Saving for College: Best Advice for Families
The Hard Reality of Tuition Costs
The headline in the morning paper says it all: "Tuition Devouring More of Family Income." It seems that tuition costs aren't just rising steadily, like a financial iceberg that we will inevitably hit. They're also responsible for a huge, gaping hole in family income, more than previously realized. And, the less families earn, the harder they'll get hit.
A study by the National Center for Public Policy and Higher Education found that for families at or near the bottom of the income ladder, tuition at public colleges and universities equaled 25 percent of income, up from 13 percent in 1980. The richest 20 percent of American families, meanwhile, continued to spend just 2 percent of income on tuition, with no change in 20 years. During the same time-period, tuition costs at state schools rose 107 percent, when adjusted for inflation.
Rather than ignore the looming reality or prepare to drown in a sea of debt, financial planners suggest that parents become savvy savers and start making use of the growing number of options to finance a child's education. We've has assembled an all-star team of experts to provide perspectives and strategies:
Q. How much has the college tuition landscape changed in 20 years?
Miller: It's 180 degrees different. When I was looking for colleges for my sons a generation ago, a financial planner told my husband and me that we should save $100,000 for each child. I thought the man had lost his mind. Today if I were going to send my son to an out-of-state public university or a good private college, the cost would be more than double that. The likelihood is great that you will not pay 100 percent of the cost from your own pocket, but let's focus on what you can realistically put aside today and what's the best way to save that money.
Hurley: The change has been tremendous. Twenty years ago there were very few investment tools specifically designed for college. In the last two years federal and state governments have come out with unprecedented help for families.
Case: I've been here (at Amherst College) 20 years. Costs have increased substantially, but so have aid amounts. The total cost for tuition and other expenses is roughly $39,000 next year at Amherst. So for a family with an income of $120,000, are they going to qualify for aid? Yes. But what's expected of them, if they don't have much in assets, is still going to be roughly 20 percent of their income. Those families typically cannot rearrange their expenditure patterns to meet that cost. So they can borrow against future income or take from savings. I think most families would prefer to do the latter.
Save for Retirement or College?
Q. True or False: Even though college costs will be enormous, you still should save for retirement first.
Miller Absolutely true in 10-foot letters. You can borrow for college. You cannot borrow for retirement. College lasts four years; retirement lasts much longer.
Hurley: Another reason is this: College is typically an investment that returns higher income in the future, through children's increased earnings. A retirement fund can also be used as an emergency fund for college. If you have an IRA you can withdraw money for college without incurring the premature withdrawal penalty. That's been true since 1997.
Case: A lot of times we see families drawing on retirement income. We tell them that's unwise. We think you should keep it in that fund and go out for a parent loan, because if you withdraw you have effectively stemmed the flow of compounding on those resources.
Q. If you are a young couple just getting established, does it make more sense to sock money into a 401K account, or split savings between a 401K retirement plan and a 529 (state-run college savings plan)?
Hurley: For most people, the answer is put it in a 401k, especially if an employer is doing a match.
Miller: Sock it in the 401k, and also look at a Roth IRA. Then, if you have additional discretionary income, identify ways to save it for college.
Q. What about the theory, "The fewer assets I have, the more financial aid my child will receive."
Hurley: That's the way the system is geared right now. In essence it does reward families that spend now, save later. But if you have the dollars, you are going to have more choice when it comes to a school. You aren't going to have to follow the aid dollars. Another consideration is that financial aid changes all the time. The way the rules work right now may not be the way they work in 15 years when your child goes to college.
Miller: The financial aid formulas are more income-intense than asset-intense. If the focus is on earning need-based aid, you need to find ways to reduce your income. The more you transfer income to assets, the better, in the years prior to your application.
Case: Income is the major factor. Regardless of what you have in the bank, the expected contribution will be the same for two families earning the same amount of money, even if one family made a decision to go to Europe every summer while the other saved for college instead of taking vacations. The need analysis is a snapshot in time. It doesn't look back and try to make a judgment on how a family did or did not accumulate assets. If a family doesn't have assets, it can't draw on them. So their only choice is a parent loan.
Q. Let's look at state college savings plans, the 529s. First, if I want my son to go to the University of California, do I have to put my money into the California plan when Nebraska's has a better rate of return?
Hurley: No, not at all. You can put your money in any state plan and use it essentially for any accredited college or university. In fact, there may or may not be any incentive to put money into your own state's plan. A lot of states do provide incentives, such as upfront tax deductions for contributions, or beneficial treatment of accounts in determining eligibility for state financial aid programs. New York does this; it doesn't count the money invested in the state's 529 plan as an asset. Some states, including Minnesota, Louisiana and Michigan, actually offer matching contributions for families below certain income levels.
Q. What's the difference between a 529 plan and a Coverdell Education Savings Account?
Hurley: The Coverdell can be withdrawn tax-free not just for college, but also for K-12 education expenses anything from tutoring and tuition to books and home computers. You're limited to $2,000 per year per child, whereas there are no annual limits with the 529. Each 529 plan established its own overall account-balance limit; the highest right now is $305,000 in South Dakota. The Coverdelll has age limits on the beneficiary he or she must be under 18 and the account must be used by the time the beneficiary is age 30. With a 529 you can set aside money to return to graduate school yourself. With the 529, the state handles investment options. With the Coverdell, you do.
Miller: A Coverdell is a child's asset. When I have worked with families that want their children to attend private school, I advise them to use the Coverdell for tax-advantaged money for elementary and high school years, and a 529 plan for college.
Pre-Paid Plans and Age-by-Age Advice
Q. What about pre-paid tuition plans, now available in 18 states?
Miller: Generally they are very good for citizens of that state, if the child is likely to stay in the state to go to school. The pre-paid plan can be a very good place to have your money if there are double-digit inflation increases in your state colleges, which we are seeing at public institutions across the country. But there are big restrictions ad limitations from state to state.
Hurley: These plans are a type of 529, but more like an insurance policy that promises to pay you a certain bundle in the future in return for your upfront investment. Most are designed for students who will be attending a public institution in that state, although all have provisions for use at out-of-state schools. Prepaid plans can hurt financial aid significantly, because they reduce eligibility on a dollar-for-dollar basis.
Q. What if I can't save anything for college, because I'm spending my education dollars on private school tuition or tutoring now?
Miller: That's a tough situation. Most families can't afford private school, elite colleges, and a comfortable retirement. This is where you have to sit down and set realistic expectations.
Case: Three years ago I was interim dean of admission here, and certainly I saw differences on applications that could be attributed to income. Be it private school or tutoring, music lessons or summer opportunities all of these are enrichments that make a child more attractive to an institution. But applications at highly selective colleges are also read in context. This particular student went to public school. Were there honors or advanced placement courses offered? Did the student take advantage of those?
Q. What's the best "saving for college" advice if you have a baby?
Hurley: If you have a qualified retirement plan, that's your first choice.
Miller: Stay out of credit-card debt. If you're in it, get out and never go back there. Next step is to pay yourself first. Decide what you're going to save and where you're going to save it, and build your budget around what's left after you've made savings.
Q. If you have a 10-year-old?
Hurley: Look at how you are investing. At this age you may be more accepting of risk because dips in the market are likely to be averaged out with bull markets. A lot of 529 plans have strategies that automatically change the asset allocation, as the child gets older.
Q. If you have a 15-year-old?
Miller: If you have a teen and haven't saved anything, it's time to readjust life and start living as if you're making tuition payments right now. Pretend your child is going to college next year. Using your income today, see what families are expected to contribute at a college of your choice. That's your savings target.
Q. What's bad advice about college savings?
Case: The most frequent discussion has to do with assets in the child's name. The federal assessment formula for student assets is 35 percent, and some institutions use 25 percent, so it's five to seven times the rate it would be if it were in the parent's name.
Miller: Beware of jumping into a 529 plan if someone tells you, "Buy this state's plan, but I won't tell you about any of the others." I've heard it said that 20 percent of young people don't go beyond freshman year. So if you save for four years in a restricted plan without other children to name as a beneficiary, then you have to pay income tax rather than capital gains, plus a penalty.
Q. Should I assume as a parent that when my child is accepted to college I'll be able to talk the financial aid officer into giving me more aid, or matching another school's offer?
Miller: Don't count on it. Schools are increasingly unable to negotiate offers and you don't know what the situation will be in the year that your child will apply.
Case: It depends on the institution. Those that give need-based aid, the Ivy League schools, are going to use a formula based on family resources to provide aid equal to full need. Still others have merit-based aid programs. Brandishing a letter from another institution that also awards aid on the basis of need, but that measured the aid in a different way, would cause us to say, "Hmm, let's look it over again and perhaps have an interview with the family." It happens. But the majority of institutions in the country can't meet full need because their resources are limited.
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