The Cost of College & How Best To Pay For It
College has started again, albeit very differently (virtual/online), then how it started in 2019…yet, remarkably many of them are charging the same tuition and more for a very different experience!
American’s focus on the costs of college have increased, and for good reason: $1.6 Trillion is the level of student loan debt in the United States. Student loan debt is now the second highest consumer debt category — behind mortgage debt — higher than both credit cards and auto loans.
*https://www.forbes.com/sites/zackfriedman/2020/02/03/student-loan-debt-statistics/#69e5ddae281f
Did you say a trillion?
To give you a better idea of how much 1 trillion is, let’s make a comparison to time with one dollar being equal to one second. At this rate, 1 million seconds would be equal to 12 days with 1 billion seconds equaling 32 years, but 1 trillion seconds would be equal to 31,689 years. The difference in magnitude is mind boggling!
These debts have a chance to lead to a future financial crisis and have already featured in the 2020 presidential campaign.
My own student loan experience
I’m intimately familiar with student loans having taken out over $30,000* to pay for my own college degree (these were fortunately paid off years early). Just like the majority of Americans, I took out loans for college to increase my job prospects. I certainly wouldn’t have obtained the job out of college I did without this degree.
*Adjusted for inflation
I don’t remember college being so expensive
This is because it wasn’t. Since 1983 the cost of college has increased a whopping 798%*, whereas housing has increased “just’’ 169%*, and cars 45%*. Close behind college is medical care at 403%*, but that’s still nearly half of what college has increased.
*Source: BLS, Consumer Price Index, J.P. Morgan Asset Management. Data represent cumulative percentage price change from 12/31/82 to 12/31/18.
So how did it get so expensive? You can thank Uncle Sam
Why has the cost of college increased twice the rate of inflation? The usual suspect: good government intentions. There were bipartisan efforts to making schools more affordable, and while these student loan programs were well-intentioned, they caused a significant rise in tuition because the supply/demand mechanism became broken. Normally, prices are held in relative check because consumers cannot afford steep increases, but when they can just borrow more and more money the tuition keeps rising. Below is an excerpt from a report by the New York Fed on this issue.
We studied the effects of a student credit expansion on tuition costs using a difference-indifferences approach around changes in federal loan program maximums to undergraduate students in the academic years 2007-08 and 2008-09. Consistent with the prediction of the illustrative model, institutions that were most exposed to these program maximums ahead of the policy changes experienced disproportionate tuition increases.
*https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr733.pdf
Just where did most of this extra tuition money go?
The money was used for higher salaries for administrators and professors. As the economist Brian Westbury explained it, student loans have become a jobs and wage subsidy program for college professors and administrators. They, not the students, are the primary beneficiaries. The universities, via government loan programs, are using the money borrowed by young adults to deliver it to the intellectual class.
Mr. Westbury goes on to say this — “Imagine if Fannie Mae and Freddie Mac announced a program to buy all the mortgages that banks made to 18 year olds who bought homes with no money down. Obviously, that policy would lead to disaster and excessive homeownership among teenagers, who would have little idea of the longterm consequences. Well, that's what's happened with colleges. Except a mortgage has a home collateralizing the loan. You can't foreclose on a degree in poetry.”
Why do people keep going to college if it so expensive? I can think of a million reasons…
People still go to college and get loans to do so because they can get better paying jobs. Wages for a person with a bachelor’s degree are 83% higher than for a high school graduate, and they are 157% higher for those with a professional degree.
*U.S. Census Bureau, Current Population Survey, 2019 Annual Social and Economic Supplement. Lifetime earnings are based on current mean earnings for workers aged 25 to 29, assuming 3% annual pay raises over 40 years
Another attractive reason: you are out of work less.
Unemployment rates are far lower for those with a bachelor’s and/or professional degree vs. a high school graduate.
So college is expensive, how can it be less so? If you have older kids
For those who will be attending college in a few years or have kids that will be, think junior college for the first few years and then transfer to a four year college. That alone will cost you 39% less and your degree won’t look anything different, but your future opportunities sure will!
*J.P. Morgan Asset Management, using The College Board, 2019 Trends in College Pricing. Future college costs estimated to inflate 5% per year. Average tuition, fees and room and board for public college reflect four year, in-state charges. Community college costs are based on tuition and fees for an in-district student.
Where you go matters less than you think
This is especially relevant as where you go to college isn’t nearly as important as going to college. A recent survey of over 10,000 millionaires revealed that 79% of millionaires did not attend prestigious private schools, 62% graduated from public state schools, 8% attended community college, and 9% never graduated college at all.
*References: Chris Hogan’s “Every Day Millionaires”
So college is expensive, how can it be less so for those with younger kids or grandkids? Introducing the fabulous 529
There is a much better way to pay for college expenses in the future. You have your money grow so there is more of it when your kids/grandkids attend college. That is why I save for my own kids’ college and help my clients do the same through 529 savings accounts.
I’m intrigued, just what are these 529s?
I’ll start with a brief explanation: 529s are investment vehicles to help you pay for college. You invest your after-tax money and don’t pay taxes during the growth period (i.e. tax deferred). You also don’t pay taxes when you withdraw the money to pay for qualifying college expenses (tuition, fees, books, even room and board in certain instances).
529s are more phenomenal than they may initially appear
While the general strategy of a 529 seems straight forward, there is much more than meets the eye when it comes to what you can do with them. I attended a presentation from a gentleman that worked on the draft legislation, and the lead senator told him 529s would be the most powerful wealth transfer vehicle available for the American public.
Here are 5 rather fascinating facts that feature why 529s are so powerful:
1. HELP YOURSELF - You can name anyone as a beneficiary — a relative, a friend, even YOURSELF. Maybe in retirement you have a goal to go back to college. You can start saving now to have tax-free funds to help offset that cost! Most people invest in 529s to help offset the costs of college for their kids or grandkids which is also a great strategy.
2. EMBRACE CHANGE - What if you, or your child or grandchild doesn’t go to college? You can change the beneficiary of a 529 at anytime to another person (yourself, another child, grandchild, etc).
3. BACK TO THE FUTURE - You can save now for the future, yet-to-be-born, beneficiaries. The principle is pretty simple when you combine facts 1 and 2. You can open a 529 and name yourself as the beneficiary (fact 1). In the future you can then change the beneficiary to someone else (fact 2). Therefore, parents and grandparents can start saving now for heirs they will have in the future. You can’t do that with an investment account without having potential taxable implications.
4. TIMELESS - With most 529s there are no required minimum distributions. This means money can be left to compound for multiple generations. You can’t do this with non-retirement or retirement accounts which have to be distributed at a certain age or at death. If your kids don’t use all of the money, you can let it grow for another few decades until the next generation needs it. This can create a significant educational legacy.
5. STACKED - The annual gift exclusion is $15,000/taxpayer (for married couples it is $30,000). There are no tax consequences to either party for gifts of this value. However, only with 529s you are permitted to stack 5 years worth of such gift contributions into a single year. An individual can contribute up to $75,000, and a married couple could contribute $150,000 per beneficiary. Grandparents with 10 grandchildren could remove up to $1.5 million from their estate in just one year.
We all want our kids to graduate from college so they have better and higher paying jobs, and are less likely to be unemployed. So, it’s important we are careful about how we go about paying for it. Please know that as a parent you should only contribute to your kid’s college savings after you have an emergency fund and are on track for retirement. See my blog on Putting your Oxygen mask on First for more details: https://www.betterplanningbetterlife.com/blog/put-your-oxygen-mask-on-first
As a Certified Financial Planner I help parents and grandparents navigate the challenging choices when it comes to paying for college so the best outcomes can be achieved for all parties. If you’d like to schedule a meeting to discuss, click the link to find a time that will work: https://go.oncehub.com/bookjonny.
Note: Prior to investing in a 529 plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in that state’s qualified tuition program. Withdraws used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
