In general I’m a pretty big nerd when it comes to all things financial. I love a good spreadsheet, and really enjoy analyzing a solid set of statistics.
Since I do a lot of this in my day job, it’s rare for me to be truly surprised by individual statistics. But I came across a few recently that really boggled my mind, and they all have to do with college planning:
- Student loan debt in the U.S. has increased 510% over the last 10 years
- Across the country, we’re taking on $2,701 in student loan debt every second
- 16% of student loan borrowers are currently in default, and another 27% are either delinquent or in postponement
These are some pretty astounding numbers. You may have already heard that tuition costs are going up 7% each year, or that as a country we now have more student loan debt than we do credit card debt. But a 510% increase over ten years is astronomical.
Since saving for & affording college is relevant to the majority of parents, I thought it’d make a great post on the blog. So, today’s post covers affording college & need based financial aid.
To get to the bottom of the issue, I’d like to welcome Melissa Ellis to the blog. Melissa is the founder of Sapphire Wealth Planning, a CERTIFIED FINANCIAL PLANNER™, and a subject matter expert when it comes to education planning.
Can you tell us a little bit about need-based financial aid?
Need based financial aid includes loans and grants. Loans are paid back, grants are funded from an outside source such as states, counties, private foundations or individual donors. Don’t be fooled thinking that you have been given a “gift” when in fact you may have taken out a very large unsecured loan.
Need based financial aid is determined by calculating the Expected Family Contribution and comparing it to the cost of attending a particular school. A CFP® with training in College Planning can do this calculation for families.
Does every school offer need-based financial aid?
Yes, institutions from local community colleges to Ivy League schools offer need-based financial aid. A wealthy family may not qualify for aid at a state school, such as the University of Missouri or the University of Oregon, or fill in your favorite state. But, that same family may qualify for thousands of dollars at a more expensive private school or an Ivy League school.
Near where I live, Missouri University’s financial aid office divides up the work by last name: each rep handles a portion of the alphabet. This ends up being very helpful, since every family is assigned a dedicated representative. That way when you call multiple times you can speak directly to your assigned rep who already knows you and your unique circumstances.
I understand that how you title assets can have an affect on financial aid awards. How does that work?
Retirement funds are excluded from the financial aid formula. There are also some exclusions on income to allow for college savings and is based on the number of children in the family. Larger families have a better chance of receiving aid than smaller families.
529 Plan funds are considered assets of the parents. However, if the students’ parents are divorced and the 529 is owned by the non-custodial parent, the funds are NOT reported on the FAFSA. But, distributions are considered untaxed income to the STUDENT, which can negatively affect the student’s eligibility for need-based financial aid.
It’s best if the 529 plan is transferred to the custodial parent during the divorce proceedings. For the 2016-2017 school year, a student’s income up to $6,400 is sheltered from the EFC calculation. After that, it is assesed at 50%. Most schools assume a student will contribute about $2,000 each year to their education.
[Editor’s note: My understanding of this rule is that the 529 account should be owned by the parent who the child spends at least 51% of their time with. Many people assume that joint custody means they won’t have to make changes to their college savings accounts, but this isn’t necessarily true.]
The FAFSA form is how schools collect this type of information. Should incoming freshman even bother to fill out the form if their parents are well-off?
Definitely! I believe some schools may even require you to fill out the form if you intend to pay tuition without need based aid. Even if a family is very well off, the expected family contribution accounts for number of children.
For example, a family with $1,000,000 in the bank, a $200,000 annual income, and one kid might not be entitled to any need based aid. But if the same family had 5 kids they might.
This is just one factor, and the expected family contribution calculation can get rather complicated. There’s really no reason not to complete & submit the form.
Another thing to consider, there are some grants at schools for a specific student type that would be missed if you do not fill out the FAFSA. Most of the information on the FAFSA can be pulled from your Federal Income Tax form automatically now, which is a new feature this year since they are now using the prior prior tax year information.
If you are planning to attend a private or Ivy League school, you will be required to fill out the PROFILE, too.
What are some good resources for parents of high school students that cover financial aid?
- High school counselors
- The financial aid office of the schools the student wants to attend. Make sure to contact them at the time of application, and definitely upon acceptance. They’re there to help you.
What about merit based aid, like scholarships. How can families ensure they’re “turning over all the stones”?
Websites like Collegeboard.org and collegedata.com will give parents insight into the schools that offer merit based scholarships. Collegedata.com gives the number of merit-based scholarships at most universities.
Not every school will offer merit based scholarships, though. MIT is one example. Several state schools, such as the University of Oregon, hand out aid until it’s all gone, so it can pay to submit your FAFSA as early in the year as possible.
When it comes to the financial side of choosing a school, what are the biggest mistakes you see families make?
Parents using 401(k) and IRA withdrawals, and/or 401(k) loans to pay for their child’s college. If the parents are under age 59.5, they’ll pay a penalty and tax on the amount withdrawn from retirement accounts. 401(k) loans can be dangerous and expensive too, since they must be repaid within 5 years. Also, if the parent loses their job the loan is considered a distribution and taxed accordingly.
401(k) loans also prevent the parent from receiving their employers’ match on contributions while there is a loan against their account. This can be very detrimental to their retirement aspirations.
What’s your favorite account for saving for college?
Your own state’s 529 plan account offers a state tax deduction to parents on contributions in most states, and offers flexibility to change the beneficiary of the account. This feature is helpful if a child decides that they want to join the workforce after high school and doesn’t want to attend college. By changing beneficiaries, the funds saved for that child can then be redirected to another blood relative.
The downside to the 529 Plan is that if funds are used for something other than qualified education expenses, the parents will pay an income tax penalty on the distribution.
For families that are not sure whether they’ll fund their child’s education, saving in a Roth IRA may be a good option. As the law is currently written, you may take your contributions out of your Roth IRA at any time. If you don’t need the money for education, they can continue to grow tax free for retirement. The downside, though, is that contributions are limited to $5,500 per year for those under age 50.
Most people who want to start saving for their kids’ college costs contribute an ESA or 529 account. They invest the funds in a mutual fund or other type of diversified product. This comes with some risk though – if the market crashes it could really crush how much a student can afford. How can families account for market risk when saving for college?
The risk in ESAs or 529 accounts should always be managed similar to retirement accounts – with respect to time horizon. As you approach the date when your child will begin taking distributions, you should be reducing risk consistently.
[Editor’s note: Most 529 plans have some type of target date option. These funds have a mix of stocks, bonds, and cash, where the aggregate risk and asset allocation changes over time. At first the fund manager will steer the portfolio toward more growth and risk, and reduce risk over time as you approach the target date. They’re slightly more expensive (to account for the extra management costs), but work pretty well if you only want to choose one fund and then forget about the account for a few years.]
Anything else you’d like to leave readers with?
When you start thinking about planning for college, don’t go it alone! There are tons of free resources out there to help you, and it’s too easy to make a bad decisions. Working with a CERTIFIED FINANCIAL PLANNER™ who’s trained in education planning is a good start. High school guidance counselors and financial aid offices at potential schools can help too. There’s a lot of knowledge out there. Don’t be afraid to ask for help!
Thanks Melissa for your input! Be sure to check out Melissa’s firm at sapphirewealthplanning.com.