At this time of year, many families with college bound children are busy navigating the financial aid application process. A college education, long viewed as a pathway to the American Dream, remains a desirable goal for many, with some studies indicating as much as a 75% increase in earning power over the course of a career through the attainment of a degree. However, the soaring costs of higher education in recent decades have even middle-to-high income families wondering how best to fund this endeavor without jeopardizing their retirement or leaving their children saddled with huge debt. Finding the most efficient and beneficial path involves an understanding of both financial aid eligibility, as administered through the relevant government regulations and University policies, and the savings vehicles and strategies available to consumers.
A Crash Course in Financial Aid
As a starting point, some financial aid basics will be helpful. Schools calculate financial aid awards by determining the Expected Family Contribution (EFC), or the portion of attendance costs that the family will be expected to cover based upon their income and assets. Parental assets, in measuring how much they will reduce financial aid eligibility, are assessed on a graduated rate of between 2.64% and 5.64%, depending upon net worth. Parental income is evaluated on a graduated rate of between 22% and 47%. Notably, the child’s resources are assessed differently, with a flat rate of 20% applied to the child’s assets, and a flat rate of 50% on their income.
In addition to the distinction made between parental and child resources, it’s also worth noting which assets are considered “assessable” for financial aid purposes, versus those that are not. Assets which do not reduce financial aid eligibility may include annuities, life insurance, qualified retirement accounts, personal residence, and other personal items (among other things). This can depend upon the method of assessment used by a particular school — a standard Federal methodology or what is known as an Institutional Methodology — but either way asset classification can play a role in strategizing for financial aid eligibility.
In light of this backdrop, here are three broad strategies that can be employed to fund college while supporting other goals (such as retirement) in the context of your overall financial plan.
Financial Aid Strategies
Financial Aid strategies primarily involve the re-categorizing of “assessable” assets so that they’re no longer counted in measuring financial aid eligibility. For example, if your child has earnings from a summer job, you could move those monies from a savings account to an IRA in the child’s name. Parental funds in a savings or brokerage account could be used to purchase an annuity or permanent life insurance (though we would caution that such instruments should be purchased only if they fit your risk management and cash flow needs and if financial aid assistance is likely in light of all resources). Parental savings could also be used to pay down a mortgage, as increased home equity will not reduce financial aid, or to purchase non-assessable school items, such as a computer, or a car. Families with multiple children should also note that their Expected Family Contribution will be reduced by half for each child they have in college.
Tax Reduction Strategies
Tax efficiency, always a worthwhile pursuit in terms of your comprehensive financial planning, can also play a role in your education funding strategies. From a tax deferral perspective, increasing contributions to your 401k and Health Savings Accounts (to the extent your cash flow needs allow) will reduce your income, for both taxation and financial aid purposes. Timing strategies could include having some of your compensation deferred (if possible through your employer), or front loading certain tax payments, such as property taxes or charitable gifts, with the effect again of reducing your assessable income. Further, if circumstances allow, one could qualify for the Child Care Tax Credit by hiring an older child as a babysitter for younger siblings. Finally, in terms of savings, most states allow income tax deductions for contributions to 529 Education Savings accounts (discussed more fully below).
Savings and Cash Flow Strategies
Retirement vehicles such as IRAs, and other instruments such as Savings Bonds, can be used for educational costs, and should be considered in some scenarios. However, the primary savings vehicle in most situations would likely be 529 Education Savings Accounts. In addition to the tax deductions mentioned above, such accounts allow for tax free growth on monies contributed, and tax free withdrawals when used for qualified higher education expenses. In such plans, (which are distinct from 529 pre-paid tuition plans), savings can be used at any accredited college in the country, so students are not limited to in state schools only. If the designated beneficiary on a given account opts not to go to college, wins a merit scholarship, or enrolls at a service academy, the account owner can change the beneficiary (within limits).
Note that 529 funds owned by a grandparent are not counted as assessable parental or child assets. Distributions from such accounts, however, are counted as income of the child, and are assessed at 50% in reducing financial aid eligibility for the following year. In light of this, it is best to utilize these assets for the child’s final year of school, when they will have no impact on future financial aid evaluations.
You will need to consult your advisor to confirm the best strategies for your particular circumstances, as the recommendations above are neither exhaustive nor universally applicable. They are designed, however, to provide an idea of the college funding landscape, some strategies to consider, and the extent to which they can be coordinated with your other goals and comprehensive plan. Raising scholars while keeping your other goals intact can be done.