Conventional wisdom continues to fall short in arming families with solutions that help them balance the priorities of maintaining their current lifestyle, getting on track/staying on track for retirement and paying for college.
We are trained to use 529 calculators to “solve” for the retail cost of college by plugging in the cost-of-attendance, determining the number of years before college begins and asking parents what percentage of college they’d like to fund — for a single student. That’s our industry’s approach to “college planning.”
And it’s not working.
The tension between a client’s current lifestyle and their future lifestyle (aka retirement) was permanently altered when companies moved from employer-funded defined benefit plans (pensions) to employee-funded, self-directed retirement plans [401(k), 403(b), IRA, etc.].
Literally overnight, it was up to the consumer to fund their future lifestyle — with little-to-no education or experience. No background in asset allocation, risk/reward analytics, tax-efficient distribution strategies, or the role of inflation in managing an investment portfolio. And at that time, there were 27 tax brackets — so the prevailing belief that an employee would retire in a lower tax bracket was reasonable.
Fast forward to today and few employees realize they are likely to retire in the lower end of their existing tax bracket or just a single bracket below where they were during their working years. Nor are they prepared for the tax time bomb that results from postponing the bill.
In an inexplicable twist of fate, just about the time this foundational financial change took hold, the cost of college began to skyrocket. Today’s parents that are “saving for college” are effectively bringing a knife to a gun fight.
Paradigm Shift Needed
College is a major capital purchase – defined as anything we buy that is not paid for, fully, with monthly cash flow. Prior to the 1990s, this was typically houses and cars. Today, many families are challenged by college costs that are the equivalent of buying a second home or a fleet of new Teslas. It’s no wonder “saving for college” isn’t working.
Parents (and their advisors) need a paradigm shift when it comes to paying for college. If we can guide parents to approach the purchase of college as a savvy consumer vs. an emotional parent stuck in a conventional wisdom mindset, we can become a hero, not an enabler.
We need to encourage and even give parents permission to think about their financial future and not just their kids’ college education. Parents cannot afford to wait and bring retirement into focus after they get the kids through college; college and retirement require simultaneous action. Nor should they deplete their retirement accounts to pay for school.
One mantra we must embrace, that seems to resonate with parents, is, “Finance their future, fund yours.”
College Financing Options
Like buying houses and cars, parents should look for any/all low-cost financing options to secure cash flow for college while continuing to maintain control of their capital, on their balance sheet, earmarked for their retirement.
Would you advise your client to pay 100% cash for a second house? Fully funding college through an after-tax savings plan is the equivalent of paying cash for another house. It’s simply not the best use of capital.
The college purchase provides more financing options than houses and cars so we are remiss if we don’t advise all parents to take advantage of them. Home equity lines of credit (nondeductible but cash-flow friendly), interest only loans that collateralize cash value insurance policies (non-structured repayment schedules are particularly attractive with these) and direct student loans that do NOT require a co-signor immediately come to mind.
Low-cost direct student loans represent $27,000 of cash flow for college:
- $5,500 freshman year
- $6,500 sophomore year
- $7,500 junior year
- $7,500 senior year
And these require nothing more than completing the Free Application for Federal Student Aid (FAFSA).
The Advantage of Cheap Money
Like most parents, I don’t want my son to graduate with college debt. But as a business owner I recognize the advantage of cheap money and attractive repayment options. Last year’s interest rate was 2.75% and this year’s loan rate is 3.73%. Although this is a significant jump, where else can you get that rate and not have to start making payments for almost five years?!
So, in our household, we’ve decided to use other people’s money to create cash flow for college. If my son maintains a GPA that keeps his merit-based scholarships flowing and finishes a four-year degree in four years, we’ll make his student loan payments — which come due six months after he’s out of school.
Meanwhile, we enjoy our current lifestyle, we direct cash flow toward our future lifestyle (retirement) and he gets a great education. When he’s done with school, we’ll deposit the monthly loan repayment into his bank account on the 1st of each month and instruct the loan servicing company to withdraw the money from his bank account on the 15th. He gets the tax deduction on the loan interest for tax purposes, we help build his credit right out of college, and we got to use cheap, cash-flow efficient money during the college years.
Seeing Is Believing
A detailed cash flow worksheet — showing parents where the money for college will come from, for all kids, all years, is in order. Think of the 529 savings as the “down payment” on the major purchase called college and then look at current lifestyle cash flow for the kids as redirected during the college years. For example, orthodontia, club sports, private high school tuition and all those extracurricular activities that your clients are finished paying for are baked into a family’s current lifestyle, so identify them and plan on keeping those flowing during the college years. Everything over and above this should be financed.
Good college planning is good retirement planning. These two important planning goals cannot and should not be done separately because they are a critical part of the same financial ecosystem for every family we serve.
Beth V. Walker is a wealth advisor with Carson Wealth Management and founder of Center for College Solutions, which is based in Colorado Springs, Colo. She can be reached at email@example.com or 719-522-2278.