College Funding is a Retirement Planning Problem, and Vice Versa
I can speak to this issue both professionally and personally. I have two kids already in college (a freshman and a sophomore) and a third who is a sophomore in high school.
The issue of college costs arises often with our clients, among almost all those with children, even those those with very high income and net worth. An acquaintance of mine with a high six-figure income described his experience of having three kids in Ivy League schools all at once, with no scholarships or financial aid, this way:
“It is like driving a fully-loaded, uninsured Bentley into the lake. Every year.”
I’m surely not the first to say it: “College funding is a retirement planning problem, and vice versa.” This is especially true with parents who began having kids relatively late in life. The question becomes:
We believe best practice is to treat both college costs and retirement income needs as known future cash flows, and to offset those future cash flows with current savings as efficiently as possible, on a risk-adjusted after-tax basis.
“Am I compromising my retirement in order to pay for college?”
How can we manage this collision of competing goals? We believe best practice is to treat both college costs and retirement income needs as known future cash flows, and to offset those future cash flows with current savings as efficiently as possible, on a risk-adjusted after-tax basis.
Our usual advice looks something like this:
1) Always max your employer pre-tax savings accounts first. This allows you to reduce current taxes and compound with dollars you would otherwise pay in income taxes.
2) With additional after-tax cash flow, set up 529 accounts as soon as possible, and start an automatic monthly savings program targeted at accumulating 50% of projected college expenses for the type of institution you expect your child to attend. For most people, UTMAs are a bad choice, simply because in college financial aid calculations the UTMA will significantly reduce financial aid eligibility.
3) Keep in mind that there is potentially enormous leverage in properly planning your college search, application, and final decision process. Only a small number of institutions (the Ivy Leagues, Stanford, a few others) persuasively offer higher incomes for higher tuitions. Likewise, technical fields like engineering tend to be a good value.
For other schools, even very competitive ones, a higher ticket price may not result in additional future income at the margin. If a kid is a strong student, you can probably manage your application process to end up with multiple competing scholarship offers, and pay way under sticker price. (But not if you have your heart set on NYU and apply early decision.)
By James S. Hemphill, CFP®, CIMA®, CPWA®/ Managing Director & Chief Investment Strategist
Jim has been a CERTIFIED FINANCIAL PLANNER™ professional since 1982. Jim specializes in complex wealth transfer and retirement transition strategies and coordinates TGS Financial’s investment research initiatives.
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