Paying for college without having a heart attack

Posted on August 31, 2011September 18, 2011 by Danielle

Only a few short months to go and many of us will be filling out those FAFSA and CSS PROFILE forms and thinking about how much we should have saved. But if you’re a little further from judgment day than I am, let me suggest that the way to eat the elephant is one bite at a time. Or divide the elephant up into three large chunks…

Let’s just assume that you won’t qualify for one penny in aid, and Junior hasn’t been offered any scholarship money at all.

Student contributions—the first chunk

Yup, I said the first chunk. If your kid isn’t willing to invest in his education, why should you? Let’s work with some nice round figures here to make it all easier to calculate. Say four years at Ivy U. costs $60,000/year. Yes, I know that colleges aren’t quite up to that yet, but wait a month or two and we will be. So, four years is going to cost at least $240,000—probably more, with college cost inflation at 6%, but let’s just go with the $240K for purposes of illustration.

Now, I firmly believe that any student, even one whose parents have no problem footing the bills, should be paying something. Not only does it tend to cut out some of the late night booze and barf parties, but it also makes the kid a better consumer. No kid who is working hard enough to come up with $20K a year is going to shell it out for classes in Bowling 101, or tolerate a professor who doesn’t show up for class. As an aside, when I was putting myself through college and grad school, I used to calculate how much each individual class session was costing me, and ask myself if I would put that much money in a meter (had there been one outside the classroom)—did I get as much value from the class as it would take me to earn that much money? Sharpens your focus, no?

So, is it possible for little Jason or Jennifer to earn $20K? Let’s see—15 hours per week for 36 weeks at $10/hour equals $5,400. Then, there’s, say, two weeks at Christmas where you could theoretically work full time—35 hours x 2 weeks x $10=$700. That leaves 14 weeks for summer break. Let’s give Junior a two week vacation. 12 weeks x $10/hour x 35 hours=$4,200. Junior now has $10,300. Sure, I know Junior will probably spend some of this, or taxes will grab a chunk, but then again, Junior probably could hold down 20 hours during school (I used to work 32 hours and take 18 hours a semester as an undergrad. But then, I didn’t have any choice—no one else was paying.) With a little attention to skill development and early hustling, he might be able to nail a job paying a little more. Maybe Jason can mow a few lawns in high school?

We’ve got a deficit here of $9,700/year. It’s grant or loan time. $38,800 will need to be borrowed by Jennifer over four years. Maybe that film or speech major isn’t looking so great right about now. But, under my principal of only borrowing up to what you can expect to make your first year out, I think this is doable. The average starting salary for a college grad in 2011 is about $50,000, according to CNNMoney. Round numbers here, don’t forget. And gosh, if you’re forking over $60K a year for Ivy U., you ought to be able to get a job with at least an average salary. Good questions for the admissions and career services officers.

There are worse things than graduating with 4 years of work experience, a cultivated eye for the bottom line, and some consumer smarts. Some people don’t learn that until they’re 40, if then.

Savings—the second chunk

The next $80,000 should come from savings. I’m not going to go through the growth vs. inflation of the four years of college—you’ll need to come see me for that level of specificity. Let’s just say you want $80,000 “in the bank” by the time Jennifer is ready to move into the dorms. Say you didn’t get religion until she was 10 years old, giving you 8 years to come up with the $80,000. Let’s be conservative and assume a 4% rate of return on your investments. You need to save $8,682/year or about $708/month. (Not figuring inflation—round numbers, remember?) Get going earlier, say when Jason was 5, and you can cut that down to about $4,811/year. I don’t think this is unreasonable—if you’re making enough money that you won’t qualify for any aid at all, you’re making enough to stash this amount of cash. Worst case scenario is you’re grossing at least $130,000/year. At more than $10K a month, it’s reasonable to think you could save less than $400 per month (it’s less than 4% of your gross).

Repeat to yourself as often as needed, “I will not skimp on my retirement savings to fund this.” If you get to this point, it’s time to think about a cheaper college.

Payment from current parental income—the third chunk

$20,000 is around $1,667 per month. Okay, you’re already used to saving $400-$800 per month toward the education, right? Now, Junior isn’t going to be eating at home—say $250 per month in savings right there, maybe more. Gassing the car once a week @ $50=$200. No more music lessons, math tutor, SAT test prep course—well, you get the picture. Most parents don’t stop to think that while they’re paying for the kid at college, they don’t have the kid vacuuming out the refrigerator with 20 of their closest hungry friends at home.

These aren’t authoritative figures and they don’t take into account your particular situation—more than one child at home, no savings, child who takes more than 4 years to complete (oh no!). That’s what individual college financial planning is for–you know, that’s the stuff I do. This is just a suggestion of how to think about dividing and conquering, without the feelings of overwhelm and panic that hit parents toward the beginning of senior year.

Surprises for college loan borrowers

Posted on August 24, 2011August 24, 2011 by Danielle

With news from Washington, we always hear about the hot buttons and often not about the details that really affect our lives. But as in annual reports, most of the meat is hidden in the footnotes. The new 11^th hour debt ceiling deal has some big surprises in it for student borrowers.

In case you missed the fine print, here’s the change. For graduate students, Stafford loan interest will no longer be waived while the student is in graduate school. Formerly, these loans did not charge interest on the principal until six months after the student graduated. As we all know, for graduate students that can take a verrrryyyy long time. Now, interest will accrue while the student is in school, and be added to payments when repayment begins. It can be thousands extra in costs for students who borrow the max. How much is this “tiny” change worth? Well, the estimate is that it will total $21.6 billion over the next two years, with the savings to be applied to maintain Pell Grants. These changes will go into effect on July 1, 2012.

Also gone is the credit for students who make on-time loan payments for 12 months. Now, all you get is a thank you—okay, probably not that either.

This change makes it even less desirable to have loans, and I still recommend borrowing as little as possible and certainly no more than what the student can expect to make in the first year out of school. The reason for this rule of thumb is that if the student is repaying with 10% of income (a reasonable figure) it will take 10 years to pay it off. As the student’s income increases, there’s some chance that a loan can be paid off early.

While I strongly believe that undergrad education should be all about acquiring a broad base of knowledge, students should keep a closer eye on career choices if they’re borrowing significantly. You don’t want $80,000 in loans as a speech or film major. However, as much as I believe in a liberal education as an undergrad, graduate school is all about specializing and it IS job training. Don’t enter that PhD program in English unless you’ve really thought through and researched what the career paths might be.

For many graduate level programs, not being offered scholarships is a pretty good indication of how much (or little) they’re really interested in you. It’s a good idea to think about WHY you’re not getting any offers. For professional school programs, less money is not necessarily an indication of how desirable you are, but employment in these fields is not the slam dunk it once was—ask any recent law graduate.

As in any financial planning issue, don’t borrow money for any investment unless you have investigated and thoroughly understand the risks involved. Start young understanding this and you’ll save yourself a lot of flimflam, whether from graduate school admissions offices or “venture capitalists” with yet another hot idea for your hard earned dollars.

Using Health Savings Accounts strategically

Posted on August 17, 2011November 7, 2012 by Danielle

Nothing’s more dull than insurance, unless you don’t have it when you need it. Health Savings Accounts (HSAs) are a relatively unknown way to acquire health insurance. Cheap, tax advantaged, and great for business owners and the self employed, HSAs can make health insurance affordable again.

In brief, first you find a high deductible health insurance policy (either with your employer or on your own if you’re the employer or self-employed). Because these are high deductible, they are often quite affordable compared to traditional policies. Then, you establish an HSA savings account with a bank, brokerage, mutual fund or other trustee, and deposit the maximum in the account: $3,050 per person covered if you or they are under 50, $4,050 if over 50. Under normal procedures, you then either use a debit card, write checks on the account, or submit bills for payment (depending on how your account provider works), up to the amount of your expenses until you reach your deductible. Once the deductible is reached, your health insurance provider covers the rest according to the co-insurance you’ve chosen. In most cases I recommend choosing a low deductible (say, $1,200 or $1,750) with 100% coverage after that, but this requires a careful look at your individual circumstances and the plans you are considering.

The beauty of HSAs is that you get to deduct the whole contribution each year EVEN IF your medical expenses are lower than your contribution. Without an HSA you can normally deduct medical expenses only after they exceed 7.5% of your income, which is some pretty big bill for many people. But with an HSA, you can spend $150 for doctors’ bills and still deduct $3,000. I like that.

Second nifty point is that not only do you get a deduction going in, but it’s tax-free coming out, as long as you use it for medical bills. Now, here’s where the strategy comes in. You don’t have to make withdrawals in the year you incur the bills. So, if you can afford to pay the bills out-of-pocket and can do a decent job of keeping careful records, you can wait until 65 to take disbursements. As long as the disbursements are for medical bills (current or previously incurred), they are tax free. So, you could accumulate bills and submit them once you retire, as you need cash.

What if you don’t keep such good records? The money can still be withdrawn after 65, but you’ll have to pay ordinary income tax if you don’t use it for medical bills. It can be a nice little account to pay for long term care insurance, prescriptions not covered by Part D, dentistry, or anything not covered by Medicare. Given all the saber rattling in Congress about reducing Medicare benefits, it might not be such a bad idea to have a health savings account in reserve.

Let’s just look at some numbers. Say you’re 50 years old, you establish an HSA and keep it going for the next 15 years. Say also that interest rates stay pretty junky for that whole period (unlikely) and you only make 4% a year with 3% inflation. When you start collecting Medicare you’ll have about $65,000 in that account, and potentially much more if you can cover a spouse or children (the account holder keeps the money even after the children “age out”). Withdraw $3,000 a year to cover, say, long term care insurance and it’ll last for about 25 years. Or take larger withdrawals and let your other portfolio(s) grow. Again, it requires some individual planning, but it’s not such a bad thing to have an extra $65,000 for tax free income.

The gap between your deductible and what you can save is just such a good deal I’m surprised it hasn’t been targeted for budget cutting measures. Maybe it’s because, so far, so few people use it. Save the whole thing and enjoy the deduction and tax-free compounding. Be one of the smart ones.

Caveat: there are a lot of details on this. There’s an IRS publication 969 that sets out all the rules, but I’d be happy to talk over HSAs with you at any time.