Paying For College: Use Cash Flow Later

Eric’s Thoughts:

The average cost of college tuition at a public, 4-year, in-state school in 2018 was $9,980. That doesn’t include things like room and board, books and supplies, transportation, or other expenses. Including those items, one year of college will cost slightly more than $25,000.

Saving for college in advance is great – and absolutely should be done – but as I outlined in our previous post on paying for college, tuition inflation averages between 5% and 9% which makes savings important, but unlikely to cover the entirety of the education bill because your savings will likely not grow faster than the costs rise.

One concept that is worth exploring in addition to saving in advance, is developing strategies to boost your cash flow when your children reach high school graduation. I’ve already discussed strategies for on-demand cash flow in a previous post, and you may be able to apply some of those for college as well, but for the specific purpose of college planning, I’m going to outline some other ways to think about building cash flow strategies specific to college savings.

Build a Dividend-Generating Portfolio

As I’ve said before, I’m a big fan of dividends. One way you can leverage dividends to pay for college is to dual-purpose your investment strategy for both college savings and retirement. By selecting stocks, ETFs, Mutual Funds, etc, that pay dividends, you can build a portfolio that will spin off a decent amount of cash on an annual basis without having to sell the underlying holdings. This may allow you to use the cash dividends to pay for things like tuition, housing, food, etc, while retaining the holdings within your net worth and, when college is paid for, go back to re-investing the dividends in your portfolio.

An example of how this may work:

Let’s assume a 6% growth in value of your portfolio each year and a 3.3% dividend yield across your entire portfolio. You start your career (Year 1) with $0 saved in a brokerage account (note – for this to work, you can’t have the money in an IRA or 401k) and invest $5,000 per year. If you have children in Year 10 (say you are 31 years old) they will be attending college in Year 28 (assume they are 18). This hypothetical portfolio would generate about $18,000 per year in dividends when they enter college – and you wouldn’t have to sell your ~$540,000 in holdings to get this cash flow.

Granted, this $18,000 won’t pay the entire cost and it isn’t adjusted for inflation, but it would go a long way toward off-setting the total college bill. In combination with savings in advance and/or additional cash flow generating plans, you may be able to pay for the entirety of your children’s college.

Pre-Paying Your Mortgage

I’m a big fan of the traditional 30-Year Mortgage and making additional payments to principal. My wife and I are currently on-track to pay off our mortgage 17 years after closing because of our additional payments. Because of this plan, in Year 18, we will reduce our expenses significantly in that we won’t be paying our mortgage each month, nor will we be paying our additional payments towards the principal. The removal of this item from our monthly budget will free up approximately $2,200 in cash flow. On an annual basis, that will generate slightly more than $26,000 in cash flow that will be closely aligned with when our oldest child will be reaching college-age.

Like the dividend example, this isn’t adjusted for inflation – which will be a big factor given how quickly college costs are rising – but in combination with other levers and other savings, we should be able to provide the level of support to our children we hope to relative to college expenses.

Having Children Work During College

One additional way to generate cash during your child’s college years is to have them work a part time job while attending school. While this may not reduce the tuition or housing expenses (you, as a parent, may want to ensure those are covered regardless of employment status), it will help cut back on the amount of “petty cash” your child requests. Having them pitch in to cover entertainment, meals out, trips with friends, etc, will help teach them valuable financial lessons and also reduce the amount of money you need to plan for.

Many parents balk at the concept of having their children work during college with objections such as “being a student is their full-time job”, but both my wife and I worked while we were in school and never once did it interfere with our education. In fact, it had the opposite effect. I learned a lot while working various jobs during college and earned some money along the way – which helped my parents save money as well as set me up for success upon graduation.

Assuming your child can find a part-time job that pays $9/hour, they can generate nearly $5,000 per year working just 10 hours per week. Or, if they can handle up to 20 hours, that annual number becomes nearly $10,000. Either way, that amount isn’t going to cover tuition and housing – but it is likely to resolve the parents of certain bills, allowing the parents to focus the financial support on actual college-related expenses rather than ancillary expenses.

There is no silver bullet when it comes to paying for college. For most of us, it will be some combination of savings in advance with ESAs or 529s in addition to writing some checks to bridge the gap. For us, we hope to cover the majority of our children’s college expenses with 529s and fill the rest with the cash flow generated from not having a mortgage payment. I’m sure we’ll have to make adjustments and pivot our plan as college draws closer, but for now, we like our plan and feel good about helping our children receive a college education without the associated debt.

Patrick’s Thoughts:

I am a big proponent of finding ways to pay for school with cash flow generated during the years your children are attending college. Not only does this allow you to maintain investments you have made over the course of your career, but it forces you to make strategic decisions earlier on in life that set you up for success. My parents had the luxury to be in this situation when I was in college, and any money they had saved for college was allocated to other means.

Another important benefit of paying for college this way is that certain college investments, as described in our previous post, can only be used for a beneficiary’s college education. While I know no parent likes to think about it, there are people out there who won’t attend college. Do you want all your savings to be locked to a specific use case that you won’t be able to use, or be penalized for using it in a different way? By planning to generate additional cash flow in the future, you can set yourself up for success and have more options as your children reach college age.

I agree with the three points Eric makes above about how to purposefully plan to generate additional cash flow in the future. I ‘d like to outline a couple other options you can look to:

Invest in Rental Properties:

Like the dividend example above, this is one that gives you stake in an asset, and can generate additional monthly returns on top of that. Let’s say you were to invest in a rental property with a 20-year loan term. If you did this 2 years before the birth of your first child, the rental property would be paid off prior to your child attending college. Taking the average rental rate in the United States, this would equate to $1,412/month or $16,944/year in gross rents coming in.

Now rental properties don’t come without their share of expenses. You still have to account for taxes, insurance, maintenance costs and management fees. For the sake of simplicity, let’s assume those are $6,944 a year. That leaves you with a net benefit of $10,000 in cash flow. While this doesn’t account for any taxes you have to pay on income, this is cash flow that you are generating due your ability to plan ahead and invest. In most cases, if you buy the house right and manage it well, you will actually be generating net positive cash flow over the life of the loan term. This is money that can be invested in additional rentals.

Let’s say over the course of 20 years you were able to acquire several rental properties that sustained themselves. You’ll be in an even better position. You get all of this on top of the appreciation of the properties. Assume you purchased a $200,000 rental property. After 20 years with an average annual appreciation of 5%, you could have an asset that is worth over $500,000. The best part? You don’t even need to sell it because it’s generating cash every month.

Be Strategic With School Choices

While this isn’t necessarily a cash flow generator, it does contribute to positive net cash flow. When I first started looking at colleges, I spent a lot of time evaluating private schools because I thought it was important that I attend the best. As my parents started to evaluate the costs, it became clear that this may not be the best choice.

While I’m not encouraging you to sacrifice the quality of your child’s education, there are some things to keep in mind. The average cost of a public school for in-state students is approximately $9,410. For out of state students the same college costs $23,890 on average. That’s an annual savings of $14,480! If you live in a state that has good public education, this is a no brainer. You will also save on associated travel costs to and from and out-of-state school. While there is value in having your children experience a new state, there is also plenty of time in life to explore the world and live in new places after college.

As Eric ended his post above, there really is no one solution when it comes to paying for college. The one commonality between savings for college or utilizing cash flow later is that they both require advanced planning. It’s sometimes hard to think about something that is decades away, but if you don’t plan now, you’re going to regret it in the future and your children will pay the price for it. This is somewhere no parent wants to be.


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