Figuring out how to pay for college is like putting together a puzzle. At first, it can feel like all the pieces are jumbled in the box. The final picture is unclear, and it can be overwhelming to know where to start. But gradually, different pieces fit together in different combinations until the puzzle is complete. If you are thinking about how the puzzle pieces of your child’s tuition bill fit together, consider the following common questions and answers as a starting point.
Q: When should I start saving for my child’s education?
A: Start saving for future school expenses as soon as possible. I started with both of my kids when they were 3 months old. Even modest savings can add up over time due to the power of compound interest. One of the most prevalent ways to save is via a 529 college savings plan because it offers tax-advantaged growth. Contributions are made on an after-tax basis, and earnings can be withdrawn tax free to pay for tuition, books, room and board and other eligible expenses. Funds used for noneligible expenses are generally subject to ordinary income tax and a 10 percent tax penalty.
You might also consider a prepaid tuition 529 plan, offered by a handful of state and private schools. In exchange for committing to a participating school, families can predict and manage college costs by paying in advance over time. This option isn’t right for every family, particularly if your child is unsure of which school they want to attend or what career paths to explore.
Q: Should I bother filling out the FAFSA?
A: Yes, every parent of a college student should consider completing the FAFSA (Free Application for Federal Student Aid). The federal government offers low-interest student loans regardless of income. The FAFSA should be submitted as soon as possible on or after Oct. 1 of each year for your student to request these federal funds for the next school year. Deadlines vary between the federal government, states and colleges, so check with your child’s college of choice for specific guidelines. FAFSA data is often required when applying for merit-based aid so it’s worth filling out the form even if you expect not to rely on federal student aid to pay tuition.
Q: How is your Expected Family Contribution (EFC) calculated?
A: A key component of the FAFSA is the EFC, which is a number that is used to determine your student’s eligibility for federal student aid. The FAFSA considers a variety of assets in its calculation:
• For parents, this includes your paycheck, money in college savings plans, and other savings and investments. It does not include home equity in your primary residence, but it does include equity in other property. Retirement savings are not considered.
• For students, the EFC includes assets they own or assets they are the beneficiary of (such as money in a custodial account, like a Uniform Gifts to Minors Act account). Your student’s assets are weighed more heavily than your own, so you may want to avoid making large gifts of cash to him or her that might adversely affect the calculation. A financial advisor can help you estimate your EFC and explore ways to minimize assets when it makes sense to do so.
Q: What kind of financial help can we expect?
A: High-net-worth families generally are not eligible for need-based aid, but there are other ways to receive financial help. Students with good grades and test scores may be eligible to receive merit-based scholarships or consideration for on-campus jobs. High performers in niche areas (athletics, music, theater, math, etc.) also may also be able to earn scholarships, regardless of income. State schools offer tuition breaks to residents. Most colleges also offer tuition installment plans, which may allow you to make payments throughout each semester rather than all at once.
Q: Is it unwise for our child to take on debt to pay for college?
A: It’s not uncommon for students to foot part of the tuition bill for several reasons. Perhaps you want your child to have a financial stake in paying for his or her education. Or, maybe your child wants to attend a college with a price above what you agree to pay. (This is often true for parents with multiple children attending college.)
However, the most common reality is that many parents are unable to save enough to cover the full cost of education. While it’s an admirable goal to want to help your child avoid student debt, it’s important to prioritize saving for your own retirement. At the end of the day, your child has decades of future earning potential and the possibility to take on loans to cover tuition. You simply do not have the same options to pay for your retirement. Once you determine what you’re willing and able to pay, have a conversation with your child to help set expectations. Your child’s choice of college and future earning potential will influence how much debt is manageable after graduation, so you may want to discuss these factors in more detail. Keep in mind that some fields of employment (teaching and health care, for example) may offer student loan forgiveness or assistance programs.
Christopher J Olsen is a certified financial planner and a retirement income certified professional. He is a private wealth advisor and owner of Bridge Pointe Financial Group, a private wealth advisory practice of Ameriprise Financial Services, Inc. He offers fee-based financial planning and asset management strategies and has been in practice for 34 years. Investment advisory products and services are made available through Ameriprise Financial Services, Inc., a registered investment adviser. Ameriprise Financial Services, Inc. Member FINRA and SIPC.