Here’s a short version of how to hack the student income contribution. Borrow more money from the federal government than you need to pay your tuition. Then, using income from student jobs and summer internships, fund a Roth IRA — a retirement account. It isn’t hard to do, and in the long run, you’ll have far more financial security. Let’s elaborate.
Some students at Yale can afford full tuition or receive sufficient aid, while others are in debt before even setting foot on Old Campus. While student loans theoretically allow students to leverage their human capital to pay for a school that’s too expensive for their means, few borrowers sing the praises of graduating in debt.
Many families logically feel frustrated by Yale’s cost, loans and student effort. Being daunted is expected; my five-digit debt to Yale carried an interest rate of roughly 4 percent, while my little sister bought a used car for less than 1 percent. That feels absolutely unfair. Clearly, there’s something wrong with the way we pay for college.
But there’s a way to turn the tables and profit from the plethora of lenders who no doubt email you around this time each year. Although the American financial system is designed to intimidate and extort, a small amount of effort on your part can be exponentially rewarding.
A Roth IRA is a retirement account, similar to a 401(k). Most Americans are eligible to contribute $5,500 after-tax dollars to a Roth IRA each year. The money in that account can be invested, and the growth of the money will never be taxed. As long as you refrain from withdrawing your profits until age 59 and a half (you can withdraw contributions anytime), the withdrawal “income” is tax free. It’s one of the most beneficial accounts of this kind.
It’s safe, if not conservative, to assume that investments will grow by 7 percent a year over the long run. Federal undergraduate subsidized and unsubsidized loans carry roughly a 4 percent interest rate this year. So investing while borrowing theoretically makes sense by that merit alone. But there’s more to the equation than interest rates.
If you don’t contribute during your four years of college, you can’t go back in time and make up that potential $5,500 per year investment — the money Yale requires students pay for the student income contribution. Conveniently, the sum of four years of student income contribution is $22,300, and work-study is paid as wages, not rerouted to pay Yale. So you don’t just miss out on four years of growth — you lose the decades of growth from which the extra money would benefit. Borrowing to fund the student effort matches up almost perfectly with earning wages to fund a Roth IRA.
If that $22,000 grew until retirement without any further contribution, it would become about half a million dollars. Accounting for 3 percent inflation, it would be worth about $125,000 in today’s dollars. In contrast, graduating with $22,000 in debt would grow at around 4 percent as you paid it off over 10 years. Monthly payments would be about $227. By the end, you would have paid a total of $27,296. Ultimately, working your way through the student effort saves you $27,000. But borrowing while investing could easily earn you half a million dollars. If the choice is that simple, the answer is clear.
Of course, this won’t be the best idea for everyone. For one, debt is referred to as “liability” for good reason. Setting yourself up for $227 per month payments for the next 10 years is no small commitment. Furthermore, you may already be one of the 16 percent of Yale students who graduate in debt. It’s no secret that the fatal flaw of the student income contribution is that the only students who absolutely must work to pay it are the ones whose parents can’t afford it. If that’s the case, attempting to add more debt may not be prudent. But remember that contributions to a Roth IRA can be withdrawn. If necessary, you could withdraw up to $22,000 if you found yourself unable to cover your debt. It’s a safety net, but it does defeat the original purpose of investing that money.
The numbers here are mostly averages and estimations, with the exception of facts about contribution limits and Yale’s requirements. Thus, the equations can be tweaked to make your future-self more or less wealthy. But even if you decreased the interest your investments will earn, you would still end up more financially secure.
This idea may sound too good to be true, too complicated to be feasible or even somehow against the rules. It is none of those things. My most heartening moment regarding this idea came when I told my head of college that I had made this choice. She shook me by the shoulders and called it genius.
Our country is severely deficient when it comes to financial literacy. This leaves us less wealthy and less secure while making income inequality far more entrenched. A little knowledge goes a long way, and I hope this article will help.
Louis DeFelice is a junior in Jonathan Edwards College and the creator of the financial website wonderlearninvest.com. Contact him at firstname.lastname@example.org .