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Types of Aid
The Federal PLUS Loan vs. Cashing Investments
Some parents cash in investments because they'd rather not borrow. Initially, this seems to make sense. However, parents soon realize that this could be one of the most expensive ways to pay--especially if it causes them to underfund a pretax retirement plan or to cash in an investment that is earning a solid return.
Parents considering using investments instead of a PLUS Loan for education costs should consider the following:
Retirement
Underfunding tax-deferred retirement plans to fund education is the most costly alternative, due to the loss of significant tax benefits. For most parents, the tax savings of a retirement plan far outweigh the interest expense of the PLUS Loan. For example, a parent in a 25% tax bracket that invests $4,000 in a pretax retirement plan will save $1,000 in taxes plus gain the returns on that money.
Liquidity
If investments are used to pay for college, the liquidity is no longer available for emergencies--or opportunities--as they arise.
Return on Investment
By cashing in investments, parents lose any future returns on that money.
It is important for parents to ask themselves the following questions when comparing the PLUS Loan with cashing in their investments:
What kind of return am I getting on my investment?
If the return is higher than the current interest rate, then it makes sense to keep your money invested. For example, if the current interest rate is 7.72%, you are earning 15% off your investments, and you keep that money invested and take out a PLUS Loan to pay for the college instead, then you are gaining 15% while paying 7.72%. That's a net profit of over 7%!
Do I have enough money in the stock market to cover all four years and each of my children?
Many parents don't--and that's why they are taking advantage of PLUS Loans now while the terms are so favorable.
If I sell my investments, what kind of tax exposure (capital gains or regular income taxes) will I have?
Am I carrying any debt above 9%?
Most parents in this situation use the PLUS to pay for school, which frees up money to pay off more expensive debts.