Losing Retirement by Degrees
February 10, 2006

Exam Time Close your books and take out a pencil and a sheet of paper for a one-question multiple-choice exam:

A college degree is:

     A) A key to financial success
     B) A retirement risk factor for the graduate
     C) A retirement risk factor for the graduate's parents
     D) All of the above

OK, it's a trick question. The correct answer should be "A" -- and hopefully that's true for you and your family. But the sad reality is that "D" gets you an "A" on this exam.

Does a degree lead to a fatter paycheck? You bet! College Board's 2005 update to their Education Pays report shows high school graduates averaging $30,800 per year, college grads $49,900, and professional degree holders $95,700.

However, the flip side of these numbers is the soaring cost of college -- a rate of increase that far exceeds inflation. Educational expenses are now so high that unwise decisions about funding them can have a devastating impact on retirement savings for the degree seeker, the parents, or both. The data for the 2004-2005 academic year shows the level of pain for the recent past.

2004-2005 Academic Year

Tuition Only

Total Cost with
Room & Board

Public

$5,132

$11,354

Private

$20,082

$27,516
Data from www.collegeboard.com

For aging baby boomers, funding college was relatively easy. Tuition costs kept pace with normal inflationary pressures. Moreover, at the height of the Cold War with the Soviets winning the race to space, Uncle Sam retaliated with the National Defense Education Act (NDEA), which provided massive aid to education at all levels, public and private. Scholarships, fellowships, and low-cost loans abounded. A reasonably bright student willing to hit the books could cover the total cost of a degree or two with scholarships, work-studies programs, and summer jobs.

Fast-forward to the 21st Century and observe the change. College costs have been growing faster than inflation for many years, and federal support for higher education is a shadow of its former self. Financial aid in the form of grants and scholarships remain a possibility for students of today. But for most families the cost of a degree means some combination of years of disciplined saving or major long-term debt.

Baby's $300,000 college education
What will a bachelor's degree cost for today's infant, 3rd grader, junior high student, or senior? We can use "time value of money" calculations based on the 2004-2005 numbers to make an educated guess. Inflation has averaged about 4% over the past 50 years, but college expenses have risen at a higher rate. So let's bump the historic inflation rate up a full percentage point for our growth estimates.

Estimated Cost of 4 Years in College (with 5% annual growth)

Starting year . . .

2007

2012

2018

2023

Public

$56,651

$72,302

$96,892

$123,662

Private

$137,291

$175,222

$234,815

$299,690

Cost Difference

$80,640

$102,920

$137,923

$176,028

So, for that little bundle of joy who starts college in 2023, a bachelor's degree from a public school will cost about $124,000, while the same diploma with a private logo will run about $300,000. Now I don't mean to heighten the basketball season rivalry between the Duke Blue Devils (my graduate alma mater) and the UNC Tar Heels (where we sent the kids) with a debate over the value of a degree. But, seriously, how do these escalating costs get funded, and at what sacrifice? The costs are frightening enough for parents with a single child; they're downright mortifying for larger families.

The vision and the reality
In a perfect world every infant would have of an Educational Savings Account (ESA) or a 529 plan jointly funded by parents and doting grandparents. The reality is that most young adults starting families are too strapped with debt to think much about college savings. Likewise, grandparents typically have to give priority to catch-up retirement contributions.

In the absence of savings, debt is the only alternative for paying college expenses that can't be covered by grants and scholarships. Unfortunately those debts are often incurred by students with no clue about the long-term financial implications of their decisions. A case in point is a friend in his early 30s with two children, mortgage and car payments, no IRA and a $75,000 college loan debt. As a teenager he convinced himself that an out-of-state college in the Midwest was the perfect place to major in psychology. He now deeply regrets (and pays dearly for) ignoring the excellent public colleges in his home state.

Speaking of whopping loans, I'm reminded of my doctor's grim humor on my last visit:

"Hi Doug," he asked, "what brings you in?"

"I just stopped in to help you pay for that fancy diploma," I jest, nodding to his framed MD degree.

"In that case," he sighed, "you'd better have cancer!"
Paying attention to costs
As we've seen, the difference between public and private school tuition is substantial. A similar difference also exists for tuition at in-state and out-of-state public schools. For students from high net-worth families and National Merit Scholarship winners, if a private or out-of-state public institution seems like the right match, go for it! Otherwise, families should think long and hard about the true benefit of that excess expenditure. Are the academic needs so special that only private and out-of-state public institutions can meet them? Or is status a primary driver in school selection? It's true that the reputations of a few upscale schools have an intangible "good will value" that may help in the job hunt. Even so, is that prestige trademark worth a $5.9 million lifetime earnings advantage over the student from State U?

"$5.9 million!" you exclaim, "How do you figure that?" Easy, take the $80,640 private-school cost difference estimated for a high-school senior and calculate the growth at 10% for 45 years (retirement age minus age at graduation). OK, let's tone down the drama by adjusting that amount to today's dollars, assuming 4% inflation. Still, that's a cool $1.1 million. Not a bad retirement nest egg!

Dos and don't for funding college

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Doug Short writes from experience about colleges and universities. After 15 years as a professor, he spent 12 years as a Higher Ed consultant for IBM, during which time he visited hundreds of campuses across the country -- public and private. He hopes one day to have the opportunity to fund college for a grandchild (hint, hint).

Footnote: A couple years after this article appeared, Doug and his wife finally became grandparents. As soon as little Caroline Elizabeth was issued her new Social Security number, they opened a 529 account with a lump-sum gift that should cover her future college expenses.

This article was originally published on the Motley Fool website. Click here to view.