It’s that time of year: the kids are sad, and the moms are glad. Again.
The sweet Vermont summer is over and school’s back in. We find this transition gets a lot of parents thinking about how they’re going to pay for their kid’s college education. There’s a lot of information about this out there on the internet and it’s a major expense in almost any approach you take to it, so there’s a lot of room for error-costly errors. Here are the fundamentals behind our general philosophy regarding this area of personal finance.
College Financing, Fundamental 1
First (and there a lot of advisors who will agree with this one): parents should not even think about putting money in an account that will detract from their long-term position if not used for education expenses until they’re confident that they’re managing cash flow properly and saving money for their own future first. Here’s why: if cash reserves have not been established and maintained, and retirement saving systems are in place for the parent, directing income to a college-funding specific vehicle increases the odds that the parent will underfund their own future and end up reliant on their children late in life. Among other things, like finding themselves in a position where they need or want the money they’ve put there for something else, which will cost them even more.
College Financing, Fundamental 2
Second, and this one will not be quite as popular, borrowing money to pay for college is not a terrible method.
We see family after family where the parent is a nervous wreck over the idea of their kid having student loan debt – like losing sleep over it kind of nervous. Make no mistake, we understand that borrowing too much or even borrowing any without a very clear plan for how it will be repaid adds risk and adds to the erosion of the family’s financial position. But when planned within the context of a cohesive strategy, borrowing the money to pay for college in the short-term can allow the family to direct the income or capital that would otherwise go to the school toward investment in longer-term vehicles to earn higher yield. Even if the yield on the investments bought with that money does not earn as much as the loan costs, or even a little less, this strategy has value because the family will have their own money compounding interest, uninterrupted, for a much longer period of time.
Additionally, parents will have access to and control of that money for a much longer period of time. Unfortunately, our physiology and general nature make it so the true value of both above-mentioned benefits are very poorly understood by we humans. Not coincidentally, the financial services industry knows this, and they have spent vast sums mastering ways of exploiting it. It’s also worth mentioning that many families will have no choice but to borrow for at least a little bit of the expense.
College Financing, Fundamental 3
Third and finally, the tax law of the 529 college savings plan was developed and written by wealthy grandfathers – bear that in mind.
No other vehicle exists that allows one to stroke a $249,999 check to a 529 plan, immediately remove it from the taxable estate, and guarantee tax-free withdrawals while controlling what the money is used for. Think that might sound appealing to a wealthy old senator?
Grandparents love their kids, but they love AND trust their grandkids, for now. So directing the money to the grandchild’s education guarantees a legacy in more ways than one. When a parent puts income in a 529 plan before addressing the personal planning needs above, and then finds they need the money, or the child doesn’t need it, or there would have been a better place to put it, the parent pays income tax (and quite possibly at a higher rate if their income has increased over the years they contribute, which is likely), and a ten percent excise penalty tax. And the state that gave them any tax credits will claw them all back at once.
Quantum Leap Is Here to Help
The cost of a college education exploded as the availability of borrowing the funding did because of supply and demand. That’s a potential source of disagreement, but there’s no debating the bell’s been rung in that area and there’s no un-ringing it. It’s literally a fortune for most families so the errors that can occur in this part of the family’s plan are naturally going to be big, too.
There’s a lot more to this, but in the interest of letting you get back to your day, I’ll close with this thought: the more choices you have, the more stability your position will have, and the sooner you learn about all your options, the more freedom you’ll have to make the best decision. Because time is the most precious commodity of all.
Have questions? Don’t hesitate to call us and schedule an appointment to discuss how to fund your child/children’s college educations.