The Wall Street Journal recently (3/17/14) did a special report on “Big Issues” with advocates squaring off on six different personal finance issues. In today’s post I’m going to give my perspective on one of these issues, “Paying Tuition: Is That the Responsibility of the Student or the Parent?”
I’d like to suggest that it’s a decision that should be made early on, and not when the child is getting ready for college visits. If the parents decide that it’s a goal to fund part or all of their children’s college costs, they have the ability to invest towards that goal versus taking out loans or tapping the equity in their homes when the tuition, room, and board bills come due.
When you invest, you earn a yield. When you borrow, you pay a rate. By investing for the children’s future education you capture that yield, tax-free in a Section 529 plan, and don’t have the future interest expense, saving the after-tax cost of borrowing to finance college expenses.
While it’s difficult to find investments that can keep pace with college cost inflation, by investing towards a future goal the parents can manage the gap between the two rates. In states that offer a prepaid tuition plan, possibly a room and board plan too, and the state stands behind the plan, parents have a lower risk option in managing college cost inflation risk – although it may mean that Jimmy or Susie has to go to State.
Among other possible outcomes, a college education is an investment in the student’s human capital. It’s the student that is going to realize the return on that investment. A traditional student, graduating in their early twenties, may have over forty years in the workforce to recoup that investment. The parents in their 40’s-60’s don’t have as much time left in their careers to repay their children’s college expenses. (Another one of the Journal’s issues was, “Is it Wise to Choose College Majors Based on Future Salary?” but I’ll save that topic for a future blog post.)
If the parents didn’t commit to this goal when the children were young, then it’s a balancing act between what the parent’s can afford to borrow, the financial aid, including loans, available to the student, and the decision where to go to school. Don’t underestimate the value of the child having some skin in the game when it comes to the study/party cost benefit analysis.
Starting out at a two year school, and possibly even living at home, and then transferring can work for most college majors. It takes some solid academic advising, but many two year schools have articulation agreements with four-year schools making the transition as seamless as possible.
Everyone faces competing claims on income. If you don’t make saving for college a priority when the kids are young, it’s going to be even harder paying for it after the fact by borrowing while they’re in school to meet these expenses when you have retirement on the horizon.