By Sandy Botkin CPA, Special for USDR
I bet you don’t know the name “Miriam Weeks.” You might, however, generate some recognition if I say the name “Belle Knox” which is her stage name.
Belle, is an 18 year old freshmen at Duke, which is one of the most prestigious schools in the US. She not only aced her SATS but got a full ride to several schools including Vanderbilt. However, none of the other schools have the same prestige as Duke. The problem was how can she afford to pay her $45,000 yearly tuition bill plus room and board since Duke didn’t give her any financial aid? Her answer: Become a porn star and amazingly has the begrudging support of her parents! Now you may be questioning her choice here, but the undeniable fact is that college tuition is quickly becoming out of reach for most Americans.
Even worse, Belle realized that incurring substantial undergraduate debt for any school, even that dream undergraduate school, results in an albatross around the neck of the debtor that could cripple their ability to not only make it in their chosen profession but could result in severely hampering their lifestyle for many years.
Here is a startling graphic example of what it takes to amortize $150,000, which has an 8% interest rate. To pay it off in ten years, it would take payments of $1,433 each month! This is in addition to taxes owed on salaries, which could take up about one-third of their salary, plus mortgage or rent payments, car payments, food, insurance, gifts, travel, entertainment etc. I think you get the message.
In fact, even $100,000 of debt would take about $955 per month to pay off over 10 years.
Thus, the question is: how can people who major in art education, history or other low paying major be able to afford paying off the debt? The answer is that most can’t do it! Even if they start earning $50,000 per year, they will still have trouble paying off this debt. In fact, studies have shown that as many as 50% of recent college graduates are either unemployed or underemployed. This could be really bad news for parents who guaranty the debt for their children because in many cases, they may be called up to ante up with the money for the debt, which could substantially diminish the retirement savings of the parent.
In addition, certain industries, such as the film industry, require people to serve as low paying interns in order to get a foothold into the industry. If a student has substantial indebtedness, they can’t afford to take these jobs, which intern would reduce their chances of success in that industry.
Finally, student loan debts are generally non dischargeable in bankruptcy unless you can show a great hardship, such as a lifelong disability from being able to be employable, which is very tough to demonstrate. Thus, these same students will be saddled with debt that they can’t get rid of.
Sadly, most high school guidance counselors are advocating that students apply and go to the most prestigious schools possible regardless of cost.
Thus, the question is: how much debt is too much debt? From a CPA’s perspective, students should only incur debt that they could pay off. Moreover, consideration has to be given to the fact that only $2,500 a year of student loan interest is deductible. If the interest isn’t deductible, this would greatly reduce the student’s ability to pay the debt off. The point is that $2,500 of student loan interest, payable at the current 6.8% interest rate would result in a maximum debt in which you can deduct the interest, of $36,764. Any more than this amount of debt results in disallowance of the deduction of the interest on the excess debt.
So the question is, “how do you get out of college with less than $36,764 in total undergraduate indebtedness, “especially if you don’t have a rich parent?
Belle’s answer was to get a high paying job in the porn industry. Frankly, I think that is a bit extreme. There are lots of choices.First, smart students like Belle could have gone to a school that would give her a substantial scholarship such as she got at Vanderbilt. . Another alternative would be to attend either a state school of community college, which is usually much less expensive than their four year college counterparts. Doing work study, especially during the summers, would also be of great help.However the best solution is to plan in advance for college expenses by having parents contribute to a qualified tuition plan as early as possible.
There are two types of qualified tuition plans. The first is a prepaid tuition plan that is sponsored by most states. This type of plan comes with guarantees that once it is funded, it will pay for four year of tuition and required fees at any state university in the state that is administering the plan and is fully tax free when used for qualified tuition. With tuition rising faster than inflation, they can be a very good deal. Even better, these plans usually allow for transfer of the fund to other family members if the main beneficiary doesn’t want to use it. Moreover, some states allow a deduction for state income tax on contributions to these plans. Check with your accountant about this.
In addition, there are prepaid tuition plans for private schools too. One such plan is called the, “Private College 529 Plan,” which is run by the Oppenheimer fund. There are over 270 major private schools who participate in this plan and guarantee tuition based tuition certificates purchased thought the plan. You can start with as little as $25 or as much as the Plan’s contribution limit of $231,350. If you are interested in this, you can call them at 888-718-7878.
The second type of qualified tuition plan is known as a section 529 plan. Here there are no guarantees of tuition. You would contribute funds to a savings account that can be invested like a mutual fund. You can make yearly contributions or contribute the funds in one lump sum. The funds can then be used for tuition, fees, room, and board and even for required equipment such as computers. It can also be used for any school even private schools. It is usually administered by financial organizations such as banks.
Bottom line: Incurring substantial debt for undergraduate education is almost always a bad idea regardless of the cache of the school’s name. Even if you are a middle class American, you don’t need to be a porn star to avoid debt. Applying to schools that would give you a big scholarship, applying to cheaper schools such as state schools and community colleges and saving up funds in advance with a qualified tuition plan will avoid the dilemma of incurring a huge debt and will result in a much more rewarding and less stressful life!
Sandy Botkin is a CPA, and attorney and lecturer on tax and financial issues. He is the author of , “Achieve Financial Freedom Big Time” and “Lower Your Taxes: Big Time” and is one of the developers of the expense tracking application “Taxbot.” For more information, you can get his books at books.sandybotkin.com.