Baby in graduation cap

Financial planning for college: should you bother saving?

Nobody wants to pay for something, then watch someone less deserving who gets it for free. A dear friend recently raised this situation: are you a sucker for saving, while somebody else spends freely and their kid gets more money from a college?

I’ll give a very qualified yes to this—there are a few situations where it doesn’t pay (very much, at least) to save for college. Let’s say you make under $75,000 a year and have no investments beyond retirement accounts. Your family probably will qualify for some serious financial aid, and would get less if you saved into a 529 plan. But I really question how much a family would be able to save on that income, and if they can, they should be pouring it into their 401k and a Roth IRA. Can a family making $75,000 a year really manage to save more than $25,000 (the maximum into these accounts)? I seriously doubt it.

If your child doesn’t finish school or joins the military instead, you might have done better saving into your own accounts.

That’s it. That other family of merry spenders who got so much more than you? Did you see the award letter? Because lots of people lie. Especially people like to “reinvent” things in the best light possible—that “aid” might have actually been in the form of a subsidized loan, or the “free ride” might have been a waiver of tuition or some small amount of “scholarship” aid. If it was a state public school, and they are remotely middle class, it’s all going to be loans. If it’s a private school, it’s probably still some loans, or they have financial issues you don’t know about, or the school competes with publics by bringing the cost of attendance down to approximately what a state uni would have cost. Cost of attendance is the important number: what it actually costs to spend a year at the school, including tuition, dorm, food, books (can be a whopper), fees, etc. Add in transportation, moving the kid’s belongings back and forth or in storage, and the inevitable dorm refrigerator (not included in the school’s website estimates).

For nine years now, I’ve challenged anyone to tell me about somebody they know first-hand, who had family income over $100k, who’s child got all costs of attendance covered with no loans, for 4 years (athletic scholarships not included). I’ve yet to have someone come up with that family, but I’m still interested. It’s always 3rd hand, or a one-year fellowship (usually after the kid is already at the school), or tuition only.

It’s easier for a college to waive tuition than it is to cover the full cost. Why? Because tuition just requires paying professors and administrators, and those costs can be averaged onto other people. You can always stick a few more people into a given class. But coming up with an actual dorm bed, feeding the kid, and providing books actually costs money. Those “free rides” you hear about that go to low income families are usually free tuition, and then a loan package for living costs—and living costs are often the whopper.

But let’s say you have family earnings of $76K-150K, and maybe even another kid who will be in college at the same time. You might qualify for some aid. What if you were really careful and managed to amass $100,000 in a 529 college savings account? At worst, about $5,000 of that would be considered “available” each year for all your kids in college. (Same for parents’ non-retirement investments). Sadly, a reduction in aid of $5,000 is real money, but compared to the total cost of attendance, it’s a drop in the bucket. But having $25,000 available each year is going to make some serious difference to your child’s options and future indebtedness.

Remember, many colleges do not cover all demonstrated financial need. They’ll give you something, but sorry Charlie if you can’t scare up the rest—I’m not sure how they can assume you’ve been honest about your finances, then expect you to come up with more. Or maybe they just don’t care because there’s somebody right behind you on the waiting list.
Some schools have grandly announced that they’ll cover all need for families making under $XX a year. Note that that does not necessarily mean free—it only means they’ll cover the gap (as they calculate it) with aid rather than loans. For example, the University of Chicago says that if you make under $125K, they’ll cover tuition. But you have to make under $60K for them to cover the entire cost of attendance ($83,760 according to the school, compared to Northwestern’s $78,654).

But here’s the hitch—the kid has to get in, and any school that announces that will suddenly see an enormous jump in their applications, so your kid has even less chance of getting in than previously. I’d genuinely like to know how many kids attend who actually receive the full ride. Does anyone seriously believe that they will fill their class by allegedly need-blind selection, and then just randomly discover that they have to cough up more money from their endowments from all the kids they just admitted? I think I hear the sound of one hand clapping.

The exceptions to this are two: your kid is a world class athlete and gets an athletic scholarship that includes living expense, or your kid is a nationally desirable scholar (think published a novel, won the Davidson or Intel, has ground breaking published research or inventions) and is willing to go somewhere lesser than the ivy league. If your kid will outrank (grades + test scores + other achievements) 90% of that school’s current population, they might be willing to ante up something to entice them to come—but you should check that the guarantee is for more than one year.
Saving for the kid’s college means they won’t be burdened with very heavy debt incurred for living expenses, books, getting home for holidays, and every other surprising thing it actually costs to go to college.

BTW, if your child does get significant merit scholarship aid, you can withdraw the amount from the 529 penalty free. Or you can just leave it alone, because there’s always grad school…

How do people rack up those huge college loans?

Recently over lunch and some very good small batch cider, a colleague asked me, How on earth do people rack up these big loans when there’s a limit on federal loans?  It was a very good question: I’ve seen some humongous student loan debt, but I decided to go back over client profiles to really check out where it all came from.

First, some basics; as an undergraduate, you have six options for borrowing to pay the cost of attendance:

Direct Subsidized Loans

These are available for undergraduates who can demonstrate financial need. The borrowing limit on these is $3,500 freshman year; $4,500 sophomore year; and $5,500 for junior year and beyond. So, in four years you could borrow $19,000, and theoretically if your program is 4 years, you can borrow up to 6 years if it takes you that long: $30,000.

Direct Unsubsidized Loans

$5,500/$6,500/$7,500. If you’ve qualified for subsidized loans, these are the upper limits for total amounts. So if you qualified for $3,500 in subsidized loans in freshman year, you could borrow another $2,000 in unsubsidized loans. If you couldn’t qualify, you could borrow $5,500. So the total in four years would be $27,000; take 6 years and the total limit is $31,000.

This level of borrowing is where I’d encourage a full stop. With most bachelor’s degrees, you need to keep a sharp eye on your likely first year salary, and that’s the standard for the limit I recommend borrowing.

Find the definitive word on federal student loans here.

Some schools have a loan program. This is much more rare for undergraduates, and limits can vary.

PLUS loans. These are available to parents of dependent undergraduate students, and directly to graduate students. The maximum is the cost of attendance, and here’s where we get into the whopper amounts—we’re talking not only tuition, but also fees, room and board, and books and equipment. The undergraduate cost of attendance at Northwestern University for 2018-2019 was $75,753. If it doesn’t go up a penny for your four undergraduate years (unlikely) you and your parents could end up owing $303,012 and I guarantee no first year job is going to offer you that salary.

Parents should think long and hard before taking these loans, and in my view almost NEVER should. What if the student drops out? Gets really ill? Goes biking around the world to find themselves? Has a major car accident? Huge investment down the drain, and it happens all the time.

Private loans. Think a long, long time before you take these. They generally appeal to people whose parents’ credit is so bad they can’t qualify for a PLUS loan, and sometimes entice borrowers by offering variable interest rates—low at first, but then watch out. Be sure you understand repayment terms and when repayment begins—sometimes, immediately.

Home equity loans. Parents (and very occasionally, older students) may be able to borrow against home equity. With the new tax laws, these loans are probably no longer deductible. Don’t, just don’t.

So we can immediately see the real dilemma—if you don’t have savings, you’re in real trouble. If family income is really low, then you should get aid. I’d recommend choosing a college primarily on that factor—how much are they offering you?  On the flip side, if you have high income but no savings, you ought to be able to pay from current income, but again college choice should be pragmatic, and you should be looking at a public college unless you can wrangle some kind of merit aid from a private school (not likely, but possible at some schools). Many schools now have a policy that aid is 100% needs based. That may or may not be actual practice. Private school aid always involves “professional judgment” from the financial aid office.

Now let’s look at the most common ways you can accumulate crippling debt.

Borrowing for living expenses

This can really run up the bill. Anyone who needs to borrow money should be choosing the least expensive living accommodations. Usually, that means the dorm. Sure, rent may be cheaper at first glance, but you also have utilities, internet, food (and you’ll end up eating out more often), maybe more transportation, security deposit; be sure you figure all costs that would be provided by the dorm.

If at all possible, a student should have a job. Research has said that the student who works 10 hours a week is better organized and often does better academically than the student who doesn’t work, or works too much.

The real problem with mounting living expenses is someone who is ill, has non-covered medical needs, or whose program is too demanding (usually grad school) to work. As an undergrad, this should definitely be raised with financial aid for “professional judgment”. Grad schools don’t care.

Choosing an expensive school

If you have to borrow more for 4 years than you can earn in the first year of employment, choose a cheaper school. Pretty much no exceptions. Most BA degrees don’t buy you huge salaries, so you don’t want to shoot your whole financial future on just a BA.

The three most important factors are who you are, where your last degree is from, and (if the field requires it) what professional certification you earn. Do you really care if a neurosurgeon got their BA from State U? Many, many CEOs and inventors have graduated from public universities.

Choosing an expensive graduate program

If it’s a professional program, you should know what the employability of the field is. If there’s a public option, take it.

If it’s an academic discipline, and they’re not paying for you, they don’t want you. Employment from graduate programs is abysmal, and statistically you’re not going to get a job as a professor without some extraordinary achievement or other practical experience that sets you apart.

Too many people stay with school because they don’t know what else to do. You’re paying for the privilege.

On the other hand, if you borrow $300,000 and walk out into a job that pays you $150K with a $200K bonus (okay, you’re a doctor), you’re probably okay. It’s not the money you borrowed, it’s what you can earn with the degree. Like any investment, it’s worth putting money in if the ultimate payoff is worthwhile.

Similarly, the BA who’s borrowed $25K has borrowed as much as if they purchased a new car. This is a doable payoff, but only if you have a job. Even better if you can cut your living expenses radically for the first few years so you can also build an emergency fund.

Most huge debt I see comes from graduate work, not undergraduate. Carefully consider the field, and maybe consider working awhile before going directly to graduate school. Hey, you might even find an employer with tuition reimbursement.

Not having a part time job

Even if you can cover everyday spending by working some dumb job part time, you’re going to save a lot of loan expense. Is that latte worth $10?—because that’s about what you’ll pay with a 10 year loan.

Dropping out before finishing

Even worse if you drop out before graduating or take more than 4 years to complete. Any time you put payments in abeyance, the interest charges balloon. People who take time off, move in and out of loan payment, etc. can see their payback amount easily double over time. Remember, the interest is ticking continually: just because you’re not paying it now doesn’t mean it’s gone away. It’s growing steadily like mushrooms in the dark.

Dropping out before finishing also involves a hidden cost—lost opportunity. You already have lost opportunity—even with a free ride, college costs you what you could have been earning by working instead. But a partial degree is worth next to nothing in the job market (for most fields), so you’ve borrowed a lot for nothing. Or, if you’ve changed majors or taken time off, you’ve paid far more in extra years of tuition (and living costs, and lost opportunity) for the same degree. Stick it out—add a minor, or suffer through. Life isn’t perfect–just wait until you get the first crummy job or boss that hates you and you have a huge loan payment to make.

Ignoring the payment or taking a payment scheme

The loan never goes away, and it keeps building. Most of the forgiveness programs haven’t worked. And, if you have any kind of professional license, it can be yanked if you don’t pay. Ignoring it only makes it worse.

IMHO we have a really broken system for paying for what has become virtually essential higher education. Until and unless that changes, we have to work the current system as best we can, and that means making some very pragmatic choices. Don’t get so snagged on the college of your dreams that you close off any possibility of fulfilling after-college dreams.

 

Ugh! UTMAs and UGMAs

I’m not sure why anyone has these accounts anymore, but they do. I mostly see them during divorces, where one spouse has tried to transfer money to the kids in hopes of keeping it out of the divorce joint property. Technically, these accounts are considered property of the children (not marital), but as with so many other financial issues, it’s largely up to what the attorneys are able to negotiate.

Funding these accounts is a pretty poor idea in most cases, however. What you’re doing is putting all the money in the kid’s name: they’re entitled to it at 18 to do whatever they want with it, and all the earnings are taxed at the parents’ rate. It used to be that as long as earnings stayed below a certain amount, the earnings were taxed at the kid’s rate so it was once a decent strategy to avoid some tax, as long as you could trust your kid not to burn through it by the time they were 18 and two months.

That tax dodge evaporated years ago, but somehow these accounts are still hanging around. Unless you’re trying to shaft your spouse, or have a child actor who’s earned the money themselves but needs some supervision, I don’t think there are many good reasons to have such an account.  They’re considered 100% the property of the child for college financial aid determinations, also.

How can you get the money out of it? The account has to be used for the benefit of the child (once funded, it’s their money), but as long as you can prove that’s how you used it, you’re fine. You’ll have to pay taxes on any gains from the sale of investments, but it’s unlikely the IRS will check up on how the money itself was spent—it’s your kid that could sue you, and hopefully that won’t be a factor.

Once upon a time I had such an account for my daughter, when the taxation was still favorable. I liked it way back then because there was no obligation to spend it on college, and I was certain my brilliant kid would get a full ride scholarship. Ha-ha. Obviously that was before I was a financial planner. We never did accumulate much in college savings in the account, being dunderheads at the time, and I eventually cashed it in to purchase her harp. She hasn’t sued me yet.

Probably the easiest way to clean out the account, besides covering tuition, music lessons, instruments, sports equipment, computers…is to move the money into a 529 plan. If you have significant gains, you’ll have to pay taxes (now playing world’s smallest violin) because 529 deposits have to be in cash. At least the (new) investment will be growing tax free.

If your child has actual earned income, you can also deposit some of the funds into a Roth IRA (up to $5,500/year depending on their earned income). They can withdraw money for college with no early withdrawal penalty, but they will need to pay taxes on any earnings withdrawn. Although they own the account once they’re adults, the tax and withdrawal penalties may slow them up a little. Also, $10,000 can be used as a down payment on a first time home purchase.

For some odd reason, most of these lingering UTMAs are also invested in savings accounts, where they’re earning practically zero for years now. I think they’re just places where people thought they were going to park some cash for college, then mostly forgot about them.  So, if you still have these accounts, resurrect them and put them to work for your kids. College is going to take whatever you can scrape together.

In case you’re wondering what these letters stand for, UTMA is Uniform Transfer to Minors Act and UGMA is Uniform Gift.