College Funding Options II
by Richard
Part I explained what drives higher education inflation. Today we will try to cope.
This is highly topical, because so many private lenders are bailing out on college loan funding. This is a self-inflicted wound Congress brought on itself, when it cut the margins on such loans, just as the credit markets locked up in the past nine months.
But Congress feels your pain. In an election year, there is no want or need that will go unsatisfied. You can expect a torrent of legislation to re-open the lending floodgates. Astute readers will recognize that the abundance of easily attainable credit is in itself a prime factor in the rate of education inflation.
Societal pressure creates unlimited demand, and accommodative loans totally unhinged from any ability to repay help to satisfy the demand. No wonder that both non profit and private schools can price with impunity.
My problem with the loans is not the cost of the debt. The low interest rates, subsidized by all taxpayers, are actually quite attractive. The downside is the mountain of debt that crushes the student and/or their families when they finish school. Notice I did not say graduate. The school bursar will tell them they are finished when the loan pipeline dries up.
Loans used to fund degrees in Business and Medicine can be serviced from above average incomes. Loans for law school are problematic, because we grind out more lawyers than can be usefully employed. And for some of the more exotic and esoteric liberal arts degrees, you will see some absolutely untenable loans that will diminish the quality of life for the poor student for decades on end.
How to dodge this bullet?
There are four pre-funding options worth pursuing. No help for your college age kids, but great for your toddlers:
1. 529 plans
I’m not enthusiastic about the limited choices available. This is a vendor driven market, given to poor selections and high fees, and you have to pick your way through the minefield carefully. Check out Morningstar, for their “best of the worst” selection criteria. The attraction is that they often qualify for state tax deductions, and always qualify for tax free earnings and withdrawals when used for legitimate college expenses.
For wealthy families, the option of pre-funding five years in advance ($12,000 x 5=$60,000) would allow parents who split the gift tax to pony up $120,000 without using any of their gift tax exemption. If two grandparents did the same, you could prefund with a cool $240,000. With good fund selection and fifteen years of compounding, you should be home free no matter where they choose to matriculate, and any leftover funds can be allocated to other family members.
2. Coverdell education IRAs
These have been pushed aside in the pell mell rush to 529 plans due to their measly $2,000 contribution limit and income phaseouts. But they offer the option of funding at the prep school level, something not available to 529 plans. So why not throw this into the mix as well?
3. The Roth IRA
Roth IRA’s can be used for college funding. Contributions can be withdrawn at any time, with no tax or penalty. It’s only the investment gain subject to the penalties. My sense is that this would be a last choice, as you will long regret tapping into the one fund that you would carry into retirement without ever incurring a tax liability.
4. U.S. Savings Bonds
Check the current rules on using U.S. Savings bonds for tuition. This applies both to series E and I bonds. Perhaps you married and started your family later in life, and you may be retired from your peak earning career. If you qualify, the bond interest is non taxable when applied to tuition. Since the ultimate interest payout on savings bonds is the lump sum you receive upon maturity, this could be a significant savings.
But…
I am not even going to go into rules for UTMA/UGMA accounts, which were popular a generation ago. Anything that gives your children control of the money at legal maturity, which may be as low as age 18, is not a viable option in my opinion.
Let’s see, they could zone out on stultifying lectures for four years (think Ben Stein in Ferris Bueller) or they could blow it all on a new Corvette. Do you seriously want them to have this dialog?
In part III, we will get into some truly exotic alternatives.
Like a frog in boiling water, we need to get there by increments before you leap away.
