Student Loans As a Planning Tool

Higher education can accelerate and expand career opportunities. Paying for it requires planning. Over the past 15 years, the percentage of college graduates needing student loans has actually decreased – from 68% to 61% – but the dollar amount of that debt has continued to increase from an average of $21k in 2008 to $29k in 2023.[1] When we include factors such as loan payments being paused during the pandemic and recent political headlines about potential student loan forgiveness, the landscape becomes even more muddled.  

Planning ahead and saving for tuition payments is the optimal strategy. Yet, it’s important to note that student loans aren’t just for those with low incomes or who didn’t properly plan ahead, they can also be used as a tool to increase financial flexibility for parents, minimize long-term taxes, and support a more sustainable retirement.

The narrative of student loans is typically centered around high school students taking on more debt than they can afford for undergraduate degrees. This overlooks that student loans are often a core element of postgraduate education. Doctors, lawyers, and dentists have some of the highest rates of debt after graduation, and few would argue that it wasn’t worth it. Paying down that debt and building financial resiliency still requires careful planning after graduation.  

Even at the undergraduate level, student loans give children some “skin in the game” as they make one of the largest financial decisions of their early adult lives. In our experience, this strategy can open the door for a money conversation that parents might not have had a clear way to approach. When done with intentionality, giving your child visibility to the financial considerations of taking on a debt via student loans can be a tool that helps build awareness and acumen in the early stages of their financial journey.

Even when you have sufficient assets to cover the cost of college, it doesn’t automatically mean that now is the best time to use them. There are still timing considerations that can significantly impact both taxes and liquidity.  

Parents’ peak earning years often overlap with children’s college tuition years, which means that selling highly appreciated assets during this period can lead to higher taxes. Money saved in a 529 is not subject to these taxes when used for tuition costs, while other asset sales may have larger tax implications. If you can defer the sale of highly appreciated company stock, or an investment property, for a few years until retirement, the tax savings could be substantial. Similarly, if you are expecting a liquidity event in the future (stock vesting, future IPO, or sale of a business), you might have the funds on paper, but short-term liquidity is an issue.  

One strategy to consider in these scenarios is having your child take out student loans. This does not mean simply shifting the financial burden to your children, but rather providing an additional runway for the parents. Parents may choose to pay down the loans in a more digestible way for current cash flow, and in their retirement years or after a future liquidity event, they can be more aggressive with loan pay down assistance. 

Once you have additional income or liquidity, it can be difficult to know where to direct your dollars for the highest impact. If a particular loan has a significantly higher interest rate than the other, that’s a great place to start. Should you pay down student loans faster, make extra payments on other debt, or put it into your portfolio? If the rates are similar, another consideration is whether the interest is tax deductible. 

Student loan interest is deductible if your income remains below a certain threshold. Once you cross that threshold – currently $70k for individuals and $145k for married filing jointly – there is no benefit to continuing to pay that interest, so it might be a good idea to accelerate payments and eliminate that debt.  

In terms of investing funds into your portfolio, a good framework to consider is thinking about the interest rate on loans as a hurdle rate for your portfolio assets. If the interest rate on the debt is higher than what you expect to earn in your portfolio, it often makes sense to focus on paying down that debt. For debt with lower interest rates, especially when the rate is fixed for a long period of time, there is a higher likelihood of seeing growth by adding funds to a long-term investment portfolio. 

Taking on additional debt often feels uncomfortable, especially when college tuition rates cost as much as they do currently. At North Berkeley, our team works with clients to analyze the levers of their financial situation to create a balance between current cash flow, minimizing taxes, and maximizing both quality of life and flexibility in retirement. Additionally, we understand a quality education can dramatically improve the course of a young adult’s life and represents a great investment in their future.  

Creating a plan to navigate college costs that is tailored to your personal financial landscape can reduce the stress of this major transition for both parents and students. By destigmatizing student loans, we can evaluate when they are a helpful tool and how to best use them alongside other financial assets.

Resources: 
1. How Much Student Loan Debt Does the Average College Graduate Have? US News