Tuition Turmoil…
A little while ago I replaced the brake pads on my car. If you’re anything like me you have a hard time finding the time for something like that, since safety is always second priority and not having your car at your disposal every second of every day is a massive inconvenience. When I finally got around to bringing my car into the shop, I was told that the brake pads were so worn down that they had damaged some other components in my brake system, and I ended up replacing a lot more than I bargained for. A classic example of how one unaddressed problem leads to another, then another.
If you look at previous blog posts, I once wrote about student loans, and how they have become normalized and accepted in society, while dragging down everyone’s wealth-earning potential. Unfortunately, that problem has led to another. Let me explain.
Image from Carl Gelin on Unsplash
A college degree used to mean something. If you had one, it meant that you were an outlier in society, an anomaly, an over-achiever, and an academic. People with that magic piece of paper (diploma) were very hirable and were almost guaranteed higher salaries. As a result, society labeled that diploma as a one-way ticket to success, and demand for college education rocketed upwards. The government recognized the value of having an educated and prosperous society to tax, so they decided to “help” by subsidizing colleges and offering federal student loan programs to students who couldn’t afford college.
Problem: Funding college with student loans is normalized.
Resulting problem: Many people are willing to overpay for college utilizing loans.
Resulting problem: College tuition goes up.
Resulting problem: Saving for education expenses becomes challenging.
With demand for college education going up every year, colleges everywhere decided to raise their prices. Why not? Students would still show up and take out loans to pay their tuition! Colleges have continued to do so for the last 20 years or so, on average every year costing 5.5% more than the last. This means that the cost of college tuition doubles every 13 years or so. Let me illustrate the effect of this.
Let’s pretend that you are a brand-new parent, and private school kindergarten tuition is $8,000 this year. Thinking ahead, you pull that money out of your bank account and bury it in a can in the backyard for safekeeping. When your child turns 5, you take those “first day of school” pictures and dig up your stash of cash. It’s not enough anymore. The “kindergarten price tag” is now $10,456 (not even factoring in inflation), and you have to cough up an additional $2,456. Had you waited 10 years, that price tag would be $13,665! If you have more than one kid, consider inflation, or take a pay cut, homeschooling becomes more and more attractive.
Image from Wes Hicks on Unsplash
What can you do about it? Here’s some options:
First, you could invest that money in bank certificate of deposits (CD’s). This guarantees a specific rate of return, and although it might not completely offset the effects of tuition increases/inflation, it’s certainly better than the “cash in a can” method. Unfortunately, CDs with longer terms (like 5 or 10 years) have lower interest rates, hovering around 3-4 % (ish), and the income earned on these investments will be taxed at your ordinary income levels (10%-37%).
Second, you could open a brokerage account and invest in some more growth-oriented mutual funds or ETFs (Exchange-traded funds). This would likely increase your returns significantly, but there is “down-side risk”, meaning you could potentially lose money, especially short-term. This is a better move if you have a long-term time horizon and you are comfortable with market fluctuations. However, the growth on these investments also taxed, this time at capital gains rates (0-20%).
Thirdly (and finally), you could open a 529 account for your child. This is by far the best option if your goal is to pay for education expenses. Here are the characteristics, followed by the cave-man interpretation.
529 Programs are sometimes offered by the state, which means contributions may be eligible to avoid state taxes. “Save money.”
Many investment choices, meaning you may be able to outpace both inflation and the rise in tuition prices. “More money.”
Contribution limits are high, and anyone can contribute to the account (useful if there is a generous grandparent or relative). “Lots of money.”
The account owner (you) maintains control of the account and can change the beneficiary to another eligible family member if they desire. “I say where money goes.”
$10,000 per year may be spent on private elementary or secondary school tuition. “Not just college.”
Earnings grow tax-free, and withdrawals are tax-free if spent on qualified education expenses. “No taxes, more money.”
The IRS has a list of qualified expenses here: https://www.irs.gov/credits-deductions/individuals/qualified-ed-expenses
The catch is that once placed in a 529, the money is designated for the benefit of a beneficiary, meaning you can’t withdraw that money for personal use without paying both the taxes and a penalty. However, you can roll that money into a Roth IRA for the beneficiary later, if there is money left over, or the child decides not to go to college. “Not an emergency fund.”
Note, there are some variations in 529 accounts, and some are better than others. Do your research or contact a professional before you throw your money at it!
This week’s quote:
“Good judgement comes from experience, and a lot of that comes from bad judgement.”
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