Planning for college gives families the opportunity to send young adults into the world on the best footing. Not only do these young work warriors learn technical skills to follow a career with a livable income, they also learn social skills by interacting with a new set of people. When not carried out properly, students and parents often see the end of academic careers with debt and no diploma. Creating a better understanding of how college funding works and the choices that are available help parents in the process of saving for, shopping for, and saving on the cost of college. This post will act as an introduction to saving on the cost of college, with a review of the family’s expected contribution.
First, let’s take a step back and look at the landscape as it exists today.
Google “student loan debt” and a barrage of articles and statistics fill your search results. As most families with college-bound students know, total student loan debt is well over $1 trillion. In fact, the most recent numbers show total student loan debt at $1.4 trillion (1.). In 33 out of the last 35 years, the cost of college has risen faster than the pace of inflation (as of October 2016) (2.)
The result has been an inflation rate of roughly 5% for the past 10 years. Compare this to the cost of college in Singapore over approximately the same time frame and you will see an inflation rate of 3.22% (3.) – more in line with what one would expect. Free tuition may also be available in countries such as Germany, which originally abolished tuition fees in 1971 (although it made a comeback from 2006-2014) (4.). Still, a free university education is not always as glamorous as it seems. For example, in Sweden, the government provides tuition to students, but students loans do pile up, with 85% of Swedish students graduating with debt (4.), though that debt does not compare to the growth or amount of debt US students incur.
Take a look at the cost of college and the median US household income.
Part of the American Dream is slipping farther away from parents wanting to see their children do better and from students wanting to experience a respectable standard of living. The math is simple; when the rate of change for college costs increases faster than incomes rise, more borrowing takes place, totaling $1.4 trillion.
I hope we start waking up to the current realities and start looking at the picture with a different set of assumptions and planning techniques. The students who recently graduated or who will be graduating soon must start looking at student loans in the same way Boomers have started looking at Social Security to maximize lifetime income. However, instead of looking for ways to increase lifetime income, graduates and parents with student loans must find ways to reduce lifetime expenses.
Students in high school or middle school, and their parents, should closely examine ways to fund college. Start with the basics. (Click here for a timeline associated with the last two years of high school.)
We must look at the larger, more basic formula for college as outlined below.
Cost of Attendance – Expected Family Contribution = Student Financial Need
Most families have this basic formula down. If you have a high school student, how many conversations have you had with him or her about the cost of in-state versus out-of-state tuition and public versus private university costs? Most families try to keep the cost of attendance down without focusing on other aid that may make more expensive universities competitive, in terms of cost, with public in-state institutions.
For example, if private university tuition is $50,000 and a public school costs $25,000, the easy choice (on the surface) is a public university. However, when private schools see that a student has significant financial needs, those schools will likely offer more scholarships, grants, discounts, and money to the student (assuming the college is seeking the student’s attendance).
Only 11% of private school students pay full price for their education (6.). Private universities spend $0.42 of every tuition dollar and revenue on scholarships and grants (6.). Recent years have shown record scholarships and grants issued from private universities.
In the end, the net cost to parents and students matter not the sticker price.
Learning how the formula works for a family’s expected contribution should be the second step.
What is the Expected Family Contribution, or EFC?
In simple terms, this number is the amount of money the government feels your family can reasonably contribute to funding a college education. The formula, while more complicated, is listed below:
(Parent Income + Parent Assets)/# of Children in College + Student Income + Student Assets = EFC
Parent Income – Between 0-47% of total income may be expected minus all taxes and allowances.
Parent Assets – Up to 5.6% of qualifying assets may be counted, such as brokerage accounts, college savings, and savings accounts. Assets such as the family home, retirement plans, and an asset protection allowance do not affect the EFC calculation.
Number of Children in College – If you have more than one child in college, your Student Financial Need changes because assets will cover multiple individuals.
Student Income – 50% of income over the protection allowance counts toward the family’s EFC.
Student Assets – 20% of all assets, including custodial accounts and savings accounts. As with parents’ assets, the EFC calculation ignores family homes and retirement plans. As mentioned before, students also get an income protection allowance.
(Stay tuned for another blog post discussing income protection allowances.)
As you can see from the formula, simplicity quickly gets lost and families start ignoring the EFC part of the college funding formula. Here are the next steps for parents and students.
1. Starting when your child is in middle school, project your income through high school and college to better understand cash flow and to examine ideal accounts to save college funds.
2. If you own a small business for which your student works, create a plan early for the student’s income to avoid a higher EFC.
3. Create a plan for the gifting of assets to the student while he or she is in college, or a few years before college. Remember that up to 20% of a child’s assets count for the EFC and that only 5.64% may be expected for a parent’s qualified assets. If Grandma and Grandpa gift stock to the kids, you may want to rethink this for a while, or Grandma and Grandpa may want to gift the stock to Mom and Dad instead. (Watch out for the annual gift exclusion amount. Talk to your tax advisor for specifics about your situation.)
1. If you work, project your income over the next few years before and while you’re in college. You may end up working more your sophomore year versus your junior and senior years. This accomplishes two items: A.) It gives you a longer timeframe for your money to compound, and B.) Because prior-year tax returns are used, a lower income will be reported on the FAFSA.
2. Be careful about receiving gifted assets. See #3 under “parents.”
3. As you plan for college, closely examine whether you will be a better candidate for merit-based or needs-based scholarships and grants.
As always, if you have any questions, use the “contact us” page to let us know what is on your mind or contact us at 317-805-0840.
We want the best for our children, and we seek to lead them towards lives that are better than our
own. Culturally, we accept the pursuit of the “American Dream.” We measure success in terms of a house and white picket fence, a steady nine-to-five job, and a sizeable bank account. As parents, how do we put our children in a position to achieve this dream? What if our children want something other than this dream?
These questions lead me back to the current reality. To help our kids prepare for this next exciting phase of their lives, what should we as parents be doing now? For most families, “college” is the answer. However, the reality of achieving it remains a challenge. It’s like watching a crowd pay to stand in line for a box of goods and the promise of a great future, but not knowing how long the line is or what the box contains.
The American Dream
We hear about the goods in the box being the American dream – buying a home with a white picket fence, having two children, working at a nine-to-five job, and having a sizeable bank account. These traits are measures of success. The American Dream tells us that a pension awaits us when we reach the age of 65, and that our children will get college degrees, putting them on track to have better lives than ours. Yet somehow, in some way, the dream feels out of reach.
Consider Generation X. They bear the once-shared responsibility of creating a retirement pension while caring for elderly parents and helping pay the inflated cost of college – all on stagnant wages. The financial planning community tells this generation, “Save more, work more, save for your retirement first. Kids can borrow money for college; you cannot borrow for retirement.”
What is the result? A lack of retirement savings, student loan debt that both parents and children will be working to pay off for decades, and high levels of stress and anxiety. Where can we start building momentum that helps parents and acts as a springboard for our children and communities? College planning. Here, we can start with one of Gen X’s biggest concerns. First, we must gain perspective on the current landscape.
Student Loan Bubble
One of the most disturbing clocks is the student loan clock (found at collegedebt.com). Take a moment to venture over there and wait for a few seconds. It likely feels similar to watching the national debt clock. Consider the growth in student loan debt over time with just federal student loans outstanding (3.)
Or how about the increase in parent plus loans versus federal loans to undergraduates(4.)
Several studies have shown that parents tap into their retirement accounts to help pay for college. Even as parents sacrifice their own retirement over time, we sit with $1.4 trillion of student loan debt, on which one generally cannot file for bankruptcy. Experts state that the student loan bubble is coming.
Is it coming or is it already here? In a recent article, Forbes noted that the percentage of borrowers not paying on their federal student loans within three years of graduating college has increased to 11.5% (1.). Compare this to the mortgage delinquencies from the great recession, which topped out at 11.53% in the first quarter of 2010 (2.). How can the bubble be on the way? It is already here.
For several reasons, we should not be surprised by the lack of conversation on this topic:
– The Department of Education does not penalize universities until their student loan default rates exceed 40% in one year or 30% over three years. Remember how terrible things were during the Great Recession? Universities would need to become three to four times worse in terms of their default rates before the school has skin in the game.
– Think about the fact that you cannot easily declare bankruptcy to eliminate student loans. Why would the student loan industry care much about defaults? The interest will continue accruing; it only becomes a question of when they will collect. The longer it goes, the more compensation they will receive. The interest does not stop piling up.
– Let us not forget the standard advice of the financial planning industry: Prioritize saving for your retirement. “Kids can borrow money for college, but you cannot borrow money for retirement.” Think about how we pay for advice. Most advisors or financial salespeople receive compensation from commissions and/or the assets they manage. The larger this pool of assets, the more money they make. Why wouldn’t they prefer that you and your child take out student loans instead of paying for college from accumulated assets? While this does not apply to all financial professionals, based on my experience it is most often the case. This is not always a prudent financial move. In 2015, Mark Kantrowitz wrote an article that discusses situations in which putting your retirement first does not work best.
Does the world seem bleak, as though all is lost? There are new and developing trends. We must
understand both sides of the student loan issue.
The first is students who have already graduated and are working to pay off their loans. These individuals must look and plan for their student loans using the same mindset Boomers have toward Social Security planning. As you look back on retirement income planning, not much thought was given to maximizing Social Security to increase lifetime income. However, as Boomers aged, they explored the rules and started developing strategies like file and suspend, or restricted claim to help increase lifetime income. These strategies were innovating. They became so popular that Congress had to change the rules on Social Security. In a comparative way, new planning tactics must be developed for current holders of student loans. People like Heather Jarvis and younger financial planners are leading the way.
The flip side involves preventing student loans from being an issue. This means that as college education consumers, we must change the way we save for, shop for, and save on higher education. Most of the time, financial services will tell you to save for college (provided you have taken care of your retirement first), but it will not tell you how to save on the cost of college. Those individuals who talk about how to save on the cost focus on getting scholarships. However, there are other ways, like smart shopping, making the schools compete for your student’s attendance, and using the tax code to create “tax scholarships.”
Next Step with College Funding
– If you face the first scenario, study the innovators who specialize in student loans. If you are a do-it-yourselfer, check out Heather Jarvis’ site: http://askheatherjarvis.com/. For those who are delegates or validators, check out the screening tool on the XY Planning Network and look for advisors who specialize in student loans.
– If you are a parent of a high school student seeking some level of education beyond high school, look for advisors who specialize in the financing of college funding, not just the filing of the FAFSA or CSS and finding scholarships. I’m talking about using the tax code to create “scholarships,” having universities compete for your attendance, coordinating contributions from family members to avoid negative impacts on aid, helping coordinate distributions from accounts, developing a smart borrowing plan, and helping families explore ways to cover any college funding shortfall. To see what this process can look like, follow this blog over the next few months.
Friedman, Zack. “Student Loan Defaults Rise – What To Do Now.” Forbes, Forbes Magazine, 6 Oct. 2017, www.forbes.com/sites/zackfriedman/2017/10/06/student-loan-default/#1f1cc56928de.
“Delinquency Rate on Single-Family Residential Mortgages, Booked in Domestic Offices, All Commercial Banks.” FRED, St. Louis Federal Reserve, 27 Nov. 2017, fred.stlouisfed.org/series/DRSFRMACBS.
Eisenhart, Maddie. “Student Debt Is Going to Be A Huge Problem for Millennial Marriages | A Practical Wedding.” A Practical Wedding: We’re Your Wedding Planner. Wedding Ideas for Brides, Bridesmaids, Grooms, and More, 17 May 2016, apracticalwedding.com/student-loan-debt-relationships/.
Mitchell, Josh. “The U.S. Makes It Easy for Parents to Get College Loans-Repaying Them Is Another Story.” The Wall Street Journal, Dow Jones & Company, 24 Apr. 2017, www.wsj.com/articles/the-u-s-makes-it-easy-for-parents-to-get-college-loansrepaying-them-is-another-story-1493047388.