Longtime visitors of this site know I had a long, drawn out, 7 year battle with student loans. We finally paid them off in March of this year (2018), freeing up about $1,250/month. A good chunk of that money went straight to childcare for our second kid. And speaking of kids, the natural progression for parents (especially those who had student loans themselves) is “Are we going to pay for college?” Followed quickly by “How are we paying for college?”
Great questions. Very difficult answers. Before we go down that road there are 2 priorities to look at and lock-in.
Priority 1 – The Basics
This section could be titled “keep them alive and healthy” for ~ 18 years.
We owe them, at a minimum all the basics: Food, shelter, clothing, medical care, diapers, toys, new shoes the second money of every month. etc, etc etc. You get the point. Baseline costs that everyone plans for (or at least thinks they planned for 🙂 )
Since you are reading a financial blog right chances are you aren’t struggling with this part.
Priority 2 – Make sure they don’t need to pay for your retirement
The best gift you can give your kid is not taking care of your retirement.
Money put towards their education is directly taken from what you are saving for yourself. You can label it as a different bucket, or put it as a separate line item in your budget. That doesn’t change the opportunity cost of the money. If it’s for them, it’s not for you.
It might seem harsh, but “pay yourself first” applies to the paying for college situation. If your kids decide to have kids, do you want them to have to make a decision to either pay for your new hip or their kid’s education? Absolutely not, take care of yourself, then start taking care of them.
We had a rule that we wouldn’t start funding our kid’s education until my student loans were gone. We broke that rule by about 2 months (mostly so we could open an account for grandparents to contribute) but I think it is a good thought exercise to go through if you still have loans yourself.
Now that is squared away let’s get back to shrinking the college cost gap
Paying for college: Shrink the “Need” Gap
We have talked about growing the gap, the difference between how much you spend and how much you earn. Looking at the cost of college we want to shrink the amount your kids need to borrow (Need). Here is the equation we are going to be working with
Need – College Savings – Costs Cut = Take
How much will they need to pay for college?
How much is in your college savings bucket?
What costs are they able to cut?
What are they going to take from a lender to bridge the gap?
Instead of viewing college loans as something that is 100% on the parents to figure out, I want to look at it as us (parents) and our kids bridging as much of the need gap by focusing on two areas:
- Cut the cost of college by teaching our kids financial responsibility
- Contributing money to a college savings bucket for them
Shrink the Gap – Cut Costs by Teaching Financial Responsibility
Student loans can be devastating, and parents are programmed to help their kids avoid devastation. Paying for college is a grand gesture, but if there is not a financial base for them to stand on after college it could be a one-time bailout. Followed by poor financial decision making that makes the free education obsolete.
My student loans sucked, but the one shining star is they forced me to get my act together financially. Our goal is to shift the knowledge I gained about money at 27, 10 years earlier (at least). That way we can attack the cost of college from two sides.
This list will likely grow, but here are some of the strategies/knowledge we will push down to our kids:
The internet has unlocked tons of different scholarship opportunities that weren’t as established when I was applying to school 12ish years ago. There are sites 100% dedicated to showing you how to apply and win scholarships. Don’t forget to look local, they might be the easiest to lock in.
Using Loans Responsibly
I’m not proud of it, but I am somewhat of an expert in using student loans for something other than tuition.
I took out extra cash to fund a lifestyle I couldn’t afford. My student loans went to rent, Keystone Light, eating out and even a vacation while I was in school. Then paid thousands of dollars in interest over the 7 years it took for us to pay them off.
It was a good (and expensive) lesson on how to use debt responsibly.
Major decision. Not saying you should push or pull your kid to a school based on money alone, but laying out the options and having them make an informed decision (including cost) is something we will do.
College Courses in High School
Still beating myself up over not taking advantage of this one. You can take college courses, for college credit, FOR FREE in high school.
People are graduating earlier (which means they start earning earlier) and spending less on school because they worked hard and were far smarter than I. Not paying thousands of dollars for generals sounds like a pretty damn good deal to me.
Understanding the impact of student loans
If someone would have laid out the numbers in terms of monthly payments vs expected salary I would have made better decisions. Not saying I would have been perfect, but my hill wouldn’t have been as steep.
Until you have to start paying the money back, it feels like free money with no consequences.
The reality is, the consequences are very, very real. We sent in up to $1,250 per month to pay down my balance, for multiple years. That is a mortgage for a decent house in Minnesota.
Shrink the Gap – Paying for College
Lots to talk through here:
- How much are you going to pay for?
- When are you going to start saving
- Where are you going to keep your money
How much are you going to pay for?
I have spent a ton of time trying to figure out what kind of goal we could set around the “How much we want to save for college” question. It is very difficult to plan out for quite a few reasons:
- Public vs. Private cost
- In-State vs Out of State cost
- Scholarships or grants
- Cost of college inflating
If we just knew were our kids wanted to go (or if they want to go at all) and could plug the future cost into one of our compound interest calculators we could set a target. But we can’t. Paying for college is a moving target that won’t be locked down until they go.
I even have a hard time saying we will pay for “half” or “all” because the range is so big it is not even a meaningful target. It could be anywhere from $20,000 for community college or trade school up to $250,000+ for an out of state private schooling.
It is never too early to start thinking about this, but with young kids, there is shockingly little we can control right now. All we know is we want to help.
Cash Flow the Cost of College When the Time Comes
Some people opt to “cash flow” the cost of college and pay out of pocket every year or semester when the bill comes. The money could come from investments you cash out or cut off the top of your take-home pay if you are still working.
Pros of cash flowing the cost of college
- Chances are you will have a better handle on your finances when you are older making this possible
- You know the actual dollar amount you need to cover
Cons of cash flowing the cost of college
- If you are paying directly from your paycheck when the time comes there are no investment gains (which can offset or beat the rising cost of college)
- I could see this strategy dipping into personal retirement accounts instead of an actual “Cash Flow” solution and that makes me nervous
“Front Load” College Savings
Another option is to “front-load” the savings or start contributing early in the child’s life (or even before they are born). The goal would be to build up a sizeable college savings bucket over time by investing.
Making the case to invest college savings vs a standard savings account:
“Since 1985, the overall consumer price index has risen 115% while the college education inflation rate has risen nearly 500%” –InflationDate.com
Generally, when we are talking about money losing its buying power due to inflation it is at ~3%. As you can see from the stat above we are losing a lot more buying power due to the rate college is increasing in cost.
I would take a standard, or even a high yield online savings account out of the equation for college savings based on that stats alone. They can’t keep up with the rising cost of college.
Use a 529 plan to save for college
Some states (Recently Minnesota!) offer income tax deductions for 529 contributions.
Pros of a 529 plan to save for college
- Gains are not taxed in 529 accounts as long as they are used for education
- Some states allow for state income tax deductions (Minnesota is one, check how your state handles 529 contributions)
- Many offer low-cost index investing options (You are not required to use your state’s plan either)
- High potential for growth/compounding
Cons of a 529 plan to save for college
- “Locked-In” to using the funds for college. If your child gets scholarships or decides not to go to school you face a penalty for withdrawing the funds for something besides education (You can switch the funds over to another child or even save them for your future grandchildren)
Use a Brokerage Account to save for college
Pros of using a brokerage account to save for college
- Not required to use the money for college. Could use it for other life events (Wedding, down payment for a home, etc)
- High potential for growth/compounding
- Can invest in anything you want (low-cost index funds)
Cons of using a brokerage account to save for college
- No tax advantages on either side (State income write off or tax-free gains)
Take out a Loan for your Child
Its an option, but it makes me nervous
News Flash: when your kids are 18 and ready for school, you are going to be older.
I will be 48 when our first turns 18 and taking out debt at that age for anything outside a house sounds like a terrible idea. I love em, but going into significant debt for them at that age. No thanks.
Don’t go out and start a GoFundMe page, but asking for 529 contributions instead of gifts is a legitimate option to boost your kids college savings account. I don’t know about other states but we have custom links we can share with grandparents for funding. If they want to start a 529 themselves that is also an option.
Paying for College – What can change between now and then?
What makes paying for college so hard is how much can change between now and then. Outside of what school your child picks here are a few other variables I am thinking about:
The cost of college
It WILL change but by how much? Will the costs stop rising at an astronomical rate or rise even faster? Like I mentioned before, moving target. We have no clue what we are up against.
College becomes less important
I doubt college will ever become obsolete, but with the gig economy growing, the internet pumping out free information and some jobs that require degrees today shifting to “trade” skills I could see college becoming less important for some sought-after jobs.
Kid Decides to go down a different path
We put too much emphasis on college being the only/best path to a high paying job. If your kids want to explore one of the trades or have an entrepreneurial bug don’t push them away from it.
Education Interest Rates
My federal interest rates were over 6% but they change every couple of years. It is possible they could be lower, or student loan refinance companies are able to disrupt the market and make government-backed loans less important. This could make the interest on student loans cheaper, but the tuition costs will likely keep rising.
Our Paying for College Plan
We started 529s for both our children and set up automatic contributions twice a month. We invested in a broad-based, cheap index fund that is available through Minnesota’s state plan. Right now we are only transferring $50/month but will start ramping that up next year (still slowly, but that’s how all good things start).
We do encourage grandparents to contribute instead of gifts (or split between a gift and the 529) to help close that gap even more. Especially at these young ages where toys are relatively cheap and they don’t need a ton of them.
Our goal right now is to simply help them out as much as possible by building their accounts for over 18 years. Depending on where they decide to go to school, it might be enough to cover a few years.
If we did our job and taught them how to borrow responsibly, it might be enough to cover it all. Depending on our financial position we might be in a place to cash flow some additional costs and help them out even more.
How are you paying for college? Have you already paid for your kid’s college? How much did you pay for your college?