For the purposes of this discussion, “college” refers to any postsecondary school [ vocational school, 2- & 4-year college, university, professional school ] that offers student aid administered by the U.S. Department of Education.
SUMMARY: The cost of a 4-year college is over $20,000 a year and continues to increase at nearly 4% annually. Paying, not borrowing, is the better way to finance a college degree. Parents can start a payment plan early by investing in a tax-free “529” college savings account. Adults should avoid using their retirement savings to pay a child’s college expenses.
The more effort a family puts into creating a college budget, the better their student’s chance for educational and financial success. There are six important issues to address in the budgeting process:
- Savings plan
- Scholarships and grants
- Family income
- Student loan as the last resort
1. Reduce the cost
High school programs which are designed to reduce the cost of college can prepare students for academic achievement and save them thousands of dollars in college expenses. Families are encouraged to consult teachers, counselors, principals, and colleges about available programs. Here are several types of programs:
- Advanced placement (AP) courses and exams are sponsored by the College Board and participating high schools (ref 1).
- Early college high schools (ECHS) enable students to earn a high school diploma and a two-year associate’s degree or 2 years credit toward a bachelor’s degree. Recruitment starts in middle school (ref 2).
- Community college classes are open to high school students without a diploma. Completion of the classes demonstrates a student’s readiness for college and the earned credit might be eligible for transfer to other colleges (ref 3).
- College-level examination program (CLEP), also sponsored by the College Board, is designed to award college credit for knowledge already acquired. There are 33 CLEP exams that award 3-12 credit hours toward a college degree (ref 1).
Students who wish to get a bachelor’s degree can save money by transferring credits from a community college to a four-year school. Money is saved by paying less at the community college and taking fewer courses to graduate from the four-year school. Firstly, it’s important to earn an associate’s degree before entering the receiver school. Secondly, there’s a risk of losing credits during the transfer unless the participating colleges have an “articulation agreement” on which courses will be credited. Thirdly, the participating colleges may have a transfer agreement that guarantees admission to the receiver school. Try searching for information about “transfer students” in the school websites (ref 4).
Carefully selected online degree programs may provide another opportunity to reduce college expenses (ref 4). Other cost-reduction strategies include adequate, —not luxurious—, room & board, frugal spending habits during college, and graduation on time (ref 5,6).
2. Choose an affordable college
Financial safety schools are those which are most affordable and likely to accept your academic credentials (ref 7). Here are some tips for choosing a college that satisfies your needs:
- Have a study goal and search for colleges that satisfy that goal.
- Search for colleges which are recommended by teachers, guidance counselors, and college-rating websites.
- Use college-ratings to help find affordable colleges [hint: try finding schools with the lowest net prices such as those listed in ref 8; net price is what you might have to pay after receiving financial aid].
- Attend a college fair [hint: ask your guidance counselor for information].
- Visit the websites of colleges that interest you.
- Contact admissions offices and request guided tours of your chosen colleges.
- Review your acceptance letters and visit the admissions office to negotiate the best financial agreement.
3. College savings
It’s cheaper to save than to borrow for college. I would like to join others (ref 9,10,11,12) in advising parents to own a tax-free 529 Savings Plan (“Qualified Tuition Program”; “QTP”) for the benefit of their young child. Owners of 529 savings plans receive favorable tax treatment on the investment returns. The best time to start is before birth or in the first year of the child’s life. It’s important to make regular deposits into the account, preferably by a payroll deduction plan. Here are some strategic details:
- By today’s rules, withdrawals from a parent-owned 529 Plan will have the least impact on the child’s eligibilty for financial aid in college (ref 13).
- The designated beneficiary of the Plan is either the child or a member of the child’s family. The designated beneficiary can be changed without transferring Plans, which allows an adult to start a 529 Plan before the birth of the child by designating a family member as the beneficiary (ref 12).
- The accumulated savings can be transferred from one 529 Plan to another by way of a roll over. The new Plan must be for the benefit of the same designated beneficiary (ref 12). There are several potential advantages, including the transfer of ownership from a third-party (e.g., grandparent) to the parent, but; beware that some states prohibit the transfer of a 529 account unless the owner dies and the transfer is mandated by court order (ref 14,15)
- 529 Plans started in year 2018 can be used to pay qualified educational expenses for primary, secondary, and postsecondary school. Misuse of the Plan for unqualified expenses will incur a financial penalty. 529s started before 2018 cannot pay for primary and secondary education; only the Coverdell ESA will pay those expenses (ref 12).
- The maximum investment is several-to-many hundred-thousand dollars depending on the specific plan. The total contributions may not exceed an amount needed to pay qualified education expenses of the beneficiary. The federal gift tax exclusion allows a tax-free limit of $14,000 ($28,000 if married, filing jointly) on annual contributions.
There are other tax-advantaged ways of saving for college (ref 12,16):
- Coverdell Education Savings Accounts receive favorable tax treatment on investment returns when used to pay qualified educational expenses from kindergarten through college. Eligible owners who file joint tax returns must have a modified adjusted gross income below $220,000. Their contribution limit is $2,000 per year up to the student’s 18th birthday (no more after age 18) and the account must be used before the student’s 30th birthday. Owners may change the Coverdell account or its beneficiary (ref 12). Owners may also rollover the Coverdell to a 529 (ref 17).
- Education Bonds are U.S. series EE Savings bonds issued after 1989 or U.S. series I Savings bonds, both of which are purchased by someone at least 24 years of age. The earned interest is tax-free if the benefiiciary is named as a dependent on the owner’s tax return, the owner’s modified adjusted gross income is below an acceptable limit, and the education expenses are qualified (ref 12).
- IRA distributions are tax-free when used to pay qualified educational expenses, but: beware that any educational withdrawals will severely impair the advantage of earning compounding returns for retirement savings.
Investments in mutual funds and custodial accounts (UTMA/UGMA) offer an unlimited opportunity for funding college. However, the balances reduce the student’s eligibility for financial aid and the returns are taxable (ref 16).
4. Scholarships and Grants
Scholarships and grants are awards of ‘free’ money to students that don’t require repayment. The application process demands time and effort by the high school student, but it’s well worth the effort (ref 18). Guidance counselors, reference librarians, and college financial aid officers are excellent sources of help. Free listings can be found online (ref 19,20).
5. Family Income
Students from high income families can rely on parents for financial help. Otherwise, they may need to earn money to pay for college. The work-study programs offered by colleges and private employers are good opportunities for students with a financial need (ref 21).
Student loans can delay college graduates from saving for retirement, a mortgage, and other big projects (ref 22). Still worse is the possible financial stress of paying a large debt (ref 9). Therefore, use student loans as a last resort. Federal student loans are generally the cheapest and safest when offered by the college financial aid office (ref 21).
Third parties (e.g., grandparents)
The student’s immediate family and the college are counterparties to each other when it comes to paying for college. Grandparents, relatives, and friends belong to the category of third parties. Third parties are valuable sources of financial aid under the right circumstances:
- Gifts less the $14,000 per year ($28,000 if married filing jointly) are exempt from the federal gift tax. A special exemption of $70,000 per donor may be paid as a one-time, five-year gift to a 529 savings plan (ref 14).
- Gifts are excluded from the gift tax when they bypass the family as direct payments to the college. Unfortunately, direct payments are counted by the college as “other income” that may disqualify the student from future aid. The disqualification is not a practical concern during the student’s final year of college (ref 14,15).
- Indirect payments to the family are likely to reduce the student’s eligibilty for need-based financial aid by inflating the “expected family contribution” (“EFC”) toward college expenses. The inflation of EFC is less when gifts are paid to the parents instead of the student. The best strategy for indirect payments is to contribute to a 529 savings account owned by the parents with the child as the beneficiary (ref 14, 15).
- A 529 account owned by a third-party does not inflate the EFC until payments are made toward the student’s college expenses. To avoid inflating the EFC, the third-party owner should transfer their account to the parents before the student applies for college. Beware that some states prohibit the transfer of a 529 account unless the owner dies and the transfer is mandated by court order (ref 14,15).
- Money borrowed by parents does not hurt their student’s chances for financial aid. Third parties can plan to make a legitimate loan to parents that includes a charge for interest. Once the parents are done paying for college, the third party has the option of forgiving the loan (ref 15).
Parents and grandparent-guardians should both avoid dipping into retirement savings to pay for a child’s college education. Instead, the child can earn income and apply for student loans.
Families who want professional help with the process of paying for college can hire a financial aid consultant. Before hiring a consultant, review the excellent advice given in references 23 and 24.
Students are required to submit a Free Application for Federal Student Aid (FAFSA) one year before attending college. Some colleges also require students to submit a CSS/Financial Aid Profile. The FAFSA and CSS Profile reveal how much a student can pay without borrowing money. It’s best if the student, with the help of the family, pays without borrowing.
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2. Christina Tyman-Wood, What is an early college high school? https://www.greatschools.org/gk/articles/early-college-high-school/ , 3/7/2016.
3. Start college early. Rise Out, Inc. http://www.rise-out.com/start-college-early/ .
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7. How to Choose Dream, Target, and Safety Schools. https://www.princetonreview.com/college-advice/dream-match-safety-schools .
8. College Affordability and Transparency Center, U.S. Department of Education. https://collegecost.ed.gov/catc/
9. Mark Kantrowitz, It’s cheaper to save than to borrow, Saving For College, 4/27/2018. https://www.savingforcollege.com/article/it-s-cheaper-to-save-than-to-borrow .
10. Mark Kantrowitz, How to save for a child’s college education before the child is born, Saving For College, LLC. College Savings 101, https://www.savingforcollege.com/article/how-to-save-for-a-child-s-college-education-before-the-child-is-born , 4/5/2018.
11. Frequently Asked Questions About 529 Plans, ICI Investment Company Institute, ici;org, https://www.ici.org/pubs/faqs/ci.faqs_529.print , 2014.
12. Tax Benefits for Education. Publication 970, Tax Benefits for Education, Department of the Treasury, Internal Revenue Service, https://www.irs.gov/forms-pubs/about-publication-970 , 1/31/2018.
13. Joseph F. Hurley and Brian Boswell, 2018-2019 Family Guide to College Savings, Saving For College, LLC. www.savingforcollege.com , 2018.
14. Robert Farrington, The Smart Way Grandparents Can Help Pay For College, Forbes/Education. https://www.forbes.com/sites/robertfarrington/2014/10/13/the-smart-way-grandparents-can-help-pay-for-college/#69ad07a17927 , 10/13/2014.
15. Safe Ways for Grandparents to Help with College Costs. Dowling & Yahnke, LLC. https://www.dywealth.com/resources/blog/safe-ways-grandparents-help-college-costs
16. Kathryn Flyn, 6 ways you can save for college. https://www.savingforcollege.com/article/6-ways-you-can-save-for-college , 9/1/2018.
17. Kathryn Flynn, When to consider a Coverdell ESA to 529 plan rollover. June 26, 2018. https://www.savingforcollege.com/article/when-to-consider-a-coverdell-esa-to-529-plan-rollover , 10/9/2017.
18. Kristina Ellis, Confessions of a Scholarship Winner. Worthy Publishing, Brentwood, 2013.
19. Scholarships. College Scholarships Org. http://www.collegescholarships.org/scholarships/ .
20. Finding and applying for scholarships. www.studentaid.gov/scholarships.
21. Federal Student Aid, U.S. Department of Education. https://studentaid.ed.gov/sa/.
22. Matthew S. Rutledge, Geoffery T. Sanzenbacher, and Francis M. Vitagliano. How Does Student Debt Affect Early-Career Retirement Saving? Center for Retirement Research at Boston College, May 2018. http://crr.bc.edu/wp-content/uploads/2016/09/wp_2016-9_rev.pdf.
23. Evaluating Financial Aid Consultants. http://www.finaid.org/scholarships/consultants.phtml .
24. Deborah Ziff, Decide if you need a private financial aid consultant, usnews;com, https://www.usnews.com/education/best-colleges/paying-for-college/articles/2017-07-05/decide-if-you-need-a-private-financial-aid-consultant , 7/5/2017.
Copyright © 2018 Douglas R. Knight