College Savings: Do Your Homework

David Blain of D. L. Blain & Co., LLC in New Bern, North Carolina, recounts a new client couple who came to him already buried by their son’s college debt: $150,000 worth of student loans they’d guaranteed. The boy had racked up huge tuition bills in the quest to become a video game designer and then couldn’t find a job, so his parents were on the hook for the whole amount.

If there’s one thing clients seem to be blind about, it’s their kids’ college educations. Sometimes advisors need not only to help them find money to pay the tuition bills, but also to be the voice of reason when it comes to parents sinking themselves into debt to help out.

“I’ve been fortunate in that none of our [existing] clients…did that [went into so much debt], contrary to our advice,” says Blain, who says his firm tries “to encourage our clients to plan in a totalistic manner, meaning that we incorporate different goals–college, new house, etc.–into an overall scenario” so that the money will be there when they need to draw upon it. He has plenty of ways for his clients to meet college expenses for children or grandchildren. Moreover, while for the majority of his clients it’s not a question of saving a couple hundred bucks a month for that long-distant tuition–he says they either plan to pay for it from their salaries or from an already-existing account–even they sometimes need to economize.

Blain is somewhat unique in that he doesn’t generally carve money out into 529s or other vehicles specifically aimed at paying for college, but he’s certainly not unique in having to help his clients face facts about how much to pay for college and how much to mortgage their own futures in doing so.

Pay Yourself First

Martha Schilling of Schilling Group Advisors in Philadelphia says she’s been telling clients determined to shoulder the entire tuition burden to “stop it…You can’t finance retirement; you can finance college.” She also has a telling client horror story; professionals with two children and more than $200,000 in annual income decided they needed a larger home. But in the real estate downturn they were unable to sell the first house, so were paying two mortgages. “They ramped up five credit cards to $117,000,” she says, and the husband also borrowed the maximum $50,000 from his 401(k).

When “they came to me…they were $2,400 short a month,” Schilling recalls. “The first thing that went was the 529, and then their 401(k).” They went on a bare-bones budget, she says, and with her help they were able to refinance their mortgage and get out of the PMI they were paying.

Says Schilling, “Isn’t it better to take care of yourself? Otherwise you’ll be a burden to those children,” leaving them to support parents in old age and perhaps even pay for long-term care.

She’s far from the only advisor to advocate a pay-yourself-first philosophy: nearly every advisor we spoke with stressed the importance of seeing to one’s own financial health before plunging into debt to finance an education. Rick Kahler, of Kahler Financial Group in Rapid City, South Dakota, concurs, pointing out that “it’s a lot more expensive on the kids when the parents don’t fund their retirement.” Clients of his were determined to finance their grandson’s education, all the way through medical school, but they’d suffered losses in the stock market, and to keep that promise they would have had to make some drastic lifestyle changes. Kahler showed them how much it would cost; “they had to decide between him and retirement.”

Right now they’ve decided, he says, to pay for the first four years of their grandson’s education and after that just help him with his rent, unless circumstances improve. “I say ‘Right now,’” Kahler explains, “because their hearts continue to get away from them and I have to help them remake that decision from time to time.”

Michelle Goldstein of Goldstein Financial Futures in Dallas says that with more parents facing job loss, she’s encouraging more clients to go back to financial aid counselors and say, “I need to renegotiate; my circumstances have changed.” Part of her job, she says, “is reminding them that safety nets are out there.”

The 411 on 529s

One of the most well-known, if not well-loved, strategies is the 529 plan, whose popularity and effectiveness have suffered quite a bit during the downturn. Still, advisors do make use of 529s to varying degrees. Schilling suggests that families with several children open only one 529 for four reasons: first, not all their children may attend college; second, one or more may receive scholarships; third, the larger balance in a single account will compound at a quicker rate of growth; and fourth, if there is money left in the account after the first child has finished, the remaining balance can be transferred to the next youngest.

Robert Cheney of Westridge Wealth Strategies in Portola Valley, California, believes that “529 plans as an estate planning and asset protection tool are generally underappreciated.” He explains that “529 regulations allow five years of the gift exemption to be contributed…in one year, and the gift claimed evenly over five years for tax reporting purposes.” A married couple, whether parents or grandparents, could therefore gift a total of $130,000 in a single year with no estate tax consequences, or, in the case of, say, five children, $650,000 in a single year. “The money and the potential growth get out of their estate faster than if regular annual gifts were made.” Not only that, but even though the funds are out of the estate, the parent or grandparent retains control of the account, and in the case of litigation, judgment, or creditors leveling a claim against the estate, the 529 funds are protected. The caveat here is that the grantor cannot gift again to the same individual for the next four years.