At the end of my last post on college planning, I asked if there were any reader questions about college stuff I could answer and a few people asked about the best ways of saving for college. Because I am a nerd, I find this to be a fascinating question and one that as I started thinking about answering it, a bit more complicated than one might expect. In the interest of simplicity let’s create a scenario: Jane is a 17 year old going to a state university as a full-time student and is planning to live on campus. The tuition at her state university is $10,000 and her room and board is $5000. She has a backup choice of a private college where the tuition is $30,000 and room and board is $6000. So, how is Jane going to pay for college?
First, Jane and her family are going to fill out the FAFSA during the spring of her senior year, the sooner the better. When she fills out the FAFSA, Jane will indicate that she wants to get financial aid information from both State U and Private College. Once she submits the FAFSA, the following things happen:
- Jane’s file gets processed so that her expected family contribution (EFC) can be determined. Her EFC is based on the following info and is the exact same for both schools:
- her parent(s) adjusted gross income
- parental cash on hand (savings and checking)
- net-worth of parental investments (excluding home value and qualified retirement accounts like 401K and IRAs)
- net worth of business or farm assets
- student adjusted gross income
- student cash and savings
- student investment assets
- When it comes to coming up with the EFC, there are a few things that are important to know:
- The formula assumes that SOME but not ALL of a parent’s cash and assets are going to go toward college expenses. The ratio is about 6% (per year).
- The formula also assumes that some but not all of the student’s cash and assets will go toward college expenses and expects that MORE of the student’s money is available for use, about 20% per year
- The EFC is for the family, so if you have more than one child in college at a time, the EFC is what IN TOTAL the family would be expected to contribute for both students. This is when having more than one kid in college at a time is helpful.
- The EFC formula is determined by law and applies to all colleges/universities. It is also not a secret. Go here and look at the worksheets if you really want to get a glimpse of what your EFC might be in the future, if you aren’t doing a FAFSA.
- The EFC doesn’t factor in consumer debt or make allowances for regional cost of living differences.
- You can have an EFC of $0 but you can’t have a negative number.
- Let’s assume that Jane’s family has an EFC of $3000. REALLY IMPORTANT NOTE: This does not mean that Jane’s family actually has $3000 available at the moment nor does it mean that either school will send Jane’s parents a bill for $3000. This is just a number used to fill in the next part of the formula.
- State U and Private College will both use Jane’s EFC to determine her level of financial need. Financial need is determined by taking the school’s Cost of Attendance (COA) minus Jane’s EFC. A
fewmany words about the COA:
- COA includes the following factors: tuition, fees, room and board, estimated costs of books, supplies, living expenses, child care (if applicable), and costs related to having a disability (if applicable).
- The COA is also NOT A BILL. A good chunk of the factors in the COA are not billed by the school (supplies, living expenses, etc) and different students will spend very different amounts on those things in real life. But the COA uses an estimate that they hope will apply to most students. For State U, for example, the cost of tuition and room and board might be $15,000 but the COA for financial aid purposes might be something like $21,000
- Don’t let the COA freak you out too much. It isn’t a real number.
- Once the math on Jane has been done it might look something like this:
- State U: $21,000- $3000= $17,000 in financial need
- Private College: $42,000- $3000= $39,000 in financial need
- Now that Jane’s level of need is determined, each school will figure out how to meet that financial need through a combination of grants and loans. Jane will get something called an award letter from each school that will break it down something like this:
- The amount of money in those categories is going to be different for each school. State U might not have a grant program but Private College will (think of private colleges as being like Kohls. There is always a sale. Hardly anyone is paying the full sticker price)
- Now, Jane and her parents can make the decision about which school is more affordable for her but they’ll want to ask some important questions about that dollar amount in the total award line:
- How much of that money is loan versus grant?
- Does Jane want to do work study? She doesn’t get that $2000 if she doesn’t get a campus job
- Are the college grants and scholarships renewable? For how long? What are the criteria for renewal? I hate to say it, but the models are built on the fact that some students won’t maintain the GPA needed for renewal but will be so attached that they’ll stay at the school anyways
- How much of those loans do we want to take out. Just because the loan is offered doesn’t mean it has to be accepted
- It is either helpful or maddening to think of a college classroom like an airplane: almost nobody paid the same amount for their seat.
- Once Jane chooses her school and accepts what aid she wants, only then does the bill arrive. If Jane chooses State U and her financial aid award was for $16,000 and she accepted the whole award (loans and all), she is not going to get a bill. Her tuition and room and board will be paid out of her financial aid award and she might even get $1000 back in cash because of the COA calculations. Or, let’s say she got offered a grant of $2,000 and decides to only accept that. She could end up with a bill of $12,000. Basically, Jane and her family will get to make some choices about how much they want to pay now and how much Jane will need to pay back later. This is comforting for some and confusing for others. Parents often want to know “what exactly will this cost us” and the answer is “well….depends….”
- If you owe a lump sum, you’ll almost always have the option to set up a payment plan so you don’t have to write one large and painful check. Instead, you can write several smaller, painful checks.
So, that is a bit on paying for college. Let’s talk about saving for college now.
When it comes to saving, there are a few things to keep in mind:
- there is no perfect formula for guessing how much money your kid’s college will cost. So much depends on where they go (community college vs state school vs private) and how long it takes them to earn a degree.
- you MUST (MUST!) prioritize retirement savings over college savings. I’ve seen parents put all their money toward their child’s future educational expenses before they max out their own retirement savings and this is just such a bad idea on several levels.
- There are some things you may want to do beginning when your child is still in high school to lower your EFC:
- consider using savings to pay down debt. Since your debt level isn’t calculated in your EFC and savings is, this might be a good time to get rid of consumer debt.
- Max out your retirement accounts instead of building liquid savings (assuming you are generally financially stable)
- Encourage elderly family members not to die and leave you an inheritance until AFTER your kid is in college. Now is not the time to come into a chunk of change, unless you want to use it to pay for college. So don’t sell that Picasso in the basement either.
- Many families invest in 529 plans. These are tax protected accounts set up to benefit the named beneficiary. A few things to keep in mind:
- Anyone over the age of 18 can open an account and designate the person it is for. An adult thinking about grad school in the future can open one for themselves. A grandparent can open one for a grandkid. A parent can open one for their child.
- There are various 529 options offered in various states. You need to do a little research but you are NOT limited to the one in your state
- 529 plans are to be used for paying educational expenses at a variety of types of post-secondary institutions. You don’t have to know where your kid is going when you open up the account.
- There are risks to the 529:
- many 529 plans are invested in mutual funds. If the stock market tanks than yes, you could lose some of your investment
- Not all plans are created equal when it comes to fees and expenses. Some will offer insurance policies so you don’t lose your money if the market tanks when your kid is in 10th grade. Some don’t. You really do need to comparison shop. This is where it might make sense to meet with a financial advisor and pay the $150 for some unbiased advice.
- If your kid opts not to go to college or if their college expenses are less than what you have saved you may face a 10% penalty plus taxes for pulling the money out of the account.
- If you are putting money into a savings account for college expenses, you are probably better off saving it in the parent’s name versus the child’s if your goal is to lower your EFC.
- Some states allow you to pre-pay tuition. So you can pay in today’s dollars for your child to go to a selected school in 10 years, when the cost of tuition has likely increased. The risk here is clear: what if your kid doesn’t want to go to that school and/or can’t get in?
The bottom line is that if you are financially stable and you aren’t carrying lots of consumer debt or paying off your own student loans and you want to save for college, you’ll want to consider a 529 plan or a savings account or perhaps CDs, depending on your tolerance for risk.