There is a strong premium on earning a college degree, perhaps driven by previous generations who witnessed the power of education.
But you may find yourself receiving a student loan bill every month, even now as you contemplate sending your kids to college. Though an education continues to pay dividends, the amount owed can seem insurmountable.
Our approach has to change.
Let’s look at a few considerations for shifting the paradigm of financial planning for college.
Saving is Cheaper than Borrowing
You can see the math with tools such as the 529 plan savings versus loan calculator. It costs you significantly more to borrow and pay back than it does to save in the first place.
Here’s an example for a couple that starts a 529 college savings plan today for a child born today with a college cost that’s $25,000 per year at their hoped-for alma mater ($100,000 for four years):
- Assuming a college cost inflation rate of 4%, your child’s tuition when the day comes will be roughly:
- Year 1: $50,645
- Year 2: $52,671
- Year 3: $54,778
- Year 4: $56,969
- Total cost: $215,063
- Let’s say you started contributing $7,000 a year starting at birth through age 17 at a 6% rate of return, with that $100,000 target in mind. By the time your teen is ready for college, the numbers look like this:
- Balance: $229,319
- Your total contributions: $126,000
Now we’ll run the scenario using the same costs, but this time borrowing the funds for college.
- Let’s say you pay off the entire tuition with a 5% interest student loan over 10 years, which is a recommended life of a loan for educational costs.
- Total cost after loan is paid: $273,731
- Total interest paid on your loan: $58,666
Now, if we put the math together:
- Total costs using loans, the borrowing route: $273,731
- Total contributions to a 529, the savings route: $126,000
In the example, it will have cost $147,731 more to borrow for school than to save!
Costs practically triple – and the loan could be around for more than 10 years if you add a mortgage and a few kids in the pay-off-debts stage of life.
Using a savings vehicle like a 529 plan or Coverdell Education Savings Account will pay off in the long run for you and your student.
Balancing Your Retirement and Your Kids’ Tuition Costs
Chances are if you have kids who are looking at college, retirement isn’t light-years off for you. You might be tempted to put your money toward your kids and their future, sometimes to the detriment or complete disregard of your retirement income planning. Ignore it – pay yourself first.
You can’t borrow for retirement!
There’s no such thing as a retirement loan or a retirement grant. Once you get there, the money you’ve saved is what you have, and whatever you receive from Social Security and Medicare. Even though it’s not ideal, students can borrow to pay for school.
Think about yourself in the future!
As parents, it’s up to us to take a step back and take the long view of these financial pressures. Bankrupting your retirement to pay for your student’s schooling could have long-term consequences that impacts you both.
If you deplete or deeply damage the retirement funds that are supposed to be gathering interest right now, you could need financial help in retirement. This could add financial stress to your children’s lives, impacting what they can save for, including limiting contributions to your grandchildren’s education.
How a 529 Plan Works
Most likely the best bang for your buck with financial planning for college is the 529 plan. This plan offers tax-free growth and distributions for qualified expenses and can give you a state tax break upfront, depending on the plan and the state. There are also no income limits on a 529 like there are on other educational finance tools such as the Coverdell ESA.
One analogy often drawn to a 529 is the Health Savings Account (HSA). The 529 can offer you a triple tax advantage like an HSA and is similarly dedicated to only one set of qualified expenses. These qualified distributions usually include tuition and fees, books and supplies, room and board, special services and computers and related equipment. 529 plans have also recently been extended to apply a certain amount to student loans.
Just know the rules when you’re using a 529:
- Contributions to the account over the $15,000 annual gift exclusion must be reported on your IRS Form 709 and will count against your lifetime gift tax exemption amount. The annual exclusion is per recipient. You can give $15,000 to each of your kids without touching the limit.
- However, you can superfund with five years of gifting in one year ($75,000 in 2021) without going over the amount as a special exception for 529s. Your annual gift tax exclusion will be used up for the next five years.
- With qualified expenses, you have to use the 529 distributions in the year they are paid. You can’t personally pay for a student’s books one year and try to “reimburse” yourself from your 529 years later.
Funding Your Child’s Future
The expense of education is on our minds when we think of planning for our kids, but it’s not the only thing. The reasons for choosing a school are broad and personal, complex and qualitative, from going to the family alma mater to pursuing a particular field of study, even if it’s not immediately lucrative.
That said, the costs of college should give us pause as we look toward the future. Funding your children’s education is a nearly universal goal, but it isn’t a given. Especially in today’s high tuition environment, financial planning for college takes strategy, discipline and forward thinking.
Your financial advisor can help you fit college funding into your overall financial plan. Whether your kids are just starting to dream of their college years or if they aren’t even born yet, it’s not too late and never too early. Get in touch today to start the conversation!
Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing.
Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investing in any state’s 529 Plan.
These examples are hypothetical only, and do not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.