Should I pay off my student loan or start saving for my child’s education?
Life usually happens all at once. It can be several years (decades) before many people pay off their student loans even if they were to put all their income towards paying them down or qualify for Public Service Loan Forgiveness (PSLF). However, life does not stop during the years that physicians transition from residents to attendings. During this time, you might buy a house, get married, and start a family. Deciding where to allocate your resources and how much should be towards your student loans or whether to save for your children, can be a hard decision for many parents.
The days are long, but the years are short
In no time at all, your child will be ready for college. The time to save is relatively short and it’s important to be prepared. You can’t tell your child to delay going to college by a few years so you can save more, or so you can get past the down market the year before they start college.
The best investment is knowledge
The cost of higher education is second only to mortgage debt and a large liability to consider for most families. Although we don’t know the efficiency of online education post-pandemic and its value for the price that is paid, 91% of families agree that higher education is a long-term investment in the student’s future.
So before you make that decision, do you know how much you need to save?
The average cost per year of a 2-year public college for the academic year 2019-2020 is $15,975
The average cost per year of a 4-year public college for the academic year 2019-2020 is $25,094
The average cost per year of a 4-year private college for the academic year 2019-2020 is $47,010
Not a small amount of change and families pay the biggest share of college costs. The average amount used from parents' income and savings has increased over the last few years.
How the typical family pays for college
Source: salliemae.com - How America pays for college 2020
Fiction: Saving for college impacts Financial Aid
There are two types of financial aid: needs-based and merit-based. Merit-based is granted in recognition of performance, talents, and leadership, and in most cases, a family’s finances are not considered.
Many parents assume that colleges will wring them dry before offering any financial aid. They assume that they will need to use 100% of their savings before a college will even consider any needs-based aid. This is simply not true.
When applying for needs-based financial aid for all colleges a family will need to complete a FAFSA (Free Application for Federal Student Aid) which is used to calculate your Expected Family Contribution (EFC). It’s not as simple as looking at a family’s income minus their expenses. It is a formula that includes your income, assets, taxes paid, and household size to determine how much of the college costs you can afford.
Since the Great Recession families are seeing the need to scale back how much they are borrowing, as well as institutions ramping up what they can do to support students.
The biggest factor in calculating Expected Family Contribution to college costs is annual income not the assets of parents. Parents’ assets are also assessed at no more than 5.64%, which includes college savings accounts. For example, if you saved $20,000 for college, the EFC formula would only include $1,128. So, the overall impact of savings for college tuition minimal.
On the other hand, a student’s assets are assessed at 20% which makes sense when the education benefit is for the student.
There are several savings options:
529 Plans – This is a tax-advantaged account. The funds in a 529 plan are exempt from federal taxes if the funds are used for qualified educational expenses such as tuition, board, and books. The funds can also be used for private elementary, secondary, religious schools, apprenticeships, and homeschooling. However, investment options are limited. If your child doesn’t use the funds, it can be transferred to a sibling.
Coverdell Education Savings account – This account allows you to contribute $2,000 per year for your child’s education when they are under age 18. However, whether you are eligible to contribute to this account is dependent on your income.
UGMA/UTMA Custodial Account – This account allows you to contribute $15,000 per person or $30,000 for a married couple. There is no restriction on how the funds are used but it must be for the benefit of the child. The first $1,100 is tax-free, the second $1,100 is taxed at the child’s income tax rate and the remaining is taxed at the parent’s tax rate. However, you have less control over how your child uses the money, once they reach the age of majority. You can’t legally prevent them from using the funds to buy a car or go on vacation.
Brokerage account – There is no limitation on how much you can contribute and the investment options available. There may be brokerage fees and you will be responsible for taxes on the investments.
Balancing loan payments and college savings
You may feel the financial pressure, to weigh up competing priorities for you and your family. Very few parents can make their own student loan payments, build an emergency fund, save for their retirement, and save for their child’s college expenses. Possibly at the cost of further delayed gratification for several years. However, for most, it can be a struggle. Deciding on how to allocate your resources and the opportunity cost of doing so can be a challenge for parents. Depending on your unique situation, we can work with you to figure out your sweet spot. Speak with an advisor to give you some clarity and confidence in your decisions.
Adviso Wealth is dedicated to working with people just like you. We want to give you the clarity and confidence you need to achieve your personal and financial goals.
To learn more, visit advisowealth.com or email email@example.com