Financial Health: Dodge the College Debt Conundrum

It’s official: Americans now owe more in student loans than they do in credit card debt.  According to the Federal Reserve Bank of New York and the US Department of Education, total student loans outstanding will exceed $1 trillion before the end of 2012.

 

Some are calling student loans the next credit bubble.  Only this time it’s the borrowers (and their co-signing parents) who will lose.  Lenders are backed by the US government and have far greater collection powers than the mortgage or credit card companies.  Often, they call on the IRS to intercept the borrower’s income tax refunds until the student loans are paid in full, and in most cases, the debt can't even be erased through bankruptcy. 

 

With the average national wage index at less than $42,000 for 2010 and yearly tuition running anywhere from $25,000 to $60,000, paying for college has become a major challenge for many families.  The best advice I can give those who have – or are contemplating having ‒ children is to start saving early.  If you contribute regularly as part of a dollar cost-averaging investment program and make smart, well-balanced investments, time and compounding returns can be your greatest allies.

 

If Time Is on Your Side…

There are a number of popular savings vehicles to choose from ‒ all into which you can make after-tax contributions.  For 2012, each parent can contribute up to $13,000 per year without triggering a gift tax.  Three of my favorites are:

 

UGMAs/UTMAs. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts are not specifically designed to provide financing for college, but many investors use them for this purpose, since the assets become available to the minor when he or she reaches the state’s specified age of maturity (18 to 21).  These accounts cost nothing to set up, and like trusts, are protected from creditors. 

 

UGMAs/UTMAs are also tax-favored and provide the opportunity for diversity in the design of the portfolio.  Investment income is taxed at the kiddie tax rate, which means the first $950 is tax-free, the second $950 is taxed at the child’s rate and the remainder is taxed at the parents’ rate for 2012.  (For children over age 18, all investment income is taxed at the child’s rate.)

 

The downside is your child may not be mature enough to manage the money when she takes receipt of it, and you can’t be guaranteed she’ll use these funds to pay for her education.

 

Trusts. For more affluent families, I tend to favor opening either a revocable or irrevocable trust account that can be custom-tailored to your family’s priorities and your child’s individual needs.  Trusts do cost money to set up, and you’ll need to file annual tax returns.  But if structured correctly, trusts give you a lot more control over the distribution of the money and how it can be used.  Unlike with an UGMA/UTMA account, you can designate at exactly what age your child will become the co-trustee and eventually sole-trustee of the portfolio. Using this approach you can provide your child the learning experience of helping to manage the investments, yet not give him full ownership until he demonstrates he can make sound decisions regarding the trust’s assets. Trusts offer flexible investment options, and are subject to their own tax rates.

 

529s. Investing in 529 or state education plans offer undeniable tax benefits:  both earnings and qualified withdrawals are exempt from federal taxes, some states waive state tax for residents and others allow deductions on contributions. Another benefit of 529 plans is that they can increase your child’s eligibility for financial aid, because according to the Free Application for Federal Student Aid (FAFSA), 529 accounts are considered an asset of the parent, not the beneficiary.

529 accounts do have their drawbacks, however: Plan quality varies by state, fees are high and investment choices are often restricted.  Investment results vary widely and in some cases, a plan’s weak performance can offset the tax savings.  What’s more, many plans limit the number of investment changes you can make ‒ some states allow only one change per year!  This greatly lessens your ability to proactively manage the account and protect it during market downturns. 

If Time Is Not on Your Side…

Even if Junior has already taken his ACTs/SATs, there’s still hope, but you’ll need to get creative ‒ fast.

 

A Matter of Degree. The cost of a four-year degree varies widely depending on which school you go to. In general, public universities are less expensive than private, and in-state public tuition is less than out-of-state tuition. But that’s not always the case. In fact, some private universities, such as Brigham Young in Provo, Utah, are among the least expensive in the nation.  

 

While Census Bureau data confirms a strong relationship between education and income, certain universities and majors have better “returns on investment” than others.  When evaluating colleges, make sure to speak with their career services or job placement department to get an idea of which companies recruit there and what opportunities exist for graduates in your child’s field of interest.  Think about what type and level of education (college, masters, grad school or vocational training) is the best fit for your child’s needs and will enhance her employability.

 

Two + Two = Four-Year Degree. Consider starting out at a community college and then transferring to a four-year school.  Many community colleges have agreements with four-year universities that outline how their courses transfer.  Some agreements even allow students who have earned an associate’s degree guaranteed admission at junior standing. In the end, your child’s degree will be from the four-year school, but you will pay substantially less. Finding community and junior colleges that are affiliated with big-name universities not only saves big money, but may even help your child get into his dream school. 

 

Look for Bargains Abroad.  Over the last decade, the number of American undergraduate and graduate students studying abroad for credit has grown dramatically due to an explosion of new programs attracting students from the US who are fed-up with soaring tuition prices. In the UK and Canada, for instance, a college degree is typically a three-year program and tuition costs a fraction of what it does in the US.  Even studying one year abroad can yield substantial savings as well as provide students with a broader perspective on the economic, social and political forces that shape our world ‒ a quality many employers will find attractive in this global marketplace.

 

Surf for Scholarships. Thousands of grants and scholarships are available, and you can find them online. Check out fastweb.com and thewashboard.org for listings. Apply early. Apply often.

 

Take Three.  By taking AP classes and exams in high school or enrolling in online courses offered by a number of universities, it’s possible to get a degree in three years, shave more than 25% off your tuition bill and begin earning a salary a year early.  A few schools, including North Carolina University at Greensboro, Bates College in Maine, Arcadia University in Philadelphia, and Lake Forest College in Illinois already offer three-year accelerated options for specific majors.  Many other universities are developing three-year programs as well.

 

Log in and Learn. Online universities are gaining in popularity not only  because they can be less expensive than your typical brick and mortar schools, but because students can work part- and even full-time due to the flexibility of being able to “attend” many of the classes by logging onto the course website at their convenience.  Though some students may miss the face-to-face interaction, for kids in certain fields of studies, these programs can work quite well.

 

Give Back. By participating in post-college service programs like the Peace Corps, AmeriCorps and Teach for America, you may be eligible for deferment plans, partial repayment, loan assistance and forgiveness.  If a student joins the Peace Corps, for example, she can get up to 70% of his federal Perkins loan forgiven after four years of service.

 

It may take a little research and resourcefulness, but if you give it the old college try, you can help your child get a degree without becoming a slave to debt.

 

Added to Financial Health on Wed 04/25/2012