Farrell: 50% solution for financing college can be tweaked

Q: We have a 13-year-old and an 11-year-old, and have been saving for their college since they were born. Our initial goal was to pay for half of each child’s college education, with our children paying for half. However, times have changed, and I’m concerned about the economy and that the next generation doesn’t start working as early as my husband and I did. My question is whether we should cut back our college savings. I don’t want to over-save, but don’t want our kids straddled with college debt, either.

Jennifer

A: You’re in a healthy financial position, which means any answer is more about values than affordability. Your question also reflects an underappreciated change in family dynamics. Many youngsters today work less and school more (including sports) before college. Yes, it has been hard for teenagers to get jobs in recent years, but the underlying trend is for parents to make greater investments in their children’s “human capital,” ranging from summer classes to camp programs to athletics.

My sense is that you’ve managed to accumulate a prudent college nest egg and continuing at the lower level won’t strain finances when the college tuition bills start. For one thing, you’re continuing to build up your household finances, meaning you’ll have ample savings to tap when the time comes.

For another, there are a number of imponderables that weigh against putting too much into tax-advantaged college-­earmarked funds like 529s and Coverdell education savings plans. For example, the final price tag for attending in-state public institutions, out-of-state public universities and private independent liberal arts college can vary widely after taking financial aid packages into account.

That’s why savers should also put some money into taxable accounts. If you don’t need that money for college expenses, you can always tap it for other purposes. What you’re doing is providing a sufficient financial cushion so that your children will feel free to apply to where you and they believe they will get the most value for the investment. Bravo.

There is no simple answer to how much your children should borrow for their edu­cation. You could calibrate it by adhering to a rule of thumb that suggests students should borrow no more, in total, than what they think their first-year salary will be at graduation. Another benchmark is that no more than 8 percent of a recent college graduate’s income should go toward student loans. Like all such rules, the 8 percent figure should be adjusted. For example, someone earning $20,000 a year after graduation shouldn’t have a total-debt-payment to total-income ratio that exceeds 5 percent, say economists Sandy Baum and Saul Schwartz in “How Much Debt Is Too Much? Defining Benchmarks for Manageable Student Debt.”

A graduate making $40,000 a year could support a ratio of 13 percent, they calculate. Under no circumstances do they recommend any new college graduate going over a 20 percent debt-to-income threshold.

I think you can decide closer to college time how much your students will pay. Your starting point for conversation is half. When the time comes for them to go to college you can make a judgment on what is right for the family at the time, plus or minus 50 percent. That’s your real return on savings: Choice.

Chris Farrell is economics editor for “Marketplace Money.” His e-mail is cfarrell@mpr.org.

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