WCI #9: The Four Pillars to Successfully Paying for Children’s Education

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli.

Welcome to the White Coat Investor podcast. Episode 9 Getting Quality Disability and life.

Insurance should be the first financial chore for a doctor to complete. Most docs don't have the ideal policy for their gender, specialty, state or health status and one in seven doctors get disabled at some point during their career. Because these policies can only be purchased through brokers, we put together a list of vetted agents who are experienced with working with the specific needs of medical professionals and who have your best interest at heart. If you have questions about insurance and what kind of policies would be the best fit for you, check out our insurance recommended list@whitecoatinvestor.com insurance and feel the peace of mind that comes with knowing you have the optimal policy in place. You can do this and the White Coat Investor can help.

Thank you for what you do. You're probably on your way into work today, maybe on your way home, and you've got a busy day ahead of you of some stuff that sometimes seems routine and sometimes seems that nobody really appreciates. But I assure you there are patients and their family members who really do appreciate what you're doing, even if they sometimes forget to thank you for it or sometimes try to bite you or throw something at you. You know how it is with patients. Today we're going to be talking about paying for college. There are a lot of things in life where the price is highly variable. Homes, cars, vacations, clothing, etc. We're generally pretty good at making rational decisions about most of that stuff. You know, we look at a house and we say, okay, we can afford that and I'd like that, so we buy it. But when it comes to college, that doesn't necessarily happen so much. So today what I hope to do is to inject some rationality into into this issue. Here's a news flash for the doctors out there. You're not going to be getting much need based financial aid for your kids when they go to college. If you haven't yet realized that that is just a fact of life. It's funny to talk to people who, you know, doctors and other high income professionals who have gone to some of these college planning seminars that the high schools put on where they encourage everybody to fill out the fafsa because you, you never know what kind of aid you're going to get. Well, here's the deal. If you've got a net worth of five or $10 million and you make $800,000 a year, you're not going to get squat. That's just the way it is. Run the numbers and you'll see. But many physician parents fill it out for the first kid and don't even bother with other kids. Of course there are a few unsubsidized loans for undergraduate that are available no matter what your means might be, but for the most part not need based aid like Pell Grants and need based scholarships just aren't going to be available to your kids. The FAFSA or the Free Application for Federal Student Aid or its slightly more complicated counterpart, the College Scholarship Service, is a method that the government has prescribed to determine what your expected family contribution should be. Each school also publishes a cost of attendance and those two numbers are compared to so if your family contribution is significantly less than the cost of attendance, the difference between the two is what can be made up with financial aid. Need based financial aid. However, the fact is that the expected family contribution for most physicians is higher than the cost of attendance for most schools. When doing that calculation, it turns out that income matters a lot more than your assets. For example, for a typical emergency dock, if you it works out that your expected family contribution is about a third of your income plus 6% of your non retirement assets. So if you're making $300,000 your contribution might be $100,000 that they expect you to make. And of course since most schools don't cost that much, you're not going to get anything. However, there are a few exceptions where applying for need based financial aid may be worthwhile and it may be worth your time to work your way through the FAFSA or the css. One exception is if your child is going to a really expensive school. Another exception is if you're a particularly poorly paid doctor with very few assets and a large family. Although bear in mind that you don't get to subtract your own student loans from your investments. So if you're still carrying your own student loan payments, your own student loans, that's not going to help you any. Another situation is where you have multiple kids in school at once, particularly if they're attending expensive schools. Finally, if you have kids in college after you're retired or for some reason you're living on a fraction of your prior income, they may also benefit from some need based financial aid in that situation. But if you're still working, you're still in your peak earnings years, you have any significant amount of money saved, your child's going to an average school, you're not going to be getting much need based financial aid from that. So that leaves what I call the four pillars of paying for your education. The first of these is probably the most important. It's school selection. And the reason why that's most important is because there is such a dramatic cost difference between the various schools. It was kind of funny the other day I was over at the junior high for a counseling session with my seventh grader and her parents where they were talking about college preparation. Granted, seventh grade is maybe a little early on the college preparation theme, but they want to start early at this school apparently. But they handed out a pamphlet that had a page in it that talked about 10 things to consider when choosing a college. It had some of the things you would expect on there, like whether it's a two or a four year school, whether it's public or private, how the academics are and where the location is. But I thought it was interesting after you went through all of that stuff, including some silly stuff like housing options, whether you were in a dorm or off campus, and whether cars were allowed, transportation options. And at the very bottom of the list was affordability. You know, the cost of tuition, the cost of fees, the cost of transportation and living expenses, and the availability of scholarships and tuition assistance. In reality, if your value for your dollar spent, if the affordability of the school isn't in the top three factors that go into school selection, you're probably doing it completely wrong. It's just a really important aspect. Many of the schools in Utah are ridiculously cheap by comparison to the average school in the flagship state university is only 7 or $8,000 a year in tuition for in state. And some of the private schools such as Brigham Young University are even cheaper than that. But I understand in lots of areas of the country that state school may cost you 15 or $20,000 a year just in tuition alone. But if you cannot, if you don't have a ton of money saved, you don't have a lot of money you can use to cash flow toward it. You simply have to make a decision to send your child to a school that they can afford. If you leave this college selection decision entirely to the child, they're likely to choose a school based on whether they like the trees on campus, based on whether the buildings are pretty, based on where their friends are going, which are really not all that important. When it comes to choosing a college, when you're getting beyond the academic considerations and the location considerations, you've really got to take a careful look at the value the school is offering for your dollar. A college education, unless you just have far more money coming out of your ears than you need, really is an investment and you need to see a return on that investment. The second pillar, after school selection, is what I call the child's contributions to the cost of their own education. This includes any merit scholarships they're able to get, whether athletic or musical or academic, but also includes work. As I tell my kids, money comes from work and college students can certainly work. Both my wife and I worked through school, both during the year and particularly in the summers, and we worked hard, did a lot of overtime in the summers. One summer I was working as a tour guide on a train in Alaska and there were 14 hour days and I learned a lot of things that summer. Aside from making a few thousand dollars that could directly reduce the cost of my undergraduate education. I also learned I didn't want to be a tour guide on a train for the rest of my life. And you know what? I that made me study a lot harder when I went back to school. I spent other summers mowing lawns. Boy, you want to learn how to get an A in organic chemistry? Go mow lawns for a summer. And you'll realize what other people do that don't get A's in organic chemistry. In school, they won't be able to work nearly as much. But a few hours a week is entirely reasonable to expect from a child taking a typical 14 to 16 hour. 14 to 16 credit hour load working for 10 hours a week is not unreasonable. And those dollars not only help them to pay for college, but they also help them to appreciate the value of money and to gain valuable work experience that they can take with them into their careers. The third pillar of affording college paying for college is college savings. And this includes money that gets put into education savings accounts or coverdell accounts and in 529s as well as other accounts. Now an ESA has some issues with it. One downside of it is you can only put in $2,000 per year. You also don't get any sort of state tax break from using it. But the benefit of an ESA over 529 is that you can actually use it before college. If you got a child in private high school or something like that, you can use that money for those expenses. You can also get very low costs on your Investments, particularly if you're investing someplace like Vanguard in an ESA.

Very.

Actually slightly more expensive to use the Vanguard 529 at Nevada or many of the other states, such as New York or Utah, that use Vanguard funds. But the 529 is the mainstay of college savings for most physicians and their families. 529 allows you to put in $14,000 per year, and you can actually front load up to five years of that. Your spouse can also do the same. So you can really get a lot of money in there in a hurry if you want to save up a lot of money for college. In some states, you get a state tax credit or a state tax deduction for the money you put in there. But for the most part, there is no deduction for the money put in. There certainly is no federal deduction, but as the money grows, it is not taxed. And when it comes out, as long as it's used for education, it is tax free. And so that's a great way to save for college. There are lots of financial advisors and financial salesmen out there trying to talk you into using other types of accounts to save for college, including whole life insurance. I think that's a terrible idea. The government has given us a great account with some significant tax brackets and with the states competing with each other to give to produce the best product, we've really got some wonderful choices in 529s, and they're continually getting better. So I recommend you do the vast majority of your saving for college inside a 529. Now, if you're worried you're over saving in a 529, remember that the beneficiary can be changed to younger siblings, to grandkids, even to yourself. So it's not a terrible thing if you save a little bit too much in it. But if you're worried about that, you can also save some money in a taxable account, either in your name or in the child's name, which is a uniform Gift to Minors account. Just bear in mind if you save in an UGMA Uniform Gift to Minors account, that that money becomes your child's at the age of 18 or 21. So if they decide they're not into college and they want to go blow it all on hookers and cocaine, they can do that. The fourth pillar of paying for college is cash flow. What I'm talking about is your current earnings. And most physicians make enough money that they can take some of their ongoing earnings and use it to help pay for their Children's college. This is especially true if you had kids relatively early in life. For example, if you went through med school and residency with some kids, they're going to hit their college years not very far after the time you get out of training. You're probably not going to be financially independent at that time. And you might not have even had much time to save up much at all for their college. In fact, there are a number of parents who haven't paid off their student loans by the time their child starts college. But you as a physician should be able to cash flow at least a few thousand dollars a year from your current earnings toward their college expenses. One of the benefits of paying directly for college are some of the tax credits and deductions that are available to taxpayers. Unfortunately, most physicians get phased out of those. For example, the American Opportunity Tax credit, which is $2,500 per year, starts phasing out at an adjustable gross income of $90,000 a year, or $180,000 if you're married filing jointly. The Lifetime Learning credit, which is $2,000 per year, phases out at 65,000 or $130,000 if you're married. The tuition and fees deduction, which is $4,000 per year, phases out at an income of $80,000 single or $160,000 married. So many phys out of these. But if you're a relatively low earning physician, or you're part time or whatever, you may be able to take advantage of those as well. And that's one good reason to cash flow some of college. But I don't have a pillar to pay for your undergraduate education that involves debt. I think it's really unnecessary for anybody to borrow money to go to undergraduate school. If you do these other four things right, you shouldn't have to do that. In fact, you don't even have to have all four of these pillars to avoid debt. If you choose a relatively inexpensive school and you work hard in the summers and work hard at school, you can cash flow your way through university, certainly if your parent physician is helping you. So even if you haven't saved anything for college, it's still entirely possible to get through your undergraduate years without taking on debt. However, once you get into professional school, medical school, dental school, law school, I think it's probably not reasonable to say that you can do that debt free. You really are probably going to end up taking out at least a little bit of loans. Plus it's harder to work during professional school. I mean, medical schools. Maybe you can do some work during your fourth year. You can probably work pretty hard between your first and second year in that first summer, really the last summer of your life. Sometimes it feels like, but for the most part you're not going to work nearly as much as you can as an undergrad. So if a parent has some money left over in the 529 after college, if they can really help from their cash flow, I think that's great. But I don't think it's crazy to take out some loans for professional school. Just realize that there's a huge difference between coming out of med school owing $100,000 and coming out of med school owing $400,000. And the difference between those has a dramatic effect on how your student is going to be able to live for the next 10 or 15 years afterward. Alright, let's move on to a few questions I've gotten recently. Here's one that came in saying I was wondering if you have any insights on disability retirement insurance. I was offered a product that I'm lukewarm about, but figured it would be worthwhile looking into. Well, I looked into it using the link that the questioner sent me and it turned out it was a non cancelable guaranteed renewable individual disability income insurance policy that in the event of a disability paid benefits into an irrevocable trust where the funds are invested. Several investment options were available, including trust options and annuity and mutual funds. Well, here's the deal with these products. Whether they're a separate policy or whether they're a rider on your typical disability insurance policy, I'm just not a big fan of them. Bear in mind that it is important that you have enough of a disability benefit to continue to save for retirement. Most long term disability plans only pay until you're 65 or 67, so if you become disabled you need to have enough income not only to pay your living expenses, but also to continue to save for retirement. However, these riders and these trusts and other sorts of structures that they've built tend to be expensive and tend to be filled with kind of crummy investments. I think you're a lot better off just buying a bigger disability benefit such that you can continue to save for retirement in your preferred way. If you're living on disability insurance that is not usually taxable money, so you have very little taxable income and investing in a taxable account is perfectly reasonable. You're not going to pay. You may not pay any taxes at all on that money as it grows because you don't have any significant taxable income, bumping you up into the higher long term capital gains and qualified dividend brackets. And so I would not worry about the tax consequences if you're investing after disability, but I would worry enough to make sure you're getting a big enough benefit that you can continue to save for retirement. So rather than paying extra for a rider like this, I would just buy a bigger policy. If you can't buy a large enough policy to cover both your living expenses and your retirement savings, you're probably spending too much relative to your income. I mean, you can really buy pretty large disability insurance policies that should be able to provide a great deal of income to you. Also, bear in mind, if you're permanently disabled long term, a lot of your student loans go away as well, so that will save some of your income. The next question comes from someone who has a lot of faith in me says great site. You seem very knowledgeable and I was wondering about your thoughts on Federal Reserve policy over the last eight years and current stock market valuations. Are you at all concerned about a correction with price to earning ratios at record levels? Well, yes, I am concerned about a correction. In fact, I expect a correction. I expect a correction about once a year on average. In the past, that's how often we see a stock market correction, which is a 10% drop in the value of the stock market. Your investing plan needs to assume that you're going to see 30, 40, 50, 60 of these during your investing career. This should not be something you lie awake at night worrying about. It should be something you expect you it's going to happen. Likewise with the bear market, which is defined as a drop in 20% in the value of the stock market index. You're going to see one of those approximately every three years or so. Now granted, it's been a little while since we had one. We had a very brief one in 2011 and of course the big one in 2008, 2009. But you kind of get the sense that we're a little bit overdue for it. Many stock market valuations are higher than their average right now, but the problem is they can stay that way for quite a long time. What you don't know is you don't know whether this is spring 2008 or whether this is, you know, 1996 or 1997. Is this only going to run for a few more months or is it going to run for a few more years? It turns out that predicting the future is very difficult and my crystal ball is very cloudy. So While I agree that valuations are certainly higher than average, I don't let that affect my investing plan at all. I continue to do the same thing I've been doing for years where I invest money. When I have it, I and I invest it into a fixed asset allocation and rebalance appropriately. If there's a correction, I'll be able to buy a few more shares at a discount. If there's not a correction, I'll have more money. So it's good either way. And I suggest you develop an investing plan that not only assumes there will be corrections, but expects them. And so you know what you're going to do when it happens, because it's certainly going to happen. All right, our last question today is About HSA Bank HSAs or Health Savings plans. The writer says, I plan to buy an ETF for my TD Ameritrade associated with HSA Bank. My plan is to do this for several years and let it compound. At some point I will want to transfer some back to the HSA bank cash account so I can start spending cash on hospital expenses. My question is, when I sell off these ETFs at TD Ameritrade, is that going to be a taxable event? I know the whole purpose of an HSA is for an account to grow and not pay taxes like a 529. This HSA bank plus the TD Ameritrade combo seems funky as you have to sell off stock at TD Ameritrade to get it back to HSA Bank. Does the IRS view these two accounts as linked to an HSA so that selling off TD Ameritrade stock is not considered taxable? Well, good news for this questioner. Everything that happens inside an hsa, swapping from one investment to another or liquidating any particular investment is not a taxable account. The only thing that's taxable with regards to an HSA is if you pull the money out and spend it on something besides health care. As long as it stays inside the account, whether it is in the savings type account or whether it's in the investing type account, is not taxable. So the way HSA bank does this, and I know because this is where I hold my hsa, is you make your contribution to HSA bank and that money then goes into a savings account that pays a relatively low interest rate. And then you can transfer money from the savings account to an investing account at TD Ameritrade, all still underneath the HSA Bank HSA umbrella. And then you can invest the money in just about anything you like. They have a lot of Vanguard and other low cost index type mutual funds that you can invest in commission free or you can pay some commissions and buy anything you like. Then when you need the money to spend it on health care expenses you you can simply sell the ETF or sell the mutual fund at TD Ameritrade. Again, if it's one of their commission free ETFs, you can do it completely free and then you can transfer the money back into the savings account over at HSA bank. But none of those transfers are taxable events. A lot of people that spend as they go from their HSAs, they just keep a certain amount of cash over there at HSA bank to pay for their ongoing health expenses. But if you want to invest some of it for the long term, you can certainly do that by using the linked TD Ameritrade account. It's a good idea for you to do that relatively early in life and realize that it's really not that big of a deal to put ETF buy and sell orders into the computer that will allow you to not feel like Wall Street's this bizarre thing off in the distance that is so mysterious you can't quite figure out how the stock market works. It's really not that complicated to put it in a few buy and sell orders and once you do it once or twice, you'll feel very comfortable with it.

Getting quality disability and life insurance should be the first financial chore for a doctor to complete. Most docs don't have the ideal policy for their gender, specialty, state or health status, and one in seven doctors get disabled at some point during their career. Because these policies can only be purchased through brokers, we put together a list of vetted agents who are experienced with working with the specific needs of medical professionals and who have your best interest at heart. If you have questions about insurance and what kind of policies would be the best fit for you, check out our insurance recommended list@whitecoatinvestor.com insurance and feel the peace of mind that comes with knowing you have the optimal policy in place. You can do this and the White Code investor can help.

Thanks for listening today. Have a great day and we'll talk next time.