College costs continue to rise each and every year. In fact, according to statistics from the College Board, college costs have grown exponentially over the last 35 years. (The last year tuition costs were stable or declined from the previous year was 1980) While the pace of tuition increases has started to subsided a bit, the costs of providing 4 years of college for a family may be the next largest expense after purchasing a home. Since families earmark such a large percentage of household savings and income toward college, financial mistakes in this area can be devastating to the achievement of other goals – namely retirement and debt management.
However, many mistakes are avoidable and you can develop a plan to attempt to sidestep the pitfalls noted below.
Much like waiting to plan for retirement until you reach your fifties, beginning to think about college when your children reach high school can be a huge mistake. Unfortunately, it is easy to put off planning for college when you have 18 years before you have to spend a penny on it. However, planning early may make college funding more achievable. Discussing and setting education goals before you have children can be a great way to get on the same page as your spouse before you expand your family. Do you both believe in paying 100 percent of college costs or do you believe your children should have “some skin in the game” and pay a portion of costs? Alternatively, it may be financially unrealistic to contribute toward college without derailing other financial goals so be careful with your commitment.
Once you have identified how much you can afford to provide, consider starting your education funding plan as soon as possible. Savings plans can be started with small monthly contributions that can be gradually increased over time.
Using the wrong savings vehicle
While there are multiple approaches to saving for college, tax efficiency and the impact on financial aid should be carefully considered. Custodial accounts, which are taxable based upon income and capital gains are also considered an asset of the child for financial aid purposes. (generally not a good thing). On the other hand, 529 plans are considered an asset of the parent (if in the parent’s name) and may grow tax free (federally) when used for higher education purposes. Keep in mind that state tax treatment varies and if the funds are not used for a qualified tuition expense, a 10 percent penalty and tax on any investment gains will be assessed to the account.
If you Identify that a 529 plan is a good choice for your family, next you must assess multiple plans per state with varying fee levels and investment choices. Additionally, 34 states offer state income tax deductions for contributions to their state plan so be sure to consider whether your home state offers these incentives before choosing a plan outside your home state. (NJ is not one of them). Be sure to choose plans with low expenses and performance as both may improve your chances of pursuing your education funding goals. Also considering reviewing Morningstar’s rating system at www.morningstar.com for a list of some of the top plans available.
Spending too much
While it may be incredibly difficult and perhaps unrealistic for an 18 or 19-year-old to know what they want to be when they “grow up”, a tremendous amount of money is spent on degrees that end up being under-utilized. Additionally, many families choose institutions that are substantially more expensive than alternatives that could provide the same post-graduate job prospects.
Consider treating the college decision like the business decision that it is. Ask yourself, would you invest $200 thousand dollars in a degree for your child that may provide the same level of income and networking opportunities that an $80-thousand-dollar degree can provide? Do your homework to determine what the best investment is for your child both in the degree and the institution they choose.
Borrowing against your retirement
With over $1 trillion in student loan debt, a lack of savings often leads parents and their children to assume tremendous levels of debt to fund college. As an alternative to taking loans, many parents consider using home equity, 401(k) loans and withdrawals from investments originally earmarked for retirement to pay for college. Any steps taken to increase debt or reduce retirement savings is the equivalent of borrowing against your retirement to pay for college. Children have many more years of earning potential ahead of them so do your best to avoid paying for college at the detriment of your retirement.
College funding can place a tremendous amount of financial strain and stress on parents and children. Careful planning may help you make wise choices that are in alignment with the rest of your financial life while still assisting your child with building their education. Since everyone's situation is unique, consider speaking to your tax and financial advisers to determine the most appropriate college plan for you.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.