Thursday, September 13, 2007

Retirement Planning and the College Loan

Retirement Planning and the College Loan

There are basically three types of college loans: the one you do not have, the one you are paying for or the one you are paying for your children.

I write the following in the book: "Yet the psychology of debt assumes that it (and this instance we are speaking about your ability to repay your collegiate debt) will soon turn bad."

“Life is a maze….” Cyril Connolly, 1944

There was a time in the not-so-distant past when college graduates and those who chose to enter into the workforce could expect to earn similar incomes. Thirty years have passed and, as we all know (or assume) this is no longer the case. In fact, when those two post-high school incomes met along that timeline in 1975, college was much cheaper.

According to the College Board, who recently stepped away from the loan business, the average student will leave college with about $20,000 of debt. (Realistically, the student who fully finances her or his education will often have as much as ten thousand dollars of additional debt above and beyond the cost of classes.) And that is just for undergraduate public school completed in four years. Many students extend their college years beyond this, attending graduate school and adding another $30-40,000 in loans.

Want to find out how much you are likely to make with that college education? has compiled a list of entry-level incomes for a wide variety of careers.

How does college play itself out in your retirement plan? There are three basic concepts to understand.

The first: A thirty thousand dollar loan can quickly turn itself upside down if the student does not pay it off early. Letting it languish for the full ten-year payback period will add as much as a third more to the cost of the education.

Second: Because the student is not likely to prioritize those loan payments, they will be much more prone to roll the debt over into some sort of longer termed consolidation loan, extending the period of payback and because of that, paying additional interest charges, fees for loan origination and in the process, learn one of life's most frequently taught lesson – debt overload. Once this happens, and if the post-college income generated from those years racking up that debt fails to match the debt, young people just starting out will be well behind the best years for saving.

Third: Parents shouldn't pay. Okay, middle class parents shouldn't pay. Diverting money to your child’s education seems noble enough and might even make you feel better but it doesn’t work if you are not using that money for your own retirement.

I have suggested that a family with a household income of less that $80,000 devote any money to growing their child. Lessons, activities, sports and travel all eat up enormous amounts of cash from the average budget. But it will produce a much better (and more attractive, at least from a collegiate perspective) citizen/student. And that child is more likely to obtain scholarships and grant money because of it.

Parents at this income level have few good opportunities to save for their own retirements. Passing up even so much as single dollar directed towards a savings plan for those later years would be catastrophic.

Incomes above that amount will not be in much better shape to save for college but they will feel the pressure of their peer group to do so. With the recent credit crunch revealing some cracks in the accounting of many households who have kept their eye on prizes they could ill afford, saving for college may add to an already strained budget.

Retirement planning rule of thumb: If your total household debt exceeds 70%, you should focus on your future and not that of your child(ren). That debt will afford them better borrowing opportunities but, on the other hand, that same debt will be creating a negative momentum for your own future.