Solving the student debt crisis

Student Debt Growth

The looming student debt crisis

As a financial advisor working with many young families, I am regularly discussing college planning. Many of my clients want to help their children with the constantly growing college tuition. Currently, the amount of US student debt is $1.56 trillion spread among 45 million borrowers. By 2023, 40% of borrowers can default on their loans. I am not running for a president, but I am very curious about the upcoming debate about fighting the upcoming student debt in America.

One recent proposal from the Republican party was to allow 529 plan participants to pay off student debt.

Another proposal from the presidential candidate Elizabeth Warren is to cancel student debt partially or entirely for households based on their income. Furthermore, many Democrat Candidate signed for free public college for all.

While all these ideas have certain merits, I am not confident that they will solve the problem long-term. As a parent and married to my wife who is paying off student loans, I would like to share my opinion.  Here are some of my suggestions

Promote 529 plans

In one of my previous articles, I discussed the benefits of 529 plans. Sadly, only 30% of US families know about or use 529 plans. It’s really striking how little Americans know about this option. 529 plans are state-sponsored tax-advantaged investment accounts allowing parents and other family members to save for qualified college expenses. It literally takes 5-10 minutes to open a 529 account.

Make 529 contributions tax-deductible

Currently, 529 contributions are after taxes. The tax advantage comes from not paying taxes on any future capital gains if you use the funds to pay for eligible college expenses. Additionally, over 30 states offer full or partial state income tax deduction on 529 contributions.

I would like to go one step further and propose federal income tax deduction up to a certain annual limit (say $5,000 or $10,000) with a phaseout over certain household income level (call it $250,000). This income deduction will help low and middle-class families save for college without putting a massive strain on their budget.  

Expand the Employer-sponsored 529 plans

In reality, most US families do not use the 529 plan because they don’t know about them or are uncertain about their investment choices. One way to popularize the 529 plan is motivating employers to include them as part of their benefits package similar to 401k plans. Employees can set up automatic payroll deposits and make regular contributions to their 529 accounts. Unfortunately, according to a recent survey by Gradadvisor, only 7% of employers offer 529 plans through their benefits.

Currently, the employer 529 match is taxable income to the parent. At the end of the year, the parent must pay personal taxes on any amount received through their employer.

I believe this provision is discouraging a lot of people to participate in these plans. In order to encourage higher participation in employer-sponsored 529 plans., the employer match should not be treated as income to the parent if used for qualified educational expenses.

Promote more work-study grants and employer-sponsored scholarships

Many college graduates leave school unprepared for the real world. Sometimes, I feel that there is a disconnect between skills learned at school and those needed to compete in the work marketplace.

While many public and private schools are doing a great job in teaching students those skills, I think we can do much better by connecting the school programs with the business. Let’s face it. Unless you are from an Ivy League school, how many students have had the chance to speak to a corporate CEO, a successful small business owner or a community leader.

With US unemployment at a record low, many businesses are struggling to find qualified workers. If we can encourage schools and employers to work together and set up employer-sponsored scholarships, internship programs, and work-study grants, we will have a lot more students learning real-life skills, earn money while study and potentially come out with smaller or no student loans.

Have personal finance as a mandatory class in high school and college

Only 1/3 states require a mandatory personal finance class in high school. And zero states mandate it in college. It may sound radical, but I believe that every high school and public college should require one personal finance class in the curriculum regardless of the student major.

Teaching kids and young adults essential financial skills like saving money, budgeting, and investing will help them make better choices later in life.

It also means that we need to find teachers who can coach personal finance. Unfortunately, finance and economics are mostly taught in business schools and largely ignored outside of the space. This is where connecting schools with local business leaders can be helpful.

Extend the Non-Taxable Loan Forgiveness

There are several Federal and State programs that offer Loan Forgiveness. However, in most cases, student loan forgiveness is treated as taxable income in the year when the loan was written off.  For some borrowers performing public service or working as teachers, lawyers and physicians in underserved areas, the loan forgiveness can be tax-free.

If your employer offers to pay off your student loans, you will receive a tax bill from the IRS. The amount of your forgiven loan will be added to your annual income and taxed as ordinary income. Knowing this tax trap, very few people opt for that option. If you can’t afford to pay off your student loan, what are the chances you can pay the taxes on the loan forgiveness?

Separately, being an elementary school teacher in a desirable area like Manhattan or San Francisco doesn’t make you financially better off than the rest of your colleagues. Most teachers can’t afford to live in San Francisco or Manhattan on a teacher’s salary, how do we expect them to pay off their loans.

Furthermore, non-taxable loan forgiveness should be designed to reward responsible borrowers who are paying off their loans regularly. I think a dollar to dollar match could encourage more people to pay off their loans.

What about loan cancellation

Canceling loans entirely or partially is a very admirable idea but it could turn into a double-edged sword. On one hand, it’s not completely fair to people who are diligently paying off their student loans month after month. And on the other hand, loan cancellation will encourage more people to take on student debt and not pay it. It might provide temporary relief, but it will not solve the problem long-term. I much rather find a way to empower and educate borrowers.

Improve student access to financial advice

How many parents or students speak to a financial advisor before taking a student loan? I bet a lot less than we hope for. Maybe it’s partially our fault as finance professionals but as a society, we need to find a way to get more financial advisors and colleges.

Before the TJCA of 2017, professional service expenses such as fees for CPAs and financial advisors were tax-deductible. I am not sure how many people took advantage of this deduction, probably not too many, but it was one way to encourage people to seek professional financial advice.

The sad truth is that the people who can afford financial advice are not those who needed it the most. So how about, make the financial advisory fees tax-deductible for low income and middle-class families. Or encourage financial advisors to provide free public service. I believe many of my colleagues will be happy to provide free advice in a meaningful and impactful way.

Reach out

If you’d like to discuss how to pay off your student loans, open a new 529 plan or make the most out of your existing 529 account, please feel free to reach out and learn more about my fee-only financial advisory services. I can meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas or connect by phone. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.

Stoyan Panayotov, CFA 
Founder | Babylon Wealth Management

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Saving for college with a 529 plan

College savings with a 529 plan

What is a 529 plan?

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.

In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation.  Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.

College tuition and fees growth between 1998 and 2018.
Source: College Board

With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.

Student Debt is Growing

The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.

Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.

Let’s break down some of the benefits of the 529 plan.

College Savings Made Easy

Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.

529 plan offers flexible Investment Options

Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.

Alternatively, you can design your portfolio choosing between a mix of actively managed and index funds, matching your risk tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed options, which limit your investment risk but also cap your upside.

Earnings Grow Tax-Free

529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Tax-exempt growth
529 plan versus taxable investment account
The chart hypothetically assumes a $6,300 annual contribution, a 5% average annual return and a 20% average tax rate on taxable income in a comparable brokerage account. The final year post-tax difference would be $14,539, without taking into consideration state tax deductions.on contributions and impact on financial aid application.

Your State May Offer a Tax Break

Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.

If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.

Use at Schools Anywhere

529 funds can be used at any accredited university, college or vocational school nationwide and more than 400 schools abroad. Basically, any institution eligible to participate in a federal student aid program qualifies. A 529 plan can be used to pay for tuition, certain room and board costs, computers and related technology expenses as well as fees, books, supplies, and other equipment.

The TCJA law of 2017 expanded the use of 529 funds and allowed parents to use up to $10,000 annually per student for tuition expenses at a public, private or religious elementary, middle, or high school. However, please check with your 529 plan as not all states passed that provision

Smaller Impact on Scholarship and Financial Aid

Many parents worry that 529 savings can adversely affect eligibility for scholarships and financial aid. Fortunately, 529 plan savings have no impact on merit scholarships. You can even withdraw funds from the 529 plan penalty-free up to the amount of the student scholarship.

For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.

Lower Cost versus Borrowing Money

Starting the 529 plan early can save you money in the long run. The tax advantages of the 529 plan combined with the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.

529 plan provide Estate Tax Planning Benefits

Your 529 plan contributions may qualify for an annual gift tax exclusion of $15,000 per year for single filers and $30,000 a year for couples. The 529 plan is the only investment vehicle that allows you to contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for a single filer and $150,000 for couples.

Other Family Members Can Contribute Too

Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.

Transfer funds to ABLE Account

Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.

Under the TCJA law, 529 funds can be rolled over into an ABLE account, without paying taxes or penalties.

Assign Extra Funds to Other Family Members

Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.