Teaching Finances to Your Future College Student
By Joe Messinger, CFP®
September 10, 2021
Updated September 2021.
Teaching finances to students is something we feel passionately about. In the State of Ohio, the legislature has gone back and forth about how to teach budgeting and financial concepts to students. They have left it to the local school districts to incorporate learning standards as they see fit, whether as a stand-alone course or more often as part of another course like economics. The results have been hit or miss.
As parents, teaching finances can fall to us, and the topics can include:
- Credit cards
- Bank accounts
Let’s look back to our childhoods.
Did you have an allowance when you were a kid? Maybe some change or a few dollars if you did your chores? Were you the kid who spent your allowance right away or did you save all your pennies toward some big goal? Some of those habits may have followed you to your adulthood. But now as the parent of a college-bound teenager, you and your teen are making plans and starting to think about life beyond college.
Teens have never paid taxes, insurance, or had to repay a loan. The school of hard knocks is not how you want your child to learn personal finance. Teens need to understand budgeting and how the decisions they make now could have a huge impact on their future quality of life. We have some tools and ideas that can help.
When teaching finances, begin with the end in mind.
Your future self will thank you. Even before setting foot on a single campus, a family needs to sit down and talk finances. Establishing a budget for college is critical. Following our 3-step process to graduate with less debt and using our free College Money Report™ can be your guide to determining how much college you can afford–to include a reasonable student loan amount. This free report helps to compare the cost of your student’s top 3 colleges and understand what they’ll expect you to contribute as a family.
Thinking about what your student’s post-graduation financial picture will look like is also an extremely important part of choosing a college. By looking at the post-graduation picture, you can back into how much college you can afford. Your student will not really have an accurate conception of postgraduate finances without an exercise like this, and we have a simple worksheet you can use.
Before you get started, be aware of these key components for the discussion:
- What target career is your student thinking about?
- With that target career in mind, what is the average starting annual salary? (You can find that information at Salary.com or Glassdoor.com.)
- How much money will you need to take out in student loans?
Please note our example today is intentionally basic. We always tell families to never rule a school out based on sticker price. It is all about your “NET COST” to attend college. The out-of-pocket amount of money families will be expected to pay, even at the same college, will vary greatly based on their eligibility for both need-based and merit-based financial aid.
For this worksheet today, let’s use these figures.
Let’s say that your student is attending a public 4-year university in state, and is looking at an average cost of $21,000 per year for room and board (note: you can also use our free College Money Report™ to determine average annual costs for your student’s dream schools here). In this example, four years will cost approximately $84,000 (assuming the cost does not rise from year to year—like we said, we’re keeping it simple). The parents have committed $50,000 from savings and cash flow to put towards college leaving $34,000 to be paid for by the student. For our example, we will assume that the entire $34,000 is taken out in student loans.
Taking all this information, you can begin with our budget worksheet.
Remember…this is a family activity. Your student won’t learn anything if you complete this worksheet for them so you and your student both need to be sitting at the table.
Let’s calculate the anticipated starting salary for your student, and plug it into the worksheet. Say your student is going to be an accountant with an average starting salary of $47,488. For our purposes, let’s use the nice round number of $48,000. We’ll assume they don’t have a spouse or additional income yet. So, their monthly gross salary is $4,000. Your student is probably going “hey, that looks pretty good!” Let’s continue…
Needs vs Wants
First up, “needs.”
The first group of expenses is non-negotiable. They must be paid each month. They include:
- student loan payments
- health insurance
- retirement savings (not technically a “must be paid”, but we think it should be non-negotiable)
- credit card payments
The student loan payment item is the one we will play with to determine how much college you can afford. Changing this figure will affect your bottom line and will give you the base guideline you need when looking for a college.
Using our average figures from above, we’ll use the total student loan amount of $34,000. A quick way to estimate a monthly amount is to plan on $100 per $10,000 in loans. This assumes you take the standard 10-year repayment plan. In this example, your grad will be paying around $340 per month. Now let’s subtract the $340 from $4,000, and we get $3,660…still good.
Continuing on…health insurance. Estimating an average monthly healthcare cost is tricky. We’ll estimate $201 per month for an average 21-year-old student.
Trying to figure out how much to save each month for retirement is difficult. Some will recommend 15%. Some say at least up to what your employer will match. If your employer will match up to 6% of your 401k contribution, then plan on 6%. 6% of the annual salary we’re using is $2,880 or $240 per month.
You can point out to your student that 6% is just a starting point. As you get raises, increase your contribution by 1% each year. You will be saving 10% plus of your pay by the time you are 30. Again, your future self will thank you!
Credit card payments
Let’s skip credit card payments and assume your grad does not have any–a nice idea indeed! At this point in the conversation, you can discuss the impact of credit cards, their pluses and minuses, and sound thinking about them.
The next item on the worksheet is taxes. We are estimating 30% of your monthly salary will go to taxes as a ballpark figure. Let’s deduct annual 401k contributions and health insurance costs from the pre-tax annual salary ($48,000 – $2,880 – 2,412 = $42,708) to give us a better picture of our pre-tax annual income. 30% of this amount is $12,812 or $1,068 per month. After our “need” deductions, we’re at $2,151 per month —darn those taxes. But we’re still looking good! We’ll use this figure as our adjusted monthly income.
More fun now…moving on to “wants.”
We move now to the second column of the worksheet, the WANTS, which has expenses more within our control because they are based on our choices in life. Your future grad can play with these items.
What kind of car do they want to drive? Do they have a dream city they may want to move to? What is the cost of living? How much will housing cost? Each of these items’ costs is based on approximate percentages of your gross salary, but these values can vary widely.
|Starting Monthly Income||$4,000|
|$$ for your NEEDS||-1,849|
|$$ Remaining For Other Living Expenses||$2,151|
|Other Insurance (5%)||-200|
|Additional retirement (10%)||-0|
|Emergency fund savings (10%)||-0|
|Total Other Living Expenses (WANTS)||-$2,600|
|What’s left for fun money?||-$449|
Well, that can’t be?!
This plan leaves us short by several hundred dollars per month?! We want teenagers to learn this lesson. You have to spend less than you earn and live within your means. Now you are forced to make budget cuts. But where? This is something families face each and every day. Do we stop putting money into the 401(k) plan at work? Live with a roommate and reduce our rent? Extend the student loan payment schedule to 20 years instead of 10 to lower my monthly payment? Take the bus to work? Get rid of cable? These life decisions are the ones your teenagers are going to face one day.
One part of the American dream is going to college to better yourself and make a good living. But the ultimate goal and the reason we work so hard is the idea of financial freedom. If we let students start out their lives tied to their student loans, they will never be able to save additional money for retirement or save for an emergency rainy day fund. How will they ever save for a down payment on a home? Or start a family? We can teach our young adults that these are the goals for a sound financial plan.
Going back to the student loan item.
We based this whole exercise on the college choice resulting in $34,000 in student loans. Think about how much more would be leftover if we chose a college not as expensive (or, on the flip side, a college that was MORE expensive–YIKES). If a student could have started with half the amount of student loans, they would have half the amount of monthly payment.
This exercise is critical because it can put the future in terms students can understand like driving a reliable car, living in a nice neighborhood, having a fast high-speed internet connection, etc. These things are often the things that they take for granted since they don’t pay for them. Tell them how much you pay for their cell phone and car insurance. They will begin to see the big picture. This exercise is an excellent way for your student to really see what their financial future can look like and how their choice of college can impact that future reality.
Worried you won’t find an excellent college that can fit your student’s financial future? Don’t worry. You can, and Capstone can help. We can help your student graduate on time with manageable student loan debt without robbing your retirement.
Original post 3/2016
September 2, 2021