Most planners think of college planning as accumulation planning – contribute to a 529 plan, invest properly, and start spending in 5, 10, or 15+ years; and if you don’t earn much income nor have a lot of wealth, you can apply for need-based financial aid. In reality, though, it’s never too late and you’re never too wealthy to keep doing good planning for college funding… but the strategies are different!
Late-Stage College Planning
At the FPA Annual Convention, Deborah Fox of Fox College Funding shared some insights into what she calls “late stage college funding for high income families” – in other words, how to help families manage the costs of college when children are on the cusp of going off to school, or may already be there, even if their incomes/wealth is too high for traditional need-based financial aid. And with a 2009 average cost of college of $19,388/year for a 4-year public school and $39,028 for a 4-year private institution, every bit of effective planning can really help!
As Fox points out, the first key is to figure out where the family stands relative to need-based aid; for many families, their income and wealth is low enough to clearly qualify, while others may have far too much income and wealth to quality. But there is a large middle space where families might qualify, with some proactive planning. The bottom line: don’t give up on the possibility of need-based aid too quickly, especially if the family is trying to fund a private college that may cost over $40,000 per year! And even if the family doesn’t qualify in one year, remember that they may qualify in a subsequent year, as the family income changes, wealth fluctuates, and in some cases as additional students go off to school at the same time (the financial aid Expected Family Contribution formulas shift significantly when there are multiple children in college simultaneously). Families who don’t qualify because of assets in the student’s name may wish to spend them down (legitimately!) and seek out need-based financial aid in subsequent years.
College Tuition Discounts And Merit Aid
Another strategy Fox highlights is seeking out tuition discounts – a reduction in the “sticker price” of the college. Since 1990, average discount on “sticker price” has risen from 26.5% to 42%. How do you get a discount? Match the student to the profile that the school wants. This isn’t just about GPAs and standardized test scores, either; it may consider talents, majors, other programs, leadership, etc.
Similarly, students may look to opportunities for receiving merit aid – broadly speaking, this is financial aid not tied to the family’s finances. And again, it’s not all about having a perfect GPA or astronomical standardized test scores; different schools have different standards, and there is opportunity if you take the time to match the student to what the school is seeking. Notably, merit aid is typically good on a sustained basis for all 4 years as long as a minimum GPA (e.g., 3.0) is maintained; it’s not year-to-year like need-based aid.
Perkins And Subsidized Stafford Student Loan Strategies
Also popular are student loans. Perkins and subsidized Stafford loans have very low interest rates, but are generally need-based and not available to higher-income families. But unsubsidized Stafford loans may be available at a 6.8% fixed rate for the 2010-2011 school year, as well as PLUS loans at 7.9% rate. In a world where so many families own homes that are underwater – which means a home equity loan is not an available loan source for college funding – these student loans may be more appealing than ever?
However, Fox warns that you should be more cautious about alternative private loan programs; they tend to have variable interest rates (and potentially a very high rate!), credit-based lending terms (which means students will need a co-signer), and repayment terms that may not be as friendly or flexible.
College-Related Tax Planning Strategies And "Tax Scholarships"
Tax planning also creates many opportunities; Fox calls these techniques “tax scholarships” to help cover the cost of college. A popular strategy is to gift appreciated assets to children, but be certain to manage around the kiddie tax. Don’t neglect opportunities to (legitimately) hire your children and pay them as well – and then have them contribute their money to retirement accounts that don’t adversely impact financial aid in the future! And don’t underestimate how much can be sheltered even within the kiddie tax constraints!
In college years – taxation on children can still be pretty low! For example, look at a student with $5,000 of wages from a campus job, $12,000 IRA withdrawal (no penalty for college use; accumulated from pre-college family employment), and a $10,000 capital gain, with the student supporting themselves (not dependent on Mom & Dad’s return). Subtract a personal exemption ($3,650) and a standard deduction ($5,700), and the result is only $17,650 of taxable income, which is $3,398 in taxes (accounting for kiddie tax), minus a $2,500 American Opportunity Tax Credit = $898 in taxes due. If Mom and Dad had that $27,000 of income, they would have paid $7,450 in taxes. Tax savings – “tax scholarship” – of $6,552. Per year!
If the parent has a closely held business, consider a Section 127 Employer Education Assistance plan, which allows the business to deduct up to $5,250 per year for college payments, and the amounts are excluded from the child/employee’s income. To qualify though, the child must be age 21 or older, be a legitimate employee of the business, and not be a tax dependent of the parent/owner Note, however, as discussed in the September issue of The Kitces Report, that Section 127 plans are scheduled to expire under EGTRRA at the end of the year, unless extended by Congress; stay tuned in December!
On a final note, Fox cautions to be careful using 529 plans in coordination with some of these strategies. If you take a 529 withdrawal but already covered some college expenses via scholarships, Lifetime Learning or American Opportunity tax credits, etc., then not all of the 529 plan will be attributable to net qualified expenses and may become taxable (with a potential penalty as well!). This isn’t a reason not to use 529 plans for saving; just be cognizant about how funds are used and college planning strategies are coordinated.
To say the least, Fox’s session makes it clear that college funding planning is a lot more than just setting up an account to save and invest, and then liquidating it over the span of four years. But please note that the above information is really just a cursory overview of these strategies. If you’re really interested in learning more about these strategies and how to apply them with clients, check out Fox’s website (also includes a sign-up for her free newsletter), her blog, and her training program for advisors. I also hope to cover these strategies in much greater depth in a future 2011 issue of The Kitces Report!
For most financial planners, the focus of college planning advice is accumulation based. After all, it seems that almost by definition, “planning” for college means acting in advance by saving up money ahead of time so that the costs can be fund