Should you default on your student loans?

Lee Siegel, New York writer and recipient of three Ivy League degrees, was roundly castigated after he proudly explained  “Why I Defaulted on My Student Loans”.

Years later, I found myself confronted with a choice that too many people have had to and will have to face. I could give up what had become my vocation (in my case, being a writer) and take a job that I didn’t want in order to repay the huge debt I had accumulated in college and graduate school. Or I could take what I had been led to believe was both the morally and legally reprehensible step of defaulting on my student loans, which was the only way I could survive without wasting my life in a job that had nothing to do with my particular usefulness to society.

I chose life. That is to say, I defaulted on my student loans.

As difficult as it has been, I’ve never looked back. The millions of young people today, who collectively owe over $1 trillion in loans, may want to consider my example.

Besides generating revulsion at Siegel’s oozing sense of entitlement, his column stirred criticism of the New York Times for “dispatching criminally negligent financial advice”.

Ron Leiber pointed out the flaws in Seigel’s explanation of how to circumvent the negative repercussions from a student loan default.

First, he tells people to get as many credit cards as they can before they stop repaying their student loans. This way, presumably, you will have plenty of credit available once your credit report is ruined and you can’t get new cards. But card issuers are constantly checking the credit of existing cardholders to look for distress signals. If they see any, they may lower your limits or close your accounts….

The second piece of advice Mr. Siegel has for aspiring defaulters is to establish a good history of paying rent. This can work, as long as you rent from a landlord who never checks your credit or a new one who relies on your old landlord’s good word.

But many landlords do check and won’t be sympathetic, especially in tight markets. Besides, plenty of people don’t want to be tenants forever, given how hard it can be to find rentals in some good school districts. Others want to plant roots and build home equity.

Will those defaulters be able to qualify for a mortgage? A judgment resulting from a default may stay on your credit report for up to 10 years….

Bank of America, one of the biggest home lenders, did not comment on whether people with defaults on their credit record would be able to get mortgages, and a Wells Fargo spokeswoman declined to categorically rule out the possibility that someone could qualify for a loan within the tarnished-credit window.

But Richard M. Bettencourt Jr., the secretary of the National Association of Mortgage Brokers and a lender himself with a company called Mortgage Network in Danvers, Mass., said he had never seen people with student loan defaults on their credit records get a mortgage….

Which brings us to Mr. Siegel’s third piece of advice: Marry well, or at least have a creditworthy partner. Then, that person can be the sole mortgage applicant. Mr. Siegel’s wife bought the home where they live, according to public records.

There are a number of problems with this approach. Some lenders may not allow it, since certain low down-payment loans in community property states require both spouses to apply, according to Wells Fargo. Of course, you’ll need to talk someone into coupling up with you in the first place, after explaining that you’re not so big on financial obligations but that you really, truly intend to honor marital ones.

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Lee Siegel, “Why I Defaulted on My Student Loans”, New York Times, June 6, 2015.

Ron Lieber, “Taking On Student Debt, and Refusing to Pay”, New York Times, June 15, 2015.

Why college graduates should prioritize retirement planning

Graduating college? It is time to think about retirement.

That’s not necessarily the advice millennials expect to hear, but it makes sense when you consider the power of compounding.

Saving “$5,000 per year only from ages 25 to 35 (10 years)” will generate a larger retirement nest egg than saving “$5,000 per year, but from ages 35 to 65 (30 years)”

Your income-earning ability is your “human capital”.  Planning for retirement requires that you find a way to replace income generated by human capital with that generated by your investments.

… Your overriding financial goal: Every year, put aside 12% to 15% of your earnings for retirement, so by your 60s you no longer need the income generated by your human capital.

While 15% may sound like a lot, definitely do it if you can.  In any case, start saving at least a small percentage and then try to increase it every year.

Of course, this advice is only applicable to college graduates who have well-paying jobs.  So the first step in retirement planning is to find a job.  I know, that’s easier said than done in many cases.

While I used to oppose the idea of college graduates living at home, I’ve come to believe it can be a way to enable new college graduates to save money and start putting aside money for retirement at an earlier age.  This is especially true in high COL areas where renting an apartment can cost well over half your income.

To learn more on this topic, read Jonathan Clements’ “Financial Advice for New College Grads”.

Life insurance is usually not a good choice for college savings

Sometimes life insurance is marketed as a college savings vehicle, primarily based on the fact that it is “typically not counted in the formula used to determine financial aid eligibility”.  But it’s usually better to avoid it since it is a relative high-cost option, and withdrawals to pay for college can be problematic.

“First, parents will have to pay income tax on the difference amount if they withdraw more money than the premium they paid, as well as a potential 10 percent penalty if they are under age 59 1/2,” says Joyce Garner, an insurance broker with Zimmerman & Ray Associates in Roseville, California.

Lessard says that there are also issues if parents decide to take a loan against their policy, as opposed to a straight withdrawal, as policy loans charge interest and require a payback schedule. There’s also the fact that, if a parent takes a large sum of cash from the policy and still needs the death benefit, the policy may lapse from the lack of cash.

It’s usually better to stick with 529 plans or other savings options that lend themselves to the logistics of making withdrawals over the time a student is attending college.

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Andrea Williams, “3 Reasons to Avoid Life Insurance Policies for College Savings”, U.S. News & World Report, April 3, 2015.

It’s hard to make students understand the severity of college debt

The New York Times ran an article in which student loan borrowers explained what they wish they had known before taking on debt.

Federal law makes debt counseling mandatory for first-time borrowers,  but “because the topic is dense and the department’s content is devoid of anecdotes, it’s tough to make the lessons stick”.  Most colleges use the Department of Education’s online counseling module, which apparently most students find difficult to navigate and comprehend.  What type of counseling would work to make students clearly realize what they were getting themselves into before it was too late?

The ideas from the article seem helpful, but some of them, like requiring a course during the first year of college, are only applicable after the money has been borrowed.  Plus that recommendation seems to be overkill and costly.

A TG report, “A Time to Every Purpose“, gives some other suggestions for colleges, including these:

• Delivering supplemental counseling, ideally in a face-to-face setting, in order to help answer questions
• Providing sample budget sheets using local cost-of-living expenses

Ultimately, it is the student’s responsibility to take the time to fully understand the implications of college debt.  Maybe students who borrow should have to pass a pre-entrance exam that covers practical knowledge about how loans will affect their personal financial situation.

Related:  “College students are ignorant about how student loans work”

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Ron Leiber, “Student Loan Facts They Wish They Had Known”, New York Times, May 1, 2015.

Should the rich pay more taxes?

Top 20% of Earners Pay 84% of Income Tax

When people claim that the rich don’t pay their fair share of taxes, do they believe that top earners should pay 90% or more of taxes?

The bottom 40% of earners pay no taxes, and actually pay negative income taxes through government transfer payments.

Why is the share of income taxes negative for 40% of Americans? In recent decades Congress has chosen to funnel important benefits for lower-income earners through the income tax rather than other channels. Some of these benefits, such as the Earned Income Tax Credit and the American Opportunity Credit for education, make cash payments to people who don’t owe income tax.

The top 1% of earners pay “nearly half the income tax”.

The average tax rate for those earning more than $1 million is 27.4%.

Professor Mark Perry says we should “thank top 20% for shouldering 84% of the income tax burden”.  So are the top earners villains or heroes?

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Laura Saunders, “Top 20% of Earners Pay 84% of Income Tax”, Wall Street Journal, April 10, 2015.

You could lose your tax refund if you have a past-due student loan

Say good-bye to your tax refund if you have past-due student loans.

In most cases, creditors are unable to touch tax refunds. Not so with student loans.

While credit card companies and other private debt collectors are barred from garnishing money coming to taxpayers from Uncle Sam, some federal and state creditors can help themselves to tax refunds via a process known as ‘offsetting.’ Under the Treasury Offset Program, these entities get a whack at your tax refund if you have an outstanding debt in certain categories, including:

• past-due child support payments
• back taxes
• any unemployment compensation owed to the state
• past-due student loans

This is another reason to pay your student loans on time, or better yet, make sure you only take on as much debt as you can afford to pay back.

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Aron Macarow, “You Can Lose Your Tax Refund if You Have Student Loans”, Attn:, March 21, 2015.

A college financial planning timeline

Don’t wait until your child’s senior year of high school to begin planning how to pay for college.  The first 18 years go quickly, and it’s never too soon to begin preparing.

Here’s one simplified approach showing some important steps along the timeline to college, with a focus on the financial planning aspect of the process.

 

Before High School

Start saving for college ASAP:  This is the relatively uncomplicated part.  Although we can’t predict the costs of college over a child’s lifetime, it almost always makes sense to begin saving early on.  Even if MOOCs or other innovations make higher education more affordable in the future, there’s usually not much of a risk in saving too much since there are options for dealing with “left-over money in your 529 plan”.

Before Junior Year of High School

• NMS potential:  If your child tends to score in the 95%ile of standardized tests, he may have a shot at earning a National Merit Scholarship.  A little test prep can make the difference in qualifying for significant merit financial aid.
• Base Income Year (BIY): If there is a chance your family may qualify for need-based financial aid, you should explore ways to minimize income during the BIY, the 12-month period that begins January 1 during your child’s junior year.  Since the BIY is used as a snapshot for determining financial need, you may want to consider strategies such as not selling stocks or property that will create large capital gains, refrain from converting to a Roth IRA, or defer bonus or other income.

Junior Year of High School

• Create list of schools:  Get serious and make a realistic list that includes academic and financial safeties.
• Can we afford it? 1-2-3:  Determine affordability by using the 1-2-3 Method or something similar.

Senior Year of High School

Senior year is the busiest time for families as they handle the many details of the college application process, including final determination of how they will be paying.  Some important acronyms:

The two main forms used in determining financial aid eligibility are the FAFSA and PROFILE.
FAFSA is the acronym for Free Application for Federal Financial Aid. It is a form submitted to the government that collects the financial information needed to decide your eligibility for federal FA. It’s also used by many colleges to determine institutional aid.
PROFILE is a financial aid application service offered by the College Board, used by about 400 colleges to learn if students qualify for non-federal student aid. There is a fee to submit a PROFILE, whereby the FAFSA is free.

The SAR (Student Aid Report) is a summary of your FAFSA responses and provides “some basic information about your eligibility for federal student aid”.

It’s important to get started.

While this outline only hits the highlights along the road to paying for college, it can be used as a springboard for further research and action.  It makes sense to start with an outline, and then fill in the details as you go along.

Most booster clubs don’t qualify for tax-deductible contributions

Most school booster clubs are not compliant with IRS regulations, potentially affecting parents and other donors who deduct contributions on their tax returns.

There are an estimated 100,000+ school, sports, band, and other booster clubs currently in existence in the United States …. Surprisingly, however, estimates indicate that less than 10% of these clubs are compliant with Internal Revenue Service Code regulations. Along with failure to register with the IRS, violation of the “inurement” prohibition under IRS Code Section 501(c)(3) is one of the most prevalent issues presently challenging local booster clubs.

This problem came to light at a local high school, where concerned parents hired a private investigator to look into their athletic booster club.

Run by parents and athletic officials in the Mount Pleasant school district, the booster club has been soliciting tax-deductible contributions for years after it was stripped of its federal tax-exempt status. In fact, the club has not filed an annual financial report with the IRS since 2009.

Contributors may face trouble with the IRS.

“I thought I was giving money to a tax-deductible charity,” said parent Mike Nicosia. “I was claiming it on my taxes. Everybody who did that, I would assume, now has to worry about an audit or a liability as far as interest and penalties.”

Even if the clubs don’t explicitly promote themselves as 501(c)3 nonprofits, many donors make that assumption.

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Jorge Fitz-Gibbon, “Westlake boosters under fire over tax-exempt status”, lohud.com, March 1, 2015.

Better math skills lead to better personal financial behavior

A new study suggests that children need to learn more math, not finance, to be better with money.

The way our schools teach students about personal financial planning may be misguided.

For decades, studies have extolled the benefits of financial education, pointing out that students who take finance classes score well on tests of financial knowledge—and higher financial literacy leads to better financial behavior.

Conclusions like these have led to a growing consensus that schools should teach children about managing their finances, with 43 states now mandating some kind of training.

Shawn Cole found this troubling. Not because the studies aren’t true: Many, he says, do show a correlation between financial education and good financial behavior. But few studies demonstrated a strong causal link.

Mandated financial education did not lead to improved personal financial outcomes.

So, the professor of finance at Harvard Business School wondered, if widespread financial education were really effective, why are so many young people struggling with debt, foreclosure and low asset accumulation? He and a group of researchers set out to find an answer. They looked at the states that mandated personal-finance curriculums in high school, and compared the financial health of students who graduated before the mandates to those who graduated after. Their hypothesis: If personal-finance education worked, the students who graduated after the programs were implemented would be better off financially.

They weren’t. After controlling for state, age, race, time and sex, and analyzing a huge pool of historical financial data, the group found that there was no statistically significant difference between people who graduated within a 15-year span either before or after the personal-finance programs were implemented. Graduates’ asset accumulation and credit management were the same, with or without mandated financial education.

But better math skills lead to better personal financial outcomes.

But the study, issued last year and currently under revision for publication, did find one school subject that does have an impact on students’ financial outcomes: math. Students required by states to take additional math courses practiced better credit management than other students, had a greater percentage of investment income as part of their total income, reported $3,000 higher home equity and were better able to avoid both home foreclosure and credit-card delinquency.

Well, this seems obvious.

“A lot of decisions in finance are just easier if you’re more comfortable with numbers and making numeric comparisons,” says Mr. Cole.

The lesson here is to focus more on better math instruction.

A new magazine from Jean Chatzky wants to teach children financial lessons.

Last month, Ms. Chatzky and Time for Kids, a division of Time Inc., introduced a magazine intended to teach financial literacy to fourth, fifth and sixth graders. The PwC Charitable Foundation, which was started by the giant financial consulting firm PwC, is backing the publication.

“Kids are very interested in money,” Ms. Chatzky said. “What we’re trying to get across to them is money is a tool that they need to know how to manage to succeed in life.”

… Each four-page issue will cover an aspect of finance, like budgeting, investing and taxes.

Perhaps this new magazine should include a section on math instruction.

Related:  ‘math skills are correlated to higher earnings’

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Charlie Wells, “The Smart Way to Teach Children About Money”, Wall Street Journal, February 2, 2015.

Sydney Emberfeb, “New Magazine Teaches Children Financial Lessons”, New York Times, February 1, 2015.

The ‘deadweight loss of Christmas’

If you’re still trying to find last-minute Christmas gifts, maybe you should relax and consider that there is a sound economic reason to give cash.  Gift-giving creates what economist Joel Waldfogel called the “deadweight loss of Christmas”, which is the monetary loss that arises from people making bad gift choices for other people.

In a 1993 American Economic Review article “The Deadweight Loss of Christmas,” Yale economist Joel Waldfogel concluded that holiday gift-giving destroys a significant portion of the retail value of the gifts given. Reason? The best outcome that gift-givers can achieve is to duplicate the choices that the gift-recipient would have made on his or her own with the cash-equivalent of the gift. In reality, it’s highly certain that many gifts given will not perfectly match the recipient’s own preferences. In those cases, the recipient will be worse off with the sub-optimal gift selected by the gift-giver than if the recipient was given cash and allowed to choose his or her own gift. Because many Christmas gifts are mismatched with the preferences of the recipients, Waldfogel concludes that holiday gift-giving generates a significant economic “deadweight loss” of between one-tenth and one-third of the retail value of the gifts purchased.

Gift cards may be cutting into the deadweight loss.

The real drag on the economy then isn’t gifts; it’s bad gifts. And Mr. Waldfogel cheers the rise of the gift card as a substitute for the bad gift: Something you can buy your niece or grandson when you have no idea what they actually like.

“What’s interesting about gift cards is that they are a lot like cash but have emerged as a way to give the choice to the recipient without the ickiness of cash,” he says. In other words, the deadweight loss problem he identified in 1993 may be on the wane because of a technological advance.

On the other hand, it is estimated that between 10 to 30 percent of gift cards are never used.

What’s not mentioned is the pleasure experienced from giving and receiving presents.  It’s hard to put a price on that, and we should remember that it’s the thought that counts!

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Mark J. Perry, “Holiday shopping? Consider the most economically efficient gift of all: cash, and avoid the deadweight loss of Christmas”, Carpe Diem, December 17, 2014.

Josh Barro, “An Economist Goes Christmas Shopping”, New York Times, December 19, 2014.
DEC. 19, 2014.