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Goodbye Assets

Catherine Horiuchi

MY TWINS ARE SENIORS in high school. That means, pandemic or no pandemic, we spent the fall applying to colleges.

Here in California, the pandemic closed public schools in March and most did not reopen for in-person teaching with the start of the current academic year. That forced parents to stand in for college counselors. The preparations high school juniors usually engage in, such as visiting colleges and taking standardized tests, didn’t occur this past spring or summer. Student athletes spent the summer practicing in parks and driveways. Grades suffered under remote learning. For all these reasons, applying to college has been more difficult.

And then there’s the price tag.

Post-secondary education can be relatively inexpensive—or it can break the Bank of Mom and Dad. The federal government supplies some grants and many loans to limit the immediate financial damage, and colleges also dole out money from their own funds. Still, the student loan crisis is front page news. That’s one reason so many parents try to ensure their young adults don’t leave college with crushing debt.

The federal government’s role begins with the Free Application for Federal Student Aid, or FAFSA, with “free” meaning it doesn’t cost you to ask. FAFSA calculates a family’s expected family contribution (EFC) based on the parents’ and student’s income and assets. On top of that, colleges use their own guidelines to distribute the grant money they control.

For families earning below about $50,000, the EFC will likely be $0. After that, the amount rises sharply—and sometimes unfairly. For instance, middle-class single parents, along with older parents with a healthy amount of savings, may be shocked by how much they’re expected to pay toward college costs. There’s no way to sugarcoat it: Parents with decent incomes, or who’ve successfully set aside a chunk of money, end up paying plenty when their kids go to more expensive colleges.

Consider the parents’ assets. In broad terms, the EFC assumes parents will put as much as 5.64% of their wealth every year toward college costs. We’re talking about things like money in bank accounts, regular taxable brokerage accounts, parent-owned 529 plans and second homes. The good news: A few key items are excluded, such as money in retirement accounts and the value of the family’s primary residence.

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Imagine you’ve carefully saved $100,000 outside a retirement account to serve as an emergency fund to cover six months of troubles. If your assets are assessed at the full 5.64%, you will lose $5,640 of the $100,000 in year one. The next year, you’ll be expected to put 5.64% of the remaining $94,360 toward college costs, or $5,322. In year three, you pay 5.64% of $89,038, equal to $5,022. At the start of Junior’s senior year, $84,016 remains in your emergency fund. The last bite will cost you $4,739, leaving you with $79,278 and a slow road to building your emergency savings back to its pre-college value.

Oops. The problem: Few students graduate in four years. Some can’t get required classes or change majors. Many interrupt their college years with work or other activities, or they drop out entirely.

The National Center for Education Statistics reports that it takes six years for 62% of incoming public university freshmen to graduate. The number rises slightly to 67% for private nonprofit schools, but drops precipitously to 25% for private for-profit schools. The six-year rate varies based on school selectivity, with a six-year graduation rate of 90% for schools with selective acceptance—meaning just one out of four are admitted—but only 34% for schools with open admissions.

Add those extra two years for your no-longer cherubic child, and your emergency fund drops to $70,587 (with contributions of $4,471 in year five and $4,219 in year six). By then, Junior’s sister could be well along in her six-year undergraduate degree, each year with its own continuing bite out of your non-retirement investments.

Numerous projections have suggested that slightly more than a third of all jobs in the near future will require a bachelor’s degree. Many respected and well-compensated professions require no more than a two-year degree in a specialized program, which your child can earn at  a nearby community college.

The upshot: It’s a wonder more parents don’t question the traditional undergraduate college experience. I fault the “college prep” track, which is the principal goal of most public high schools. My advice: Talking through the myriad college options, and how to pay for them, is a homework assignment that needs to be completed by all high schoolers—along with their parents.

Catherine Horiuchi recently retired from the University of San Francisco’s School of Management, where she was an associate professor teaching graduate courses in public policy, public finance and government technology. Catherine’s earlier articles include Leaving EarlyGood Company and From Two to One.

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Catherine
Catherine
6 months ago

Reminds me of my brother with his small suitcase full of copper pennies. He didn’t make much on that investment, but was able to use it to build his upper body strength when planning a mountain climbing trip.
It is interesting that at once point the US government banned the private ownership of gold coins.
Parents of high schoolers — even middle schoolers — are well advised to consider consequences of the prior prior year return. In my case, it’s the reason I didn’t convert an old IRA into a Roth IRA and probably won’t do that for a few more years.

greglee
greglee
6 months ago

So goodbye to college prep for those old fashioned schools that waste time on history, art, philosophy, and hello to trade schools that teach really useful disciplines. Those hiring officers that require traditional educations that waste time on airy-fairy stuff that is irrelevant to modern life are obviously incompetent. We can teach students how to program much more economically — and that’s the future.

Mariah Davis
Mariah Davis
6 months ago

Catherine, I would completely agree. I believe one of the most broken parts of this system is the fact that the estimated family contribution makes the assumption that students are ENTITLED to that percentage of their parent’s savings or income. Whether or not a student gets the full support of the estimated family contribution, FAFSA holds no mercy or willingness to budge on the scholarships or loans they are entitled to. I was told once that the only way to disassociate myself from my parent’s income (at the age of 21!) was waiting to go to college until I turned 25, marriage, pregnancy, or joining the military.

SCao
SCao
6 months ago

For saving to cover big expenses such as 529 for college, the key is to start early. There are pros and cons (https://www.wsj.com/articles/pros-and-cons-of-529-accounts-for-college-11553450400) for 529, however overall I think it is a very good way to save for college, especially given the tax advantage for qualified expense, and if the 529 account is directly opened (vs. via a 3rd party).

Richard Quinn
Richard Quinn
6 months ago

You hit the nail on the head. We don’t have a student loan crisis, we have an education system crisis. The average student loan payment is about the same as a car payment.

Not only does it take too long for a degree, many students are unprepared for college and must take remedial classes. And, as you correctly note, many jobs claim they require a degree, but in fact the job does not. I spent nine years at night obtaining a degree and not one class was needed for my jobs.

Back in the late 80s I had one, two or three children in college for ten years in a row. Good luck.

Catherine
Catherine
6 months ago
Reply to  Richard Quinn

Thanks for the kind wishes. I’ll be sure to write about some of the ongoing activity. The application process is not dissimilar to a cold-calling job hunt. The students don’t know what they are getting into and honestly neither do the universities, hardly. Strange times!

puppyqaz222
puppyqaz222
6 months ago

While kids in college, for incomes over 100k, there is i effect a
1) 5.64% wealth tax and a
2)47% tax on marginal income

Where “tax” is reduction of the discount a college offers.

So if you work more and earn an extra $1000 to help pay, almost all of that money is eaten by fed, state, ss, then college discount clawback, leaving you nothing for your effort.
The 5.6% wealth tax is devastating if you have 3-4 kids and get hit by it 10+ years in a row.

My advice? Consider 0 in 529s, and instead prioritize IRAs/401ks which are invisible to the efc calculations

Catherine
Catherine
6 months ago
Reply to  puppyqaz222

This is so true! I didn’t even talk about the income hit. Or the discount rate. Your advice was exactly the path I took. Honestly, the 529 works best if you know what’s in your future, and I have no crystal ball, never good at guessing.

puppyqaz222
puppyqaz222
6 months ago
Reply to  Catherine

529s are AMAZING if your household income is 300k+, but they act just as a wealth building tool. Not as an “affording college” tool.

Between 90k and 220k, roughly, with 2+ kids, you will maximize total family wealth much more through IRAs/401ks. Colleges actively penalize you for saving in 529s by counting 5.6% of this years 529 balance AGAINST you (reducing any aid by that amount), year after year.

Note: this is calculated on your total 529 balance, NOT on the 529 money saved for 1 student. For example, your 9 yr olds 529 balance will count AGAINST your 20 yr old college student’s financial aid!

Kristine Hayes
Kristine Hayes
6 months ago

I wish more parents and high school counselors would encourage students to look into ‘traditional’ college alternatives. Trade schools, the military, community colleges and certificate programs can all provide great paths to meaningful careers. And, of course, there’s no reason why a student can’t enroll in college later in life, once they know a bit more about what interests them and what their skill sets are. I know when I was 18 I didn’t have a clue about what I was good at or what I wanted to do for the next 35+ years of my life.

Catherine
Catherine
6 months ago
Reply to  Kristine Hayes

One of my twins knows exactly what she wants to do, and at least some college is required as an entry card. The other has no clue. You are correct about many paths, and also straight into work, where once working, in some professions your employer will suggest and pay for you to go to college.

Kristine Hayes
Kristine Hayes
6 months ago
Reply to  Catherine

It’s funny how some people know exactly what they want to do at 18 while others have no idea. I graduated from high school with a classmate who knew she wanted to be a doctor. She went straight through college and medical school and into a career as a physician. I spent the first three years of my college education taking classes in a variety of subjects just hoping I’d find something that would stick.

Thomas Taylor
Thomas Taylor
6 months ago

I wish you luck as well. I know it will never happen and I realize there are a lot of complications, but I would like to see the colleges and universities become responsible for the loan(s) the student takes out and/or have skin in the game. As it stands now, the student loan system mess is ultimately a taxpayer obligation. There is no incentive or reason to hold down costs so it continues to balloon ever higher each year.

Catherine
Catherine
6 months ago
Reply to  Thomas Taylor

I think student loans only started about a half century ago, and colleges have been around over 500 years. So there are other funding mechanisms. We could benefit from a more extensive dialogue on higher education in the US.

greglee
greglee
6 months ago
Reply to  Catherine

One such other funding mechanism is the assistantship system used by grad schools. Students support themselves by teaching. That could perhaps be extended from college teaching down to secondary school teaching.

Peter Blanchette
Peter Blanchette
6 months ago

This is why smart parents often have life insurance on both spouses to ensure that in the event of the death of one parent that these type of life costs like a kid’s education can be covered.

Catherine
Catherine
6 months ago

Every couple could benefit from a hard look at what would happen if one died unexpectedly at least once a year, maybe when doing their taxes or deciding how much they can save or spend that year. In this pandemic, my family has had hard conversations about what would happen if a second parent died suddenly. For many families, it is more achievable to backfill a missing income through term insurance than to self-insure through direct saving.

Peter Blanchette
Peter Blanchette
6 months ago
Reply to  Catherine

That was the whole point of my comment. In the event of a death of one spouse, life insurance is a tool to make sure that the family’s finances is not totally wrecked and to ensure that any children can afford college. Not every family(especially young families) has the financial wherewithal to sustain a death of a breadwinner. Except for the elite, life insurance is a more practical option. I have known many people who’s financial lives would have been devastated if they were not protected by life insurance.

David Donohue
David Donohue
5 months ago

It’s stunning that a part of the reason for 6 year degrees is a lack of HS academic preparedness. I’ll bet many were well prepared for sports! I taught HS 9th grade English for several years, right out of college (age 21), and was the only teacher fearless enough to spend six weeks working on grammar rules. I used all kinds of methods to make it palatable. Foremost in my mind were my first college papers, returned to me with a sea of red. It worked. The following year the foreign language teachers were telling me their jobs were easier, because they didn’t have to teach English along with their language grammar. Parents need to wholly own their children’s academic performance, communicate regularly with the teachers, and enforce strong academic discipline at home. Forget the NHL and NFL, get them hitting the books hard every night. Inspect and review homework, and demand excellence. College, and related aid, will take care of itself.

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