College Savings and Financial Aid
With the start of the school season, parents and grandparents are now a year closer to their children and grandchildren’s entrance to college. Few areas of financial planning are more complicated for parents than ensuring that their children will have enough money to pay for tuition, room, board, books, transportation and other related expenses. But the payoff—the likelihood that a good college education will expand their children’s opportunities to enjoy gratifying careers and higher lifetime incomes—is worth planning for.
What makes the task so complicated is that, on the average, college bills have been rising—and continue to rise—faster than after-tax personal income. Even more challenging, especially when college is still years away, is the uncertainty inherent in the never-ending kaleidoscopic changes among government and college financial aid programs and relevant federal and state income tax provisions—not to mention lower real after-tax returns on savings and investments.
Parents unable or unwilling to plan until a child is a high school junior may have to contend with less uncertainty, but, deprived of the prospects of many years of returns on their savings and investments, they have the disadvantage of having to cough up a lot of money out of assets and current income in a short time.
Those who start as soon as a baby is brought home from the hospital may maximize the benefits of compounding interest or equity returns over at least 18 years, but they are aiming at unknowable targets which even skilled financial planners can’t forecast with certainty. Among them: Will the baby grow up to be a prospect for Harvard—with its high costs—a community college, or a vocational school?
In the face of all the unknowns the best that parents and planners can do is start with what is known—such as the year in which the child is expected to start college—and split the others between the likely and the unlikely. The year provides not only the probable period for accumulating asset to meet college expenses, but also the probability and extent of other liabilities, including retirement.
In planning the financing of a child’s college education, it may be helpful for parents to know how the share of the total cost that they may be required to pay will be determined by the child’s school on the basis of:
- What they estimate, when filling out the federal student aid form, to be their “expected family contribution” (EFC), subsequently converted into an “official” EFC.
- What the school calculates to be the amount that the family is expected to pay and the amount of federal student aid for which the family is eligible, based on school policies as well as federal law. The calculation takes into consideration more than easily predictable things such as parents’ compensation and assets. For example:
- Whether a family has other children who will be going to college—helpful to wealthy as well as poor families;
- Whether a child is admitted to a high-cost private university or a state college;
- Assets in the child’s name, which may reduce financial aid eligibility.
Whatever the family’s share, the rest—for over one-half of all undergraduate students—comes from financial aid:
- Federal programs, which provide two-thirds of all student financial aid through (a) grants, such as Pell grants, that are based on need, cost of attendance, and enrollment status, and (b) direct or guaranteed loans, such as Stafford loans, on which interest may be deferred until graduation and may be deductible from taxable income up to $2,500 annually. The Free Application for Federal Student Aid (FAFSA) is a great place to start: www.fafsa.ed.gov.
- Loans and grants from universities and colleges. While most of their aid is in the form of loans, grants account for a growing share. Some base their aid on merit as well as need, which may also be helpful to upper-income families.
- Scholarships from a large variety of organizations ranging the alphabet from the American Legion to the YMCA. A great Web site for scholarship is www.fastweb.com.
While there are so many different scholarships, loans and grants, and federal programs, millions of college students miss out on valuable financial aid every year simply because they mistakenly believe they won’t qualify for aid or they are intimidated by the process, say financial planners. Yet applying for financial aid can make the difference between affording the school you want to attend, and attending the school you can afford. It can even make the difference of being able to stay in school once you’re enrolled.
While some students would not have qualified because they had sufficient financial resources, many left money on the table. In fact, the study concluded that 850,000 low-income students would have qualified for federal Pell Grants, which is money that students don’t have to pay back.
But don’t assume that because you are a middle-income or affluent family you won’t qualify for aid. A recent study by a Harvard professor found that 22 percent of families making $100,000 or more were receiving financial aid. Also, while you might not qualify for aid from a lower-cost college, you might qualify for aid from a more expensive—and perhaps for you, more desirable—school. And just because you don’t qualify for aid one year doesn’t mean you won’t the next. The school’s aid pool or criteria may have changed, or your circumstances have changed, such as a second child entering college.
One of the greatest myths about financial aid is what impact savings will have on it. How you save—such as a custodial account versus a 529 savings plan—will influence a family’s EFC, especially for affluent families on the margin for aid. The Harvard study, for example, shows that saving in certain types of college investments reduces aid more than an identical amount saved in different types. A Certified Financial Planner™ professional can help you sort out which options are best for your particular circumstances.
The key, however, is to not skip saving for college because you don’t want to risk reducing financial aid. Remember, the majority of aid these days is loans. It’s usually better to save in advance and earn interest than to borrow later and payinterest.
Not knowing years earlier what loan and grant possibilities are likely to be, it is essential for parents to start early to accumulate the family’s share—after determining whether tax law would make accounts’ ownership by the child, parents, or other relatives more advantageous.
Aside from conventional taxable and tax-exempt investments, there are special tax-sheltered vehicles, such as 529 Plans and Coverdell Education Savings Accounts (ESAs). To learn more about all of your options, give us a call. We also recommend the web site www.savingforcollege.com.