Losing Retirement by Degrees

Pop quiz! 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! The 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 quantifies the level of pain for the recent past.

For aging baby boomers, funding college was much easier. Tuition costs kept pace with normal inflationary pressures. Moreover, at the height of the Cold War, with the Soviets winning the space race, 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 their degrees with scholarships, fellowships, work-study 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 via grants and scholarships remains a possibility for students of today. But for most families, the cost of a degree means either 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, third-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)

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. 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 an Educational Savings Account (ESA) or a 529 plan jointly funded by parents and doting grandparents. But 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. I've got 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?"

"Well, I stopped in to help you pay for that fancy diploma," I jested, nodding to his framed M.D. 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 "goodwill value" that may help in the job hunt. Even so, is that prestige trademark worth a $5.8 million lifetime earnings advantage over the student from State U?

Yes, I said $5.8 million. Take the $80,640 difference between the cost of private and public college for a high school senior. Then calculate its growth at 10% for 45 years (the time between that student's age at college graduation, and the beginning of retirement age). The result: Slightly more than $5.8 million.

We can 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!

Do's and don'ts for funding college

• Prioritize your own retirement funding ahead of your child's college expenses. As Robert Brokamp, editor of the Motley Fool Rule Your Retirement newsletter puts it, "If you don't have enough to cover tuition, your student can apply for financial aid and borrow money. However, there are no scholarships or loans for retirees. If you haven't saved enough to retire, then you can't."
  
  
• If you're fully funding your own retirement savings, consider opening Education Savings Accounts (ESA) or 529 Plans for your children. Visit the Motley Fool College Savings web page for more details.
  
  
• If there are grandparents in the picture with solid retirement plans, consider asking them to help out. High net-worth grandparents with an estate plan might consider putting some of their bequest into an annual gift toward college for their cherished heir.
  
  
• If college costs are a sensitive issue in your household, explore the possibility of a two-year college for a low-cost jump start on earning that degree.
  
  
• Most important of all, help your children make sensible decisions about college. Educational loans make it easy to rack up debts that could undermine financial stability for decades. Don't let BMW convertible tastes overwhelm a Honda Civic budget.

If you need help in prioritizing your financial goals to make sure nothing comes between you and your golden years, try out the Rule Your Retirement newsletter for 30 days.

Fool contributor 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).