The FIRE community is filled with astounding success stories based on the 4% withdrawal rate. Think of a childless hipster hitting $1M, and exchanging their work badge for $40K of fixed living expenses for life.
A fine plan for the hipster. But if you have children like me, you might be in for a nasty surprise: the exorbitant cost of college.
Simply put, college costs a sh*tload. If you are planning to help your child, factoring in college costs might disrupt your early retirement plans.
But fret not. Secret Life of FI has you covered. With careful planning, you can reduce the sticker price of college. In this post, I’ll focus on the cost of college and key decisions that impact potential aid.
In Part 2, I follow up by comparing specific scenarios, using my own finances, that forecast the amount of expected aid at various early retirement setups.
Part I contents:
Estimated college costs
College costs vary widely by state. But a good average for a 4 year state university is ~$30K a year. How much of that will a college expect an early retired parent to pay? The answer can vary widely.
On one end, your early retirement lifestyle might allow a $20K sticker price reduction a year. On the other extreme, however, you could end up being on the hook for all $30K.
If you have two children like me, that could mean an additional $60K a year. Double that if they go to a private college (there goes your stealth wealth cover too).
Who pays full sticker price?
Statistics suggest about 1 out of 4 families are charged full sticker price at state universities. It’s easy but incorrect to assume this 25% is all mass affluent.
First, the mass affluent are more likely to send their kids to private college which aren’t included in this metric. That means that the 1 of 4 families who pay full sticker price are mostly middle class.
Second, even if the affluent send kids to state schools, they can still secure aid. Shielding wealth from government is a practice as old as time – rules written for the rich by the rich.
Third, consider the marriage penalty. While marriage comes with certain tax benefits, that goes out the window for college funding. Standard tax deductions and credits count on taxes but not on the FAFSA. If you have 2 parents with full-time incomes, even lower class incomes, you will likely qualify for 0 aid.
College value vs debt
Even if you do secure aid, it’s unlikely to cover the full cost, leaving students (or parents) to make up the difference. The majority use loans, pushing crippling debt on the parent, the child, or both.
And for what gain? Research suggests that outside of a few sexy BS degrees (computer science and engineering for example), most college degrees now have a negative ROI.
Take a look at the graphic below. A scant few degrees dominate the higher income side of the graph. Hundreds of degrees populate the mid to lower income bars, barely tracking with a median US salary.
While the average college grad’s lifetime earnings may still outrank the high school grad, studies suggest the ROI may still be negative due to financial loss (1) from not working 4 adult years and (2) compounding interest of student debt.
I am all for paying full sticker price, when the purchase is value for value. But the full sticker price of college is not worth it. In fact, its spiraling out of control in the US, and is now second only to mortgage debt.
How early retirees can secure aid
Fortunately, with careful planning, early retirees have a great opportunity to reduce the cost of college.
At a basic level, financial aid is determined by non-retirement assets and income alone, two figures that an early retiree has a certain measure of control over. For early retirees, your ability to tap aid will come down to 3 key decisions: retirement timing, mortgage debt, and throttling your income.
Let’s dive into the optimal decision to make for each.
1) Retirement timing
The one is simple. Be fully retired and no longer receiving an income by January 1 of your child’s sophomore year (spring semester) in high school. The FAFSA uses “prior prior year” tax returns to determine aid. Nothing will determine aid, especially federal, more than your decision to be retired by this specific tax year.
2) Pay off your mortgage
FIRE often recommends you keep a low APR mortgage, to keep money invested in the stock market. Makes perfect sense, until the tax years counted on the FAFSA come knocking. That additional $25K you had to withdraw for your mortgage payments is income and it will likely disqualify you from aid.
If you want to reduce the sticker price of college, pay off your mortgage before you retire. This has two benefits:
- It dramatically reduces your living expenses
- It will also drain your countable non-retirement assets, as home equity is not scored on the FAFSA.
3) Throttling your income
You can pursue several options to restrict your reportable income. This doesn’t necessarily mean eliminating expenses, but it does mean careful planning. Here are the sources of income considered on the FAFSA that FIRE adherents should plan to throttle:
- Reduce Brokerage income. Your income might be too high if your brokerage is large or heavily tilted toward high dividend stocks, bonds, or REITs. Try shifting to other mutual funds, like a total stock market index or even a no-dividend fund like Berkshire Hathaway. This will reduce your dividend income, and you will only realize gains when you choose to, rather than when the fund auto pays its quarterly dividend.
- Side income. Side investments/hustles and rental income are included in the FAFSA. If you have a rental you’ve been toying with dumping, now is the time. Assets account for far less than regular income on the FAFSA.
- Defer Roth conversions. One of FIRE’s top 3 teachings is probably that early retirees should convert IRAs to Roth to reduce future taxes and RMDs. But even if its tax free due to the standard deduction (link), the conversion is still income to the FAFSA. Therefore Roth conversions, which have nothing to do with college, will eliminate you from college aid consideration. Plan ahead and defer doing this for 4 years.
Other hacks to maintain college aid
While the parlay of your mortgage, assets, and income will be the biggest determiner of college aid, an early retiree can supplement with other options.
Here are other ways to fund college that won’t increase the Expected Family Contribution formula reported on the FAFSA.
1) Work study jobs
If my children roll burritos at Chipotle, their income will reduce benefits. But if they work at the university book store, it won’t. If you are able to snag aid, this is a no brainer: take the work study job instead, even if it pays less.
2) Borrow from grandparents
The child or the parent can borrow from grandma to cover various expenses. You can even pay it back with interest, and its well worth if it means maintaining a federal pell grant. Just make sure to spend it rather than pile it in the bank where it gets counted as an asset.
3) Subsidized Stafford Loans
Your student will be eligible for up $5500 a year in subsidized student loans. Interest is deferred until 6 months after graduation. Its like a 0% APR credit card good for four and half years.
Its a no brainer. Take it. $22,000 over 4 years you don’t withdraw not only keeps your income lower (and your aid higher), that money left in your brokerage will get compounding interest. After graduation, you can choose to pay it off, and you may be $6-$8K richer in market return.
4) Cash
Cash is king, right? If you are early retired, its especially king on the FAFSA. Whether its in the bank (where it counts as an asset) or under the sink (where its unreported), its still superior to being on a W-2 or 1099 form as income where it will erode benefits.
It may be worth withdrawing ~$30K per kid or so out of your brokerage prior to the first tax year counted against the FAFSA. Take it half in cash and use it for your kid’s living expenses for the next few years and maybe park the rest in a savings account for misc. non-tuition items.
You will give up opportunity costs in the market, but compare that paltry loss to losing a $7395 pell grant per year, per child, and you will see good old fashioned cash can make a lot of sense.
5) Supercharge 529 plans
The intricacies of a 529 education savings plan are beyond the scope of this article. But one feature makes them hugely advantageous for the early retiree: withdrawals are both (1) tax free and (2) exempt from the FAFSA as reportable income.
Let’s say you plan to live off $40K a year (of which you estimate $25K counts as capital gains income) and want to contribute an additional $8,000 a year to room and board for your student while she is in college. If the $8,000 comes from a 529 distribution, it will not count as “income” on the FAFSA, keeping your income levels from rising.
The best solution then is to supercharge the 529 before you retire, by transferring out of your brokerage (or any other investments you hold) to the 529, forever locking in its withdrawals (and gain) as exempt income.
6) Use HSAs for college
HSAs are brilliant tripled tax advantages accounts that most FIRE families are juiced about. What do they have to do with college? Nothing intentional, but they can be everything . . . if you plan years in advance.
Neither assets nor distributions from an HSA count on the FAFSA. In that regards, they are even better than 529s. But how do you tap the money to pay for college? Its actually quite simple: you can submit for a distribution whenever you want, even years in the future, for expenses incurred in the past. Here is a simple primer.
Basically, keep receipt for dental work, glasses, emergency room visits, etc. Wait until your kid is in college, then submit for reimbursement, and viola! Instant tax free funds blind to the FAFSA.
7) Take out a HELOC
If else fails and you still need to withdraw some funds to support your children’s college, you can always take out HELOC or home equity loan. Sure you’ll pay a little interest for the short period of time you carry it, but the payoff is it will provide funding that is not not counted as income and is therefore exempt.
An early retiree undoubtedly will have hundreds of thousands of dollars of equity built up in their home, so short term borrowing here is a small tradeoff for maintaining college aid with a low “paper” income.
8) Fund the last 2 years of college penalty free
This FAFSA “year prior prior” format is a pain on the front but a god send on the back end. This means, that all of your tax years counted for aid are expired by the time your child is a college sophomore in the spring semester.
At that point, for the next 2 and half years, you can take as much capital gains and earn as much income as you want, with no impact to aid. Plan your cash flow ahead to ensure you keep a low income but can still afford to support your student for the first one and half years of college; after that fund it however you want.
That wraps up Part 1. It’s a lot to take in for an early retiree planning college funds for their children. How can all of these factors and decisions be applied to determine whether or not your early retirement plans will disqualify you from aid?
I’ll cover this in Part 2, where I’ll dive into my own personal financial situation, and I’ll run several simulations that demonstrate how much aid you can expect with specific income/asset figures.