Back to School: Planning and Paying for College
By Brian Seay, CFA
Founding Partner, Capital Stewards
College is the second largest purchase for most families with for one child, let alone two or three. Four years of college now costs between $80,000 and $300,000 per child. Yet we spend more time talking about the next car we plan to buy than we do college. When we do get to the discussion, we skip straight to how much to save and the right tax strategy. However, it's really important to take a step back and think about the product we're actually buying. Do we need the $80,000 version or the $300,000 version? What is the purpose of college? What do we get for that huge investment? The answer might surprise you and might be different for each of your children.
As advisors, we can help optimize saving and tax strategies, but none of that matters if we don’t get the big picture right. So here we focus on getting the college decision right. Then, we discuss the tools to help fund the right college decision. Here is our framework to help families make smart college decisions:
The right school choice is the one the aligns all of the elements of the framework, not just academics, cost or “fun.” How does the school help the student accomplish their career goals? Is the cost right for the outcomes desired? Can we afford it without taking on too much debt? Aligning all of these elements is how we make smart college decisions. A smart college decision is one that propels a student towards their goals, allows them to enjoy the journey, and doesn’t burden anyone financially long-term.
Is College Worth It?
The world is always changing, but college graduates still earn more on average than those without degrees. But anytime we use averages it's important to be aware that no one is really “average”. Some students will have above average results, others below average restuls. We need to help our students align the elements of the framework for them to acheive average, or even above average results. We will discuss specific schools in a minute, but what makes college “worth it?” Research shows the results are determined by 1) the subject a student studies and 2) their effort and engagement with the coursework. It’s clear from multiple research projects that some majors pay more than others. Paying more in tuition to earn more long-term may be a good economic trade-off. But paying more to study a field with few economic opportunities is not a good idea. Additionally, and not surprisingly, students that apply themselves in college actually improve their critical thinking capbilities. So for college to be “worth it”, students need to choose the right major, at the right school, at the right cost and be engaged. Back to the framewok again.
Do elite colleges matter? Does it matter if we send a child to Harvard or another expensive private school?
The answer is that it depends on the student and their intended profession. Research from the Wall Street Journal shows that school “rank” and status does matter in fields like business and some liberal arts majors that tend to send students on to graduate schools. In these cases, research shows that the prestige of the school has a major impact on future earnings. But for other fields, like science, technology, engineering, and math, it doesn't matter whether you go to a prestigious expensive school or a lower priced state school. The expected earnings over time, turn out to be the same. Again, what matters is aligning the student’s planned major with their choice in school. Study after study shows that your student will determine their own long-term economic success, not the name on their degree.
Is everyone in your family on the same page?
Investing in college is like buying a house. Potentially a $300,000 house. And you talk about that extensively with your spouse before you purchase a home, but not before making college decisions. We often ask parents when we sit down: Are you and your spouse on the same page about paying for college? Often times the answer is a blank stare and no. One says we're paying for college in full and the other plans for the children to work through school. There is no right or wrong answer, but it’s critical that you are on the same page as a family about paying for college AND about where that spending fits with your other savings goals.
It is also important to have this conversation with your kids sooner rather than later. Ron Lieber, in “The Price You Pay for College,” recommends talking to students about college long before it’s time to start visiting schools. We recommend 8th or 9th grade. The early conversations do not need to be about specific dollars or about putting pressure on your kids to keep a 4.0 GPA. Discussing the process in general and what factors matter will help them make smart choices in high school. Discussing how sports, extracurriculars and grades all contribute to gaining admission and paying for school will help get everyone on the same page. I like to frame it simply in terms of options. The more effort a your student puts in during high-school, the more options they will have available when it comes time to choose a college. Simple and straightforward.
Paying for College:
Often families are surprised at the lack of financial support they receive when it comes time to send kids to college. Lets start with athletics. According to the NCAA, only 2% of high school athletes receive some form of scholarship to college, and most of those are less than a full ride. So this is not an option for the vast majority of families. Parents are also surprised at how little “merit” and “need based aid” they receive. You will likely be surprised by your “Expected Family Contribution” when going through the financial aid process. While you may be able to lower business income in certain years to help, financial aid offices are keen to spot many tricks. So it’s unlikely that parents will successfully beat the system. The college is a business and it is attempting to entice the most competitive students to attend school. They use discounts and “awards” to entice students. If your student isn’t in the top tier of admission candidates for a school, the school will likely not feel the need to discount the price to entice them to attend.
That means the majority of school funding is likely to come from 1) savings, 2) current income and 3) loans. Some families may be able to write the check each semester out of their current income, that makes the process simple. For most, paying for college requires long-term saving and potentially taking out loans to foot the bill. Clearly the goal is to minimize the debt required to complete school, but not all college debt is bad. Again, it depends on the student, the school and the major. If the student has a high aptitude and desire to go into a field with really high salaries, then some debt to enable that goal may be a good long-term investment. If the student is simply borrowing to stay in school or attend a more prestigous school, then debt may result in more long-term financial pain than it’s worth. If debt is required to fund college, the first choice should always be subsidized or unsubsidized loans borrowed directly from the federal government, which the school can help facilitate.
So the keys to paying for college are 1) making a good choice about how much to spend and 2) saving ahead of time to minimize debt required. Remember, if you haven’t saved as much as you would like, the goal isn’t to send your child to the most expensive school possible. The goal is to make the right choice, based on your resources and their aspirations. Saddling them - or yourself - with debt for life will likely not help anyone. See our other post nearby on paying for school when you haven’t saved “enough.”
How much should we save and where?
Just to give some context, if you have a newborn and desire to fully fund college at a very low cost public school, you should be saving at least $250 each month for 18 years. That number increases to $650 or more each month for elite private schools. If you are starting later, then the number will be higher. So the short answer is start now and start big.
For most families, the 529 plan is the right account to use. Other options exisit, like Educational Savings Accounts (Coverdell Accounts), or even retirement accounts like IRAs or ROTHs. Education Savings Accounts have income and contribution limits that make them less practical. The same applies to IRAs and ROTH IRAs. While the tax deductions may feel good, many families have too much income to contribute. Even if you can contribute to an IRA, savers usually cannot fully fund college and their own retirement within the contribution limits.
529 plan contributions are generally deductible on your state income taxes. That's true in Alabama and Georgia. In Tennessee, there is no state income tax, so there's nothing for you to deduct from. 529 plan earnings grow and can be withdrawn tax-free to pay for educational expenses. We recommend opening one account for each child in your family. Grandparents and friends can also make contributions, regardless of who owns the account. In fact, direct parental ownership of the account will help in the in the finanical aid process. So have Grandma and Grandpa contribute to one 529 plan instead of opening their own accounts. 529 plans have the flexibility to transfer funds between children. So if one child earns a full scholarship or decides not to go to school, the funds can be used by their younger siblings. There is some risk that an only child doesn’t attend school or that accounts are overfunded. We recommend not quite fully funding 529 accounts, especially for younger children, to ensure the savings is optimized without the risk of tax penalties after everyone completes school.
According to Sallie Mae, only about one-third of parents actually use a 529 plan when they pay for college. So if you're wondering if everybody else around you has saved exactly enough for college via 529 plans - the answer is no. In fact the majority have not. So no matter where you are on the journey to college, starting now will put you ahead of the game. For more discussion on choosing and paying for school, check out our latest podcast on “Back to School.”
If you would like professional guidance on college planning, we would be delighted to help. Simply schedule an intro call to get started.
Additional Resources and Sources:
WSJ: Do Elite Colleges Lead to Higher Salaries?
The Atlantic: Does it Matter Where you Go to College?
National Bureau of Economic Research: Estimating the Payoff to Attending a More Selective College