified higher education expenses. Or, they may be rolled into a 529 plan.
Note: There is an annual purchase limit of $30,000 per owner, and $30,000 for Series I Bonds. The purchase limit of Series I Bonds isn’t affected by the Purchase of Series EE Bonds. The bond proceeds may be used for your own education, your spouse’s education, or the education of a dependent for whom you claim an exemption on your tax return. There is an income phase-out on the interest exclusion based on the year you redeem the bonds; income limits are adjusted annually for inflation. If the bonds are in your child’s name, they are not eligible for the exclusion.
3. Prepaid Tuition Plans. These programs allow you to pay for all or part of your child’s future college tuition at today’s prices. If you are able to place a lump sum of money into the plan when your child is born, you can purchase at today’s rates a four-year degree that your child will use in 18 years.
Note: The plans are administered by individual states and are typically only redeemed at public colleges and universities in that state. If the student opts to attend college out of state, the plan typically pays the average in-state rate and the parent pays the difference — which can be considerable. So refer back to your spreadsheet to determine the best option for your family.
4. Coverdell Education Savings Accounts (ESA). This plan allows you to contribute $2,000 a year, but there is no federal tax deduction. The accumulated investment interest earnings are tax-free, if used for education.
Note: Parents must contribute to these accounts before the child turns 18, and the funds must be used by age 30. These plans can also be used for K-12 private schools.
5. 529 College Plans. By far, this is the most widely used savings strategy for higher education. A tax-advantage plan that allows your investment earnings to grow tax-free, the distribution is not taxed — so long as it pays for tuition, fees, books, supplies, and any approved equipment the student may need to study at accredited institutions. Depending on your home state, you may have tax deductions and/or credits for contributions to the 529 plan. And unlike the Coverdell Education Savings Plan — which is limited to a $2,000 contribution a year — the 529 plan allows parents to contribute a larger amount: $14,000 from each parent, or $28,000 in one year. If you should come into a windfall, it is possible for each parent to contribute $70,000 each, or $140,000 as a couple, and treat it as if the gift was given over a five-year period. Parents can also contribute a lump sum, establish a dollar-cost average program, establish a systematic investment program from your bank — and also encourage contributions from family members and friends with gift certificates.
Note: For purposes of financial aid, this plan has minimal impact since it is considered to be a parental asset, and is factored in using a financial aid formula at a maximum rate of 5.6 percent. (This means only 5.6 percent of the 529 assets owned by the parent are included on the Expected Family Contribution, EFC, which is calculated during the financial aid needs-analysis process.) This is lower than the 20 percent to 25 percent rate assessed by the UGMA/UTMA custodial accounts.
For more information, visit EBW’s online Financial News at Egan, Berger & Weiner’s Knowledge University.