We all know the drill: The month before your baby is due, while the paint in the baby’s room is drying, you go to your broker’s office and get the paperwork to set up a college savings account of one type or another. This post was originally titled “Saving for College,” but as I learned more, I decided to focus on the Financial Aid aspect instead.
The financial aid process comes with its own acronyms, the first I ran into was FAFSA, (Free Application for Federal Student Aid, only use the Dot Gov site, other sites charge a fee). Next came EFC, the Expected Family Contribution. This chart, generated from the site FinAid is a great start to understanding the process:
This chart is based on parents’ income and assets. You can see that as income rises, the percent expected to be paid toward college rises from about 17% at $40K to over 30% right after $70K income level. Assets are not treated so harshly, rising from 2% to 4% as income increases. Equity in one’s home isn’t counted at all.
On the other hand, 50% of student income is expected to pay for college (ouch!) and 35% of student assets.
Parents’ retirement accounts are not considered in the equation, and a 529 account is considered a parent’s asset, not the student’s.
Before I discuss a few strategies to maximize the aid your child would receive let me observe that the average cost for a private four year school was $25,143 for the 2008-9 school year and the public four year cost averaged $6,585 (it was just announced that these numbers rose by 4.3% for 2009-10). Looking at the chart above you can see that for a public school an income above $60,000 will make aid hard to come by, as an income above $120,000 will support the full cost of private school.
A number of strategies that can make a difference in your EFC:
Fund your 401(k) until it’s max’ed. If you reduce your income from $60,000 to $50,000, you will save $2,350 in the EFC hit as well as $1500 in federal tax for a total $3,850. (See Fairmark to better understand your tax bracket.) After graduation, if you must withdraw the $10,000 you will only be hit with $2,500 in both tax and penalty. (Just making a point, save it till you retire.)
If you are sitting on an investment (non-retirement account) portfolio, and still have a mortgage, pay it in full. $100,000 in assets will be “taxed” at $3,000 per year at the $60,000 income level and $3,200 at higher incomes. If your mortgage is 5%, this translates to over an 8% return on the money each year for the four years of college.
Given the 35% of student assets expected to be used for college, I now understand why so many freshmen are driving expensive cars. Consider, $50,000 in the student’s name will be spent down to $8925 over four years, $41,074 expected to be used for college. In another case of “unintended consequences,” it actually makes sense to go buy a car and blow the money. A better choice would be to take advantage of tax sheltered retirement accounts, 401(k) if the student works a regular job while in high school, Roth IRA if working for a company with no retirement account. The IRA limit is $5000 this year. One can deposit up to 100% of their earned income into an IRA up to that $5000 maximum.
Other advice I’ve run across suggests having your children close together as the aid formula is kind to those with two or more students in college at the same time. If your two children are a year apart, perhaps the older one wants to take a year off before returning to school. These two suggestions are a bit extreme, but will increase your potential aid nonetheless.
Suggest to any helpful friends or relatives who with to help with the cost that they wait until graduation and apply that gift to any loans, but not gift it to the student while in school.
If you are well above the income levels that will qualify you for aid, congratulations, you’ll be paying your student’s way, but if you are in that middle, I hope these strategies help you. For more on this topic, see the article When Saving Means Losing.
Joe
