The ABCs of College Planning
Depending on how old your kids are, you may have ample time to plan ahead, or graduation is on the horizon and the clock is ticking.
Sorting through the process, from 529 plans, to taking out loans, to financial aid from the government or the college, to scholarships, there are so many options.
Taking a step back and looking at the big picture, and then breaking it down into a series of decisions and action steps can reduce stress and help you manage costs.
Reduce Costs Where Possible
If college is around the corner, the first thing to help reduce the cost is to submit the Free Application for Federal Student Aid (FAFSA). Even if you don’t think you’ll qualify, you should submit it. The FAFSA is what qualifies students to receive grants, student loans, and other financial aid. If you have multiple children you should definitely submit for everyone, as it impacts the Expected Family Contribution (EFC) – in a good way.
Applying for scholarships is another way to lower college costs and doing so has never been easier. There are scholarship websites students can use and apply to while they’re still in high school, local businesses may offer scholarships to recent grads, colleges typically offer academic and athletic scholarships - there are many options available.
While a degree from a top-tier school does have its advantages in the workforce, it’s not entirely necessary. The important thing is to find a school that aligns with your budget.
Should You Supplement with Student Loans?
Going to college debt-free is the ideal state, but student loans when used to supplement other sources of funding can take the pressure off both parents and children. Federal loans generally provide lower interest rates than private loans and have the ability to be paused by the government, as we’ve seen throughout the pandemic.
Private loans are issued by organizations such as banks or credit unions and typically have variable interest rates. Federal loans are generally preferred over private loans as payment periods are more borrower-friendly and the lower interest rates can save money over the length of the loan.
For parents with several children to get through college, student loans can bridge the gap during the college years. Once children are out of school and the financial burden is lighter, it’s always possible to use the gift tax exemption to help ease the burden of loans.
To Save or to Invest?
529 plans let you put money away for college and if the funds are used for qualified education expenses, the withdrawals are not subject to federal income tax. This means that the account can be invested and grow tax-free. They may provide state tax benefits, but these vary from state-to-state. 529 plans don’t have annual contribution limits and contributors to the account can use the gift tax exclusion to avoid paying taxes on the funds. If the 529 plan is a parental account or dependent student account, the first $10,000 of savings is excluded from the EFC calculation, and only a limited percentage (currently 5.64%) of amounts above that are included.
Similarly, qualified withdrawals are not counted as income. Withdrawals made for non-qualified expenses are subject to income tax and a 10% penalty on the earnings and 529 plans can also have more fees than a traditional savings account so it’s important to do some research and find low-cost options that fit your criteria.
While 529 plans are considered an investment, the options are much more limited than a standard investment account. For this reason, some families opt to save for college in a standard taxable investment account. These accounts don’t offer tax benefits, but the funds can be used however you’d like without penalty.
The Takeaway
When it comes to paying for college, there’s a lot to think about. There are many variables to consider, but the most important thing is recognizing the need for planning and taking action ahead of time. Being proactive is much less stressful than being reactive, especially when it comes to money and savings. By laying out your options, weighing the pros and cons, and taking your own financial situation into account, you can begin to build a flexible plan that meets your needs.
Andrew Comstock, CFA
Principal - Wealth Advisor