Hosted by Creative Planning Director of Financial Education, Jonathan Clements and President, Peter Mallouk this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
[0:00] – Paying for college
[5:41] – College debt
[14:37] – Biases people have from childhood
[18:30] – Peter Mallouk tip of the month
[20:06] – Jonathan Clements tip of the month
Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education, here at Creative Planning in Overland Park, Kansas. And with me is Peter Mallouk, President of the firm. It’s September 3rd, it’s the day after Labor Day. Everybody’s heading back to school, back to college, back to work, and that brings us to our first topic this morning, paying for college. So if somebody comes to you and says, “Peter, I got a toddler. She’s going to be heading off to college in 18 years. I want to make sure that I can pay for my daughter’s college education. What should I be doing?”
Peter Mallouk: I think the first thing we would do is we prioritize goals. Usually that’s not the only goal people have. They also have a goal to retire, so we would want to have a plan that accounts for both of those things. And assuming we have the luxury of having enough cashflow to fund both, we would take care of the retirement with 401k and other things we’ve talked about in the past. But with education, for most folks, the best tool is a 529 plan, so you open a 529 plan for each of your kids. These are very state-specific. States have different plans, they have different laws for terms of tax breaks. Some states you get an income tax deduction if you contribute to the plan. Some states you don’t. States have different limits on what you can put in there. So this is something that, unfortunately, has become a very complicated area of the law for something that should be very, very simple for people to figure out. It’s very disappointing.
It’s a great example of when politicians have an idea of how to help people and find a way to confuse everybody at the same time. But if you get some reasonably good advice, you’re going to get to the right 529 plan. Sometimes it makes sense to leave your state and go to a lower cost plan. So you really want to find a plan that we can get a break and we can have a very low cost and a good contribution limit. And then we want to contribute enough to be able to meet most of the needs in the future. And the reason I say most is, if you overfund to this plan, let’s say that you get enough money in there for your kid to go to the college that you had targeted, but then they get a grant or a scholarship, well, now we’ve got extra money in the plan. It’s a nice problem to have, but if you take it back out, you’re going to pay a penalty and taxes. There’s other solutions. You can direct it to another kid. You can direct it to a grandkid or somebody else. We want to make sure you don’t overfund it, especially because most people have multiple goals, not just one goal.
Jonathan: So, one of the things that you mentioned, which was interesting, was beyond making sure you’re funding retirement, that should always be your top financial priority. You mentioned financial aid, scholarships, grants. One of the really tricky parts I think about funding college accounts is looking forward 18 years and saying, “Will we be eligible for substantial amounts of financial aid?” I suspect that most people who are listening to this podcast are going to have pretty decent incomes. Probably financial aid is not going to be a major consideration. But for anybody who has a relatively modest income, even funding a 529 plan may not be the right choice, because 529 plans, while they’re looked at relatively favorably in the financial aid formulas, they are still assessed-
Jonathan: … and they will reduce the amount of financial aid you get. So, if you’re on a relatively modest income, I would say maybe you should just fund those retirement accounts. Maybe you should focus on paying down the mortgage, put the money in an IRA, even just build up your regular taxable account. Do all of these things rather than necessarily put the money in account dedicated to paying for the child’s college education.
Peter: Right, and there are a lot of strategies around this where some people have their parents make contributions to 529 plans, or grandparents, and they try to get it to count less in the financial aid formulas. It’s one of these areas that’s become quite a labyrinth and has a lot of decision-making. If you go to the other end of the spectrum, from the folks you were talking about to say the very affluent, they shouldn’t use 529 plans because it uses their annual exclusion. If you put $15,000 in a 529 plan for your kids’ college, that counts as the $15,000 you’ve given them every year. It’d be better to give that $15,000 to a trust for your kids. And when the kids go to college, you are able to keep giving them $15,000 and pay for college directly because paying for college directly doesn’t count as part of the annual exclusion. So, whether you’re on the modest end of the spectrum that you are referencing or the middle where we started, or the ultra-affluent that I just covered, there’s different answers to all of those questions.
Jonathan: I would just throw in two other things to keep in mind. One is the financial aid rules are constantly influx. There’s a good chance that down the road, perhaps 529 plans will be assessed more heavily or perhaps down the road they won’t be assessed at all. The rules are constantly influx. You just don’t know how they’re going to play out. But the other thing I would mention is that the one account you probably don’t want to fund for your kid at this point is a custodial account. If you’re looking to pay for college, a custodial account, which was, when I was raising my kids, the account of choice, is no longer the account of choice. One, that money counts as the child’s asset, which means it’s assessed very heavily from a financial point of view. And two, the kid gets control of that money when they reach the age of maturity.
Peter: I make that number one. I think that’s the biggest problem with that one.
Jonathan: Well, my kids know that they would be cut out of the will if they took their custodial account and used it to buy the Ferrari. And in any case, there wasn’t enough in the account for a Ferrari. But that is a risk.
Peter: Yes, for sure. I think when you talk about financial aid, one of the topics we’re going to talk about today is the student loans and student debt and financial aid has really helped fuel this problem. College used to cost a certain amount of money. The government comes in and says, “We’re going to help you all go to co college. We’re going to give you really low interest rate loans.” So what do the colleges do? They raise their prices. There’s more people that have access to money and the people that had access before now have cheaper access to money. So it created this acceleration of education inflation, where we have inflation every year has been around 2%, but education’s been more than double or triple that because you have all this extra money thrown in the system and it’s thrown in at a really low cost. So, again, the government trying to come in and help people out and actually creating higher education prices for all and creating a kind of debt culture when it comes to college.
Jonathan: So, we’ve encouraged kids to take on student loans with these cheap rates and with these tax breaks. That, in turn has allowed colleges to raise prices. We’ve ended up with students walking out of college on average with $30,000 of debt, and I’ve heard many horror stories of people who have six figures of undergraduate debt. And now we have politicians suggesting, “Well, let’s forgive it all.”
Peter: Right. I think with the other thing that we had is we have all of these schools that came out of nowhere that were really businesses that said, “Hey, the government’s going to give all these loans. Let’s go set up a college,” and hundreds of these popped up all over the country that were kind of fake schools. And just recently, the government said, “We’re no longer going to let students get loans to go to these schools,” and these schools are closing and these kids have the debt. I see a solution where what you’re probably going to see is they’re not going to forgive everybody’s student loans, and there’s a lot of issues with that, or certainly, I hope not. I don’t think that’s fair, and I’ll get to why. But I think what they will do is they’ll say, “Hey, if you went to this set of colleges, we might forgive those loans,” and I think you’ll see the banks participate in the cost of that.
But I think the problem with forgiving student loans is, let’s say you have two kids from the same neighborhood and one kid’s mowing lawns, mulching, interning, working 40 hours a week, saving money. And then you’ve got their parents working three jobs, and then they pick a school that maybe isn’t their first choice, but it costs less. You got another kid doesn’t work at all. He’s just getting hammered all summer long and hanging out and partying, and then they pick a school that’s more expensive. They go out of state to school and then they go get art history in Romania in the 1700s as their major. So this latter kid has $100,000 of debt. The first kid has no debt because the family killed themselves, took their second choice. And now we’re going to go forgive the kid’s loan that… it’s not a fair outcome. It’s not equitable.
I think the second you start to have policies like that, you are going to have a lot of other unfair policies. You got somebody discussed forgiving car loans, which is literally the most ridiculous thing I’ve ever heard. You see somebody’s driving around with an old junkier car and somebody else bought a new car, and now we’re going to go forgive this guy’s loan. We have to have a system that encourages responsible behavior. So there are a lot of problems with the student loan system and it needs to be fixed. There were a lot of sham colleges that started because of that system and they need to be shut down. But we can’t punish the people that did all the right things and reward the people that didn’t.
Now, there are a ton of people with a ton of debt that did all the right thing that that’s… so I don’t want to be misunderstood there. The system just didn’t serve them well, but the outcome of saying, “We’re going to forgive all of that and not forgive the others.” It’s interesting. There was an African American billionaire who recently at a college graduation announced he was going to pay off everyone’s debt, and they were showing all the faces of the kids that were all super excited. What I was curious with the faces I wanted to see were the kids that delayed going to college for two or three years and saved up the money and worked two or three jobs, and their roommate who didn’t do any of that just had all their debt forgiven. There are those faces too. We’re not hearing a lot about those folks.
Jonathan: Yeah. I think there are two things that I would add to this. One is when we think about student debt and we say, “Oh, student debt is the problem,” it’s rather like saying insurance premiums are the problem. Insurance premiums are not the problem. Healthcare cost is the problem, and that’s why you end up with high insurance premiums.
Peter: That’s right.
Jonathan: College costs are the problem, which is why you’ve ended up with this ridiculous amount of student debt. If we’re going to address the problem, let’s address the real problem, which is college costs, not the debt that is a consequence of that. And maybe what we need is greater transparency in college pricing, getting away from this ridiculous system where there’s the list price, but nobody pays the list price because of grants and other sources of financial aid. Attacking student debt is attacking the symptom, not the problem.
Peter: Right. I think, politically, we’ve become so insane that we can’t find the very basic common sense solutions. So you have on the right, not all the right, but the very far right, we shouldn’t pay for anything ever. And then you’ve got on the far left, literally, we should forgive everybody’s debt. Everybody should go wherever they want for free all the time. It’s crazy. This idea that we can’t pay for education is a little silly. We pay already for kindergarten, all of grade school, middle school and high school. Somehow we’re surviving. No one politically is promoting the idea that Americans should pay for grade school or high school. So is it insane to think that we could have maybe a college in every state that was close to free, $2,500 a semester or something? It’s not that far off from where some state colleges are already and say, “Look, each state’s going to have one of these. The federal government’s going to subsidize it a little bit,” and problem solved.
If you choose to go to some school that’s $50,000 a year, God bless you, deal with your debt. Grow up and deal with your debt because you’ve got an outlet here. We can give people that outlet. The country can afford to give them that outlet. As with most political issues, there’s a very reasonable, probably solution in the middle that can make it where no one in America can say they can’t get an affordable, good college education, and we don’t feel the need to be forgiving debt either.
Jonathan: I would just add one more thing, and I’m going to climb on my soapbox a little bit for this one, which is-
Peter: I just got off mine, so you’ve got room.
Jonathan: Thanks for the extra space here. We talk about these kids like they were dumb asses for taking on 30, 50, $100,000 of college debt. But the question in my mind is, where were the parents? What were the parents doing while these kids were signing up for a college they couldn’t afford that was going to involve taking on these tens of thousands of dollars of college loans? Now, I realize that not every parent can afford to pay for their kids’ college education, but that does not mean at that point that you say, “Okay, I have no influence over my child’s decision, and I should just let them go ahead and make whatever choice they want.”
The parents need to stay involved. If your child is going to be studying to become a social worker and end up with $100,000 of student loans, and you don’t try to guide them towards a lower cost college, you are abrogating your responsibility as a parent. It is simply bad parenting, and you should be ashamed of yourself. So, for goodness sake, even if you can’t help your kids pay for college, help them with your advice. Guide them towards some sort of sensible choice, so they don’t end up spending their twenties and thirties regretting the financial decision they made around college.
Peter: Agreed. I think one of the things we talked about that I’ll just tack onto is the amount of debt, and really it’s the amount of debt relative to what you’re getting. If somebody’s got $100,000 of debt, and they’re a doctor, well, great, I’ll do that all day long. You’ve been guaranteed employment for forever. You’re destined to become a millionaire even if you only contribute to your retirement plan. That’s totally worth it, whereas $50,000 of debt with a degree that doesn’t translate into a job in today’s economy is too much. And so that’s the other factor people should be looking at is, what does this particular degree, what’s it going to translate into being in terms of earning power?
Jonathan: So, when I was growing up, one of the things that my parents really valued was education, and it was made clear to my siblings and to me that wherever we wanted to go to college, my parents would pay. It was part of our family’s value system. And so when I raised my kids, it was exactly the same. It was wherever you want to go, we will cover the tab. I bring this up because before we started recording this show we were talking about the biases that we sort of inherited from our parents and that we bring into the adult world. And that’s a big bias of mine, but I know you see this every day when you talk to clients.
Peter: Yeah. I think when clients come in, really their financial situation is partially derivative of the job and things like that. But the second big component, if you have two folks that are equal, the biggest component will be the biases they bought out from being a kid. Some folks grew up in an environment where there was nothing. It was very tough to get by and there’s this great fear of losing money. It doesn’t matter how much money they have. They see a path back to the way things were and they are very nervous about that path. That causes them to become very conservative with the way they invest and it also causes them to really not enjoy their money, I mean to really be able to spend and enjoy their money.
The whole other end of the spectrum, you see people that never really had to match a dollar. Maybe they didn’t earn the money themselves, never had that first job and they never had to match that to spending. They’ve never seen a negative consequence because they never earned anything themselves or grew up in an environment where it didn’t matter and so they’ve never had the negative repercussion. And we’ve got clients who we cannot get them to stop spending. We tell them, “Look, let’s make this as simple as possible. If you take this out with this pile of money and you don’t put money in, you’re going to run out of money in seven years.” But they can’t comprehend that it’s true because they’ve never experienced a time where things haven’t worked out. The biases are very, very powerful. It’s amazing how we take on what we learn from our parents, I think.
Jonathan: Yeah. I remember hearing from my parents was them talking about inflation all the time. And I must confess, I spent most of the eighties and nineties waiting for inflation to come back and, of course, it still hasn’t happened. And then because I grew up in the seventies, the ticket to wealth was to own real estate and preferably heavily mortgaged real estate because real estate prices were rising with inflation. Meanwhile, every uptick in inflation, the cost of servicing that mortgage was going down. And so I remember my mother saying, “You cannot go wrong with real estate,” and it stuck in my mind and at the time. I thought, oh, this is the secret to financial success. But now I look back at it and it says to me, this is how people are getting so stuck in the present and believe stuff just because it was true at one moment in time. And if you stick to these beliefs that are really driven by momentary events, you can end up making financial mistakes for the rest of your life by just repeating what you thought was successful.
Peter: Yeah. I think our financial framing is stretched to an analogy over to music. I’ve found that a lot of people have a period of time they listened to music, whether they’re listening to seventies or eighties or nineties or whatever. And I have a theory that the type of music you listen to was your favorite part of your life. So if you’re listening to seventies music that maybe that’s the part that you associate it with the best time of your life, or eighties and so on. I think that it’s the same thing with our financial framework. There’s some period of our life that there are formative years. I think they’re the teen years or early twenties where that gets locked in, and we’re either validating that or trying to overcome that framework for the rest of our lives. And so I think that’s a very, very powerful bias, and if people can become aware of it, they can start to see how it can encourage or affect their thinking about money.
Jonathan: All right, Peter. Well, I think we probably ran through our time allotment for this time around. As usual, we’ll finish with the tip of the month. So what is your tip of the month?
Peter: My tip of the month is doesn’t insure things you don’t need to insure. Insurance is designed as basically something of, if I had to pay for this, it would be painful for me to pay for it, and so I’m going to transfer that risk to a third party and I’m going to pay them some money to do that. So I expect to lose on the math formula, but the idea is I’m protecting myself against a big loss. So, if you’ve got a junkier car that’s worth $2,000 and it would not be a problem for you to write a $2,000 check to replace it, we don’t need to insure that car. It’s the physical car. We still need insurance in case we hit another driver or there’s healthcare. But we don’t need to ensure that car itself. If you’re buying some technology, TV, a sound system, and it’s $8,000, you don’t need the warranty unless you can’t afford to replace it.
The idea is to cover the parts that would hurt. An example is we might still ensure a home, but we don’t need to insure every dollar of it. So most claims are $5,000 or less. If you’ve got a deductible that’s $1,000 and you’re paying a premium, know that a lot of the premium you’re paying for is to cover that small claim, that 5 or $10,000 claim. If you can afford to pay that, talk to your insurance agent and say, “Hey, if I raise my deductible from $1,000 to $5,000 or $10,000, will I save a lot of money? Oftentimes you will, and that makes sense because you can cover that part of the risk. Now, sometimes the math doesn’t work out. It varies from company to company and zip code to zip code. Sometimes they go, “Hey, you’ll only save $30, in which case you should leave your deductible low. But look at all of your insurance and say, “Do I need this, and do I need this much, or can I raise the deductible?”
Jonathan: And my tip for the month ahead, Peter, is to encourage people to draw up a letter of last instructions. This is essentially a guide to your estate for your family and your other heirs. I mean, this isn’t a document that has any real legal standing. It’s not like you need to talk to an attorney to draw it up. It’s not like you get it notarized. It really is your chance to help your family settle your estate after you’re done, and you can go any which way you want on it. I mean, you can list your usernames and passwords for your accounts. You can list personal effects and who you want to have each of these personal effects. Stuff that’s probably of not great value, but may have strong sentimental value you want to make sure that they go to particular people. It’s also a chance for you to explain why you’ve left the money the way you have, just in case you’re leaving slightly more to one child over another. This way, people can understand the reasoning behind your estate.
You might also mention the assets that you own, in case there’s a safe deposit box or something else, so that people know where to find the assets. And finally, you might want to suggest, “Well, here’s my obituary and these are the newspapers or the college magazines or the school magazines that I want it sent to.” It’s really you can go any which way you want with this letter of last instructions, but the more detailed it is, the happier your family will be.
Jonathan: So that’s it for this month, Peter. We are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance to future performance. The information contained herein has been obtained from sources deemed to be reliable, but is not guaranteed.