How much college savings is enough?

Dear Liz: My husband and I have three children, two in elementary school and one in middle school. Through saving and investing, we have amassed enough money to pay for each of them to go to a four-year college. In addition, we have invested 15% of our income every year toward retirement, have six months’ worth of emergency funds and have no debt aside from our mortgage and one car loan that will be paid off in a year. Considering that we have all the money we will need for college, should we move this money out of an investment fund and into something very low risk or continue to invest it, since we still have five years to go until our oldest goes to college and we can potentially make more money off of it?

Answer: Any time you’re within five years of a goal, you’d be smart to start taking money off the table — in other words, investing it more conservatively so you don’t risk a market downturn wiping you out just when you need the cash. The same is true when you have all the money you need for a goal. Why continue to shoulder risk if it’s not necessary?

You should question, though, whether you actually do have all the money your kids will need for college. College expenses can vary widely, from an average estimated student budget of $22,261 for an in-state, four-year public college to $43,289 for a private four-year institution, according to the College Board. Elite schools can cost even more, with a sticker price of $60,000 a year or more.

Another factor to consider is that it may take your children more than four years to complete their educations, particularly if they attend public schools where cutbacks have made it harder for students to get required courses in less than five years, and sometimes six.

So while you might want to start moving the oldest child’s college money into safer territory and dial back on the risks you’re taking with the younger children’s funds, you probably don’t want to exit the stock market entirely. A 50-50 mix of stocks and short-term bonds or cash could allow the younger children’s money some growth while offering a cushion against stock market swings.

A session with a fee-only financial planner could give you personalized advice for how to deploy this money.

Using a Roth for college: hazards and benefits

Dear Liz: My husband and I have been putting 5% and 6%, respectively, into our 401(k) accounts to get our full company matches. We’re also maxing out our Roth IRAs.

The CPA who does our taxes recommended that we put more money into our 401(k)s even if that would mean putting less into our Roth IRAs. We’re also expecting our first child, and our CPA said he doesn’t like 529 plans.

What’s your opinion on us increasing our 401(k)s by the amount we’d intended to put into a 529, while still maxing out our Roths, and then using our Roth contributions (not earnings) to pay for our child’s college (assuming he goes on to higher education)?

Our CPA liked that idea, but I can’t find anything online that says anyone else is doing things this way. I can’t help but wonder if there’s a catch.

Answer: Other people are indeed doing this, and there’s a big catch: You’d be using money for college that may do you a lot more good in retirement.

Contributions to Roth IRAs are, as you know, not tax deductible, but you can withdraw your contributions at any time without paying taxes or penalties. In retirement, your gains can be withdrawn tax free. Having money in tax-free as well as taxable and tax-deferred accounts gives you greater ability to control your tax bill in retirement.

Also, unlike other retirement accounts, you’re not required to start distributions after age 70 1/2. If you don’t need the money, you can continue to let it grow tax free and leave the whole thing to your heirs, if you want.

That’s a lot of flexibility to give up, and sucking out your contributions early will stunt how much more the accounts can grow.

You’d also miss out on the chance to let future returns help increase your college fund.

Let’s say you contribute $11,000 a year to your Roths ($5,500 each, the current limit). If you withdraw all your contributions after 18 years, you’d have $198,000 (any investment gains would stay in the account to avoid early-withdrawal fees).

Impressive, yes, but if you’d invested that money instead in a 529 and got 6% average annual returns, you could have $339,000. At 8%, the total is $411,000. That may be far more than you need — or it may not be, if you have more than one child or want to help with graduate school. With elite colleges costing $60,000 a year now and likely much more in the future, you may want all the growth you can get.

You didn’t say why your CPA doesn’t like 529s, but they’re a pretty good way for most families to save for college. Withdrawals are tax free when used for higher education and there is a huge array of plans to choose from, since every state except Wyoming offers at least one of these programs and most have multiple investment options.

Clearly, this is complicated, and you probably should run it past a certified financial planner or a CPA who has the personal financial specialist designation. Your CPA may be a great guy, but unless he’s had training in financial planning, he may not be a great choice for comprehensive financial advice.

It’s National 529 Day!

College studentWho doesn’t love obscure commemorative/promotional days? But this one is worthwhile since it brings attention to the state-run college savings plans that can help you pay for your children’s future education.

Here are the most important facts you need to know about college savings:

If you can save for college, you probably should. The higher your income, the more the financial aid formulas will expect you to have saved for college–even if you haven’t actually saved a dime. Even people who consider themselves middle class are often shocked by how much schools expect them to contribute toward the cost of education. (By the way, it’s the parents’ assets and income that determine financial aid, so if you don’t help your kid with college costs, he or she could be really screwed–no money for school and perhaps no hope of need-based financial aid.)

More savings=less debt. Most financial aid is in the form of loans these days, so your saving now will reduce your kid’s debt later. (A CFP once told me to substitute the words “massive debt” when I see “financial aid.” So when you say, “I want my child to get the most financial aid possible,” I hear: “I want my child to get the most massive debt possible.”

529 plans get favorable treatment in financial aid formulas. These accounts are presumed owned by the parent, so less you’re expected to spend less than 6% of the total each year–compared to 35% of student-owned assets.

Learn more by reading “The best and worst 529 plans” and this primer on Motley Fool.

Graduating without student loans is tough

Education savingsA few months ago I gave a verbal spanking to a woman who equated college loans with handouts. She wondered why people didn’t just delay college for a year and earn enough money to pay for their entire education, as she did back in the day.

I pointed out that there weren’t many jobs available to newly-minted high school graduates that paid $60,000, which is about the minimum you’d need to pay for a four-year degree today.

Apparently my reader isn’t the only one having trouble keeping up with the times. A recent New York Times story quoted Virginia Foxx, a Congresswoman from North Carolina who heads a House subcommittee on higher education and work force training, saying she was bewildered why people went into debt instead of working their way through school the way she did.

Here’s what Times writer Ron Lieber pointed out:

But students nowadays who try to work their way through college without parental support or loans face a financial challenge of a different order than the one that Ms. Foxx, 69, confronted as a University of North Carolina undergraduate more than 40 years ago. Today, a bachelor’s degree from Appalachian State, the largest university in her district, can easily cost $80,000 for a state resident, including tuition, room, board and other costs. Back in her day, the total was about $550 a year. Even with inflation, that would translate to just over $4,000 for each year it takes to earn a degree.

A plucky, lucky few manage to get through college with no loans or parental support. But many of those who try wind up dropping out, unable to balance the work hours required with the demands of school.

If you’re one of those who may be stuck trying to pay your own way, Zac Bissonnette’s book “Debt Free U” can provide helpful guidance. If you’re a parent or a policymaker, however, you should check your views about the viability of kids’ working their way through college with today’s realities.

Kids, ignore your elders: college is worth it

CollegeOld folks can offer wisdom about many things, but you might not want to trust them when it comes to 21st century economics.

I’m hearing too many older people espouse the view that college degrees aren’t as valuable these days because more people have them. They need an Econ 101 review. It’s true that the price or value of something may drop if the supply increases—but only if the demand for that thing does not increase as well.

In the case of college degrees, demand has risen dramatically. Part of that is because so many jobs that didn’t require degrees have been made obsolete by technology or been outsourced overseas. (When Grandpa says he knows lots of people who made good livings without post-high-school training, ask him what they did—and if those factories and union jobs still exist.)

But employers are pickier as well, using college degrees as a screening device for jobs that in the past didn’t require them.

It’s true that incomes for college graduates dropped during recent economic hard times and unemployment rose. But the situation was a lot worse for folks without a college degree, according to a Pew Charitable Trust report released yesterday.

Back to supply and demand: The demand for post-secondary educations helped push up the net cost of college during the 2000s. The College Board says the net price of college tuition (the sticker price minus financial aid) rose 75% between 2002 and 2011.

But now demand seems to be softening, according to a Moody’s Investor Service report, thanks to a tough economy and a smaller pool of high school students. As a result, more schools are freezing tuition costs or at least holding down the increases and offering more financial aid. That’s good news for those heading off to college in coming years.

None of this means a college degree is worth any price. Too many families are overdosing on debt to get educations they really can’t afford. Getting a good value also requires college students to pick their majors carefully, since some degrees are worth a lot more than others.

But college degrees are and will remain all but essential in the 21st century if you want to get ahead financial, or even just remain in the middle class. That wasn’t true in Grandpa’s day, but it’s true now.

Why college is more expensive now

Dear Liz: Thank you for your response to the reader who complained that college students who received student loans were getting a handout. You did a great job of highlighting the challenges today’s students face, but you didn’t talk about the main underlying cause. This is the defunding of state universities by state governments. In Oregon, for example, the state has gone from funding over 50% of the costs to current funding of 6%. The difference has been made up by tuition hikes and increasing the proportion of out-of-state (and foreign) students who pay much higher tuition. This is part of the reason that students are crowded out of classes. In Oregon, the medical school found it was better off giving up all state aid and going it alone. Other universities in Oregon are considering taking the same action. Schools founded with state money and supported for years with tax money will no longer be operated for Oregon students. They will be more like private schools, perhaps moving out of the reach of middle-class students. So the answer to the reader is that she did get government help to get through school, help that is now curtailed so students have to finance it themselves.

Answer: The reader didn’t specify what type of college she attended. But the withdrawal of state government funding in recent years has definitely made public college educations more expensive for many students. Meanwhile, many private schools have expanded their financial and merit aid budgets so that some students can attend a private college at a lower net cost than what they would pay for a public school.

Student loans aren’t handouts

Dear Liz: I am increasingly annoyed by the entitlement attitude of today’s students. Why should the taxpayers (me) pay to educate somebody else’s children? I remember when there was no such thing as a student loan. If I wanted to go to college and didn’t have the money for tuition, I delayed starting college until I had worked for a year and saved up the money. Many of my friends did this, as did I. Now these kids stand around with their hands out looking for somebody to bring them their education on a silver platter. I wish you would say something about this in your column.

Answer: Let’s start with the obvious, which is that an education costs a heck of a lot more than it did when you were in college.

The College Board reports that a student attending an in-state, four-year public university needs to budget an average of $22,261 to pay for the 2012-13 year. Which means the total cost to get an undergraduate degree would be about $90,000, assuming he or she can get all the required courses in four years (something that’s increasingly difficult because of state budget cuts in education).

Not to put too fine a point on it, but there aren’t many jobs these days that would enable someone (particularly someone without a college degree) to save the full cost of a college education in a single year. Even someone who started out with two years of community college would need to budget about $8,000 for each of those years, according to the College Board, and the total cost of a four-year degree would still be around $60,000. Some people would pay less if they got a lot of financial aid or lived at home, but any way you cut it, the tab is much, much higher than it has been in decades past.

Something else has changed since you were a student, and that’s the importance of having a college education if you want to have a decent financial life and remain in the middle class. In your day, people without college educations — even those without high school diplomas — could find well-paying jobs. Those jobs have increasingly been phased out by technology or they’ve gone overseas. The manufacturing and technical jobs that remain often require at least some post-secondary education. Having a college degree is what having a high school diploma used to be — an essential entry-level credential in many fields.

Our nation and our economy need educated workers if we’re to be competitive in a global economy. It also would help to have an expanding pool of well-paid workers to pay taxes toward things like roads, defense, police and fire protection and Social Security, from which you presumably benefit.

This is why governments promote post-secondary education with a relatively small amount of grants for the needy, and a relatively large amount of loans for everyone else. The first federal student loans were part of the National Defense Education Act of 1958; today, most students borrow at least some portion of their education costs.

You see, most kids (and their parents) aren’t standing around waiting for a handout. Most financial aid these days comes in the form of loans, which have to be paid back. These loans aren’t necessarily cheap — the rate on a Stafford student loan is 6.8%, while graduate and parent PLUS loans have 7.9% rates (plus a 4% origination fee that’s deducted from each disbursement).

If students or their parents default, the government can garnish their wages, seize their tax refunds, take a chunk of their Social Security checks and trash their credit. There is no statute of limitations on federal student loans and only rare relief in Bankruptcy Court, so borrowers can be pursued to their graves for what they owe.

Yes, many families overspend on education and overdose on student loans. The majority, however, graduate with a reasonable amount of debt (about $26,000 on average) that can be repaid from their now-higher earnings. Student loans aren’t a handout — they’re an investment in both the graduate and our economy.

Don’t buy an education you can’t afford

Dear Liz: Please make me feel like I’m doing the right thing. My daughter happens to be very talented academically and athletically. She will graduate from one of the best prep schools in the country. She also plays ice hockey and is being recruited by some of the best schools. However, we are of middle-class means. We were given outstanding aid from her prep school, which made it very affordable. The net price calculators of the colleges recruiting her indicate we won’t get nearly the same level of support.

We have a lot of equity in our home and about $25,000 total in college funds for both of our children (we also have a son in 9th grade). We make about $185,000 as a family and pay about 12% to mandatory retirement and healthcare accounts. I’m hoping by some magical formula we can beat the “calculator” but I’m not so confident. So please tell me that paying for an elite education is worth our sacrifices. Our daughter has worked very hard to put herself in a position to gain entry into these schools, but I just need an expert to make me feel better.

Answer: An expert who makes you feel better about buying an education you can’t afford isn’t doing you any favors.

So let’s do a reality check. The amount you have saved for both your children would pay for a little more than one semester at most elite schools, which run around $60,000 a year these days. If she finishes in four years, that’s a price tag of about a quarter of a million dollars.

Of course, most college students don’t pay the sticker price for college. They get some kind of help. You, however, can’t expect much of that help, since you’re really not “of middle-class means.” At your current income, you make more money than about 95% of American households. Financial aid formulas don’t particularly care that you may live in an expensive area or that you prioritized spending over saving, only realizing too late that you can’t afford the schools your daughter wants to attend.

The exceptions may be Ivy League schools, many of which have committed to capping tuition costs even for upper-income families. If your daughter gets into one of those schools, she may have a shot at an affordable education.

Other schools may be willing to give her “merit aid” to induce her to attend, especially if she’s an outstanding hockey player and they want outstanding hockey players. But you’ll still be left with a sizable bill and only one way to pay for it: borrowing, either from your home equity or via federal student loans. Your daughter can borrow $5,500 in federal loans her first year, but as parents you can borrow up to the full cost of her education from the federal PLUS loan program.

Which leads to the question: Is taking on up to a quarter of a million dollars in debt for an undergraduate degree a sacrifice or is it insane? Before you answer, consider that some research shows that students who are accepted to elite schools, but attend elsewhere, do just as well in life as people who actually attend those elite schools. (The exceptions are kids from lower-income families, who actually do get a boost in life from attending elite schools. Obviously, that doesn’t include your child.)

Also consider how you’ll feel about making payments of $1,800 a month or so for the next 30 years to pay for this education. And how you’ll feel telling your son, “Sorry, kid, we spent all the money on your sister. You’re on your own.”

The picture may not be as grim as all that. You may get a better deal from one of these schools than you expect. But you should start managing your daughter’s expectations now and look for some colleges you can actually afford in case the dream schools don’t come through for her.

High incomes limit financial aid

Dear Liz: As an avid reader for years I have never felt as compelled to write as I did after reading your column regarding college financing. I disagree that college financial aid is based primarily on income or that “typically [parents are required to] contribute less than 6% of eligible assets.”

We filed a Free Application for Federal Student Aid for our daughter, and our expected family contribution was calculated at $43,000. The school offered my daughter just $2,000 in work study, at a university with a $38,917 annual tuition. Our combined income is $175,000 and our liquid savings (not including retirement accounts) is $145,000.

We could pay 6% of our income (about $12,000) or 6% of income plus savings ($19,000) per year without taking loans, but not $38,000. I have attended several “paying for college” seminars and found their estimated contributions quite sugar-coated compared with the reality.

Rather than paying 6%, is the reality 25% of our income? Please let me know if we have done something wrong, and how to rectify it.

Answer: The 6% limit on eligible assets is not a cap on how much you’ll have to pay for college. As the original column said, income weighs more heavily in financial aid calculations than assets, and your income is high.

The federal financial aid formula assumes families with high earnings have more disposable income to pay for college than lower-earning families. The formula also assumes high-income families have had ample opportunities to save for college, whether or not they actually have.

You could use the net price calculator on the college’s website to see whether your liquid savings are having an effect on your expected family contribution. At some schools, using savings to pay down a mortgage or other debt could result in a lower expected contribution.

But you still might not get aid, even if you could move the needle on your expected contribution. Many colleges “gap” their students by not supplying enough aid to meet all their needs. And while some private colleges offer merit (rather than need-based) scholarships to attract the children of wealthier parents, top-tier schools tend not to, because they know they can attract excellent candidates without such help, said Lynn O’Shaughnessy, author of “The College Solution: A Guide for Everyone Looking for the Right School at the Right Price.”

Even if your family doesn’t have financial need according to the formula, your daughter is still eligible for federal student loans of as much as $5,500 in her freshman year. Federal student loans are flexible debt with fixed interest rates and many repayment options, so they shouldn’t be feared, especially in reasonable amounts. If, however, you would have to borrow much more, and that borrowing would interfere with your plans for retirement or other financial goals, you probably can’t afford this school and need to start looking for colleges you can afford.

New tool helps you compare financial aid offers

You’ve gotten the college acceptance letters, and their accompanying financial aid offers. But how do you really decipher how much college will really cost you? More than 1.5 million students and their families are wrestling with these issues, and the Consumer Financial Protection Bureau wants to help. The bureau just announced a tool that can help you evaluate your options. From the CFPB press release:

The beta version of the Financial Aid Comparison Shopper has more than 7,500 schools and institutions in its database, including vocational schools and community, state, and private colleges. It draws information from publicly available data provided by government statistical agencies. With the prototype, students and their families can compare the following across multiple financial aid offers:

·         Estimated monthly student loan payment after graduation;

·         Grant and scholarship offers;

·         School-specific metrics such as graduation, retention, and federal student loan default rates; and

·         Estimated debt level at graduation in relationship to the average starting salary.

The Financial Aid Comparison Shopper also includes a “Military Benefit Calculator” that can estimate education benefits for servicemembers, veterans, and their families. The calculator includes military tuition assistance and Post-9/11 GI Bill benefits.

You’ll find a link to the cost comparison tool here. Take a look, run some numbers and give the CFPB your feedback.