By Dr. Dean Skarlis, President
“You can take out loans for college, but there are no loans for retirement.” It’s a familiar refrain among those in the financial services community and has been sound advice for many families for years. But in 2017, it may be the worst advice a financial advisor can give to his clients. Here’s why.
Cumulative student loan debt in the United States has surpassed $1.4 Trillion. It now exceeds all consumer credit card debt. Approximately 71% of students who attend 4-year colleges have taken on student loans…and that’s just student loan debt. Add to that parental debt which is approaching $100 Million, and the fact that many parents have added home equity loans to their debt service (which is not counted in the above figures), and you have a crisis – a big one with lasting effects as this Money Magazine article describes.
The reason loans have exploded is of course, the rising cost of college. Tuition, room, board and fees have increased by more than 1200% over the past 30 years. When I first began my business 13 years ago, there were a couple of dozen colleges whose total costs had eclipsed $40,000/year. Today, those same schools – and many others – have now crossed the $70,000/year mark – that’s more than $280,000 to educate one child. Compare these numbers with most private schools back in 1986 when I began college. Tuition, room and board at my private college was $11,000/year. That same school now charges more than $55,000/year. Even public institutions now exceed $100,000 over 4 years in California, New York and many other states.
As a result, most middle and upper middle class families have few options other than to take out huge loans or attend a community college. But the problem with the “old school” advice is that families who take out loans in today’s world, must seek hundreds of thousands more than I did in 1986. Back then, it was more reasonable for my peers and I to borrow $5,000 per year and pay back the $20,000 in a realistic time frame. That covered almost half our total cost. Today, this is next to impossible. If a student takes federal student loans each year of college, he would have to repay $27,000. If he adds an extra $15,000/year in private student loans, you now have $87,000 over four years. This is a significant burden for just about any family. This scenario also assumes that mom and dad, student, or someone else will cover almost $200,000 for an expensive private college or about $15,000 at a SUNY school from a mix of savings and cash flow. That’s a tall order.
Most of the clients with whom we work are in their mid to late 40s. On average, they have saved $300,000-$500,000 in their 401(k), IRA or other qualified plan. Some teachers or public employees have pensions. It is for these families that I have begun to give what some would call radical advice. Others deem it bad advice. But here it is: Rather than save the maximum of $18,000/year (or $24,000 for people over 50) in your qualified retirement plan, divert some of those dollars into the college savings vehicle of your choice. If a family lives in New York State, the New York 529 plan offers a state tax deduction of up to $10,000 for married parents filing jointly ($5,000 for single parents). While the tax math still favors your full 401(k) contribution, the amount of loans parents and students need will be significantly reduced.
A 47 year old with $400,000 in his 401(k) or IRA has plenty of time to continue saving for retirement, and most models indicate that his nest egg will turn into $1.6 Million even if he stopped contributing completely (assuming he retires at age 65 and realizes an 8% annual rate of return) – which I never recommend. On the other hand, a family with two children, may have to pay in excess of $600,000 for college over a much shorter time horizon – often within 6 or 7 years. I have found that most parents have tried to save for college, but just don’t have the time or resources to set aside enough money, given the ridiculous rise of college costs. Most of our families have amassed less than $60,000 for college. So their only remaining option is to take out huge loans.
Moreover, because assets are counted at only 5.64% of their value in the financial aid formulas, saving more will have only a minimal effect on a family’s Expected Family Contribution (EFC), and if the family’s other income and assets are too high to garner more aid, then there will be no financial aid lost. We teach our clients these and other strategies to help them maximize financial aid, enhance tax savings and increase merit scholarships.
The bottom line is that college costs have skyrocketed at a pace much faster than any other expense, including health care, over the past 20 years. And the traditional advice of taking more in student and parent loans does not cut it anymore. It’s time for a paradigm shift.