By Eric Bank
College can seem costly, but with an early start and prudent planning, it can be reasonably affordable. Much rests on the college your child attends and the financial aid offered to you. The trick is to start planning while your child is still young and to learn about the most efficient methods to pay future college expenses.
The biggest education expenses are:
Tuition: Usually calculated as a cost per credit, with a set number of credits earned by each course. You’ll frequently come across three- and four-credit classes, although some courses may offer a different number of credits. Attending college full-time college requires a set number of credits per term, usually at least 16. Many schools divide the academic year into fall and spring semesters and one or two summer sessions. Other colleges utilize a trimester schedule or another variation. Online courses may not have a fixed timetable, and usually are available at a much lower cost.
Fees and Books: Schools extract various types of administrative fees, principally for registration. Students can easily spend hundreds of dollars per term on books and other educational materials, even though many schools offer discounted materials online.
Room and Board: You can save money if your child lives at home or with a family member while going to school. Otherwise, expect to pay for your child’s food and rent. Many colleges offer on- and off-campus housing and a dining plan for a fixed cost per term. Alternatively, your child might make different arrangements involving private housing and/or dining, and if you want to pay these costs, you’ll have to figure them into your budget.
Other Costs: Always assume other costs will arise, including special tutoring, transportation, athletic programs (equipment, uniforms, etc.), and more.
As is plain to see, you’ll have to consider many cost components when planning how you’ll pay for your child’s education. This guide will overview important facts about college costs and some strategies for paying these costs.
The College Board compiles the average annual amounts for tuition, fees, room and board, categorized by school location and type. Undergraduate programs in your state will, on average, be less costly than out of state ones. Not surprisingly, two year programs cost less than four year ones, and public schools charge less than private schools.
The 2015-16 average yearly costs for full-time tuition, fees, room and board, are:
Public Two-Year In-District
Public Four-Year In-State
Public Four-Year Out-of-State
Private Nonprofit Four-Year
Tuition and Fees
Room and Board
As you can see, the costs vary noticeably. A student attending a two-year community college and residing at home will need $6,870 on average for the two years. Dispatching a child to a nonprofit private college for four years will set you back an average of more than $131,000. As these are only averages, you might have to shell out even more for the privilege of having your child attend one the country’s top universities, although these schools frequently offer liberal financial aid packages.
The balance of this guide offers strategies to help make education expenses more affordable via the use of savings, aid and loans. Many students earn income while attending school by participating in various activities, including private tutoring, full- or part-time jobs and college work-study programs. Since this guide focuses on parents, we will not discuss student income any further.
You can finance your child’s education using your portfolio of investments, but you might prefer to cover education expenses via tax-favored programs.
Section 529 accounts are tax-free as long as you apply distributions to qualified college costs. The two major plan types are:
Prepaid Tuition Plans: These are state-sponsored accounts in which you pay in advance for tuition credits at a qualified educational institution within the state, frequently at a discounted rate. The state invests the money it receives– you simply are buying guaranteed credits. There is also a national program, the Independent 529 Plan, that applies to about 300 educational institutions throughout the country.
College Savings Plans: These are investment accounts in which you control contributions that grow tax-deferred. Cash from these plans is distributed tax-free when used to cover qualified education costs, including fees, tuition, room, board, books and supplies. The amount you accumulate for your child hinges on the plan’s returns. These plans are offered by mutual fund companies that invest the funds for your benefit.
529 Plan contributions that exceed the yearly federal gift-tax exemption ($14,000 in 2016) may be subject to the gift tax, although you can sidestep the tax if you invoke your lifetime gift tax exemption -- $5.45 million per individual in 2016. A special codicil allows you to contribute a lump sum amount equivalent to five-years-worth ($70,000) of the yearly gift-tax exemption and then use the exemptions over the subsequent five years, penalty-free.
You can circumvent inquiries from the IRS about the proper use of 529 Plan withdrawals by electronically transferring distributions directly to the college. Many plans provide this feature, and also facilitate monthly contributions straight from your bank account.
The money in a parent’s 529 plan is included in federal aid formulas, at an assessment rate of 5 to 5.6 percent per year. However, grandparents may get a better deal when they distribute money from a 529 Plan. Generally, distributions from a grandparent’s 529 plan decrease the student’s federal aid by 50 cents for each dollar, but won’t decrease federal aid at all if distributions are postponed until the federal aid is finalized, normally by the end of the sophomore year or sooner.
When selecting a College Savings Plan, be mindful that most states which assess income tax provide a deduction or credit for plan contributions. For instance, Michigan offers a state income tax deduction of up to a $10,000 for 529-Plan contributions. The benefit to you is the contribution times your state income tax bracket. So, if your tax rate in Michigan is 4.25 percent, your tax deduction could be as high as $425.
Another important issue is the plan’s expense ratio. Michigan assesses a moderate 0.2 percent fee if you put the plan’s funds into a stock index fund. Other states might charge somewhat more, so it makes sense to examine how the fees add up. For instance, you’ll shell out more if you transact via a stockbroker and trade frequently.
Coverdell plans permit you to contribute as much as $2,000 annually. The money grows tax-deferred, and distributions for qualified education costs are tax-free. Contributions may be disallowed if your earnings exceed specified limits. Coverdell accounts don’t provide tax deductions for contributions. You must initiate a Coverdell account prior to the student’s 18th birthday, cannot add money after that date, and must distribute all the money as of the student’s 30th birthday. You can also use Coverdell accounts to pay private school expenses for grades K through 12.
You’ll usually pay a 10 percent early-withdrawal penalty when you distribute money before age 59 ? from a retirement account, such as a traditional IRA or 401(K). That’s in addition to regular income taxes on the withdrawals. However, you can make early withdrawals from IRAs without penalty if you use the money to pay qualified education expenses for yourself and/or other household members. The penalty exception doesn’t encompass qualified retirement plans such as 403(b)s or 401(K)s, but you might be allowed to borrow money tax-free from these plans, up to specified limits. Another option for tapping into your retirement plan early and penalty-free is by receiving a series of substantially equal payments. Bear in mind that money you distribute from your retirement account to finance your child’s education won’t be available for your retirement.
The interest income from Series I and Series EE U.S. Savings Bonds is tax-free when you cash in the bonds and apply the proceeds to pay for qualified educational expenses at eligible schools – i.e. schools that can receive money from federal student aid programs. This tax break is only available if your income doesn’t exceed specified thresholds. The bonds must be issued in the parent’s name(s), not the child’s. You can purchase up to $10,000 in Savings Bonds annually. The disadvantage of this method for financing education costs is that savings bonds are currently paying puny interest.
Students often receive scholarships and grants to help pay for post-secondary education. This is tax-free money, and it decreases the money parents must cough up to help pay education expenses. Scholarships are merit-based, whereas grants are based on need. Aid is offered by the federal government, state governments, schools, and non-profit or private organizations.
Students can apply for federal student aid by submitting a Free Application for Federal Student Aid (FAFSA). The form elicits financial data and sources of student assistance. The federal government distributes grants based on specific eligibility criteria, including:
Enrollment in a qualified school, at least half-time
Having a high-school diploma or equivalent
Maintaining satisfactory academic grades
Registering with Selective Service
The amount of aid a student will receive is based upon a complicated set of regulations that take into account parents’ “expected family contribution,” which is determined by family income, college costs, savings plans, and so forth. The information included in the FAFSA determines the amount of federal aid a student will be provided. Parents can employ various strategies to reduce their expected family contributions, including:
Postponing Social Security benefits, if applicable
Postponing capital gains on stocks, bonds and other investments
Taking capital losses
Earning rental income, which is frequently excluded from expected family contributions because depreciation can eliminate the profit (on paper) of property rentals
Not making tax-deductible contributions to retirement plans, because they are added back for purposes of calculating aid – that’s a bad deal
Owning a small business, because its value is excluded when computing aid
The federal government also provides two programs, the Lifetime Learning Credit and the American Opportunity Credit, that permit you to annually claim $2,000 - $2,500 per student for qualified educational costs.
Student loans assist parents by decreasing the money they feel they must contribute to their children’s schooling. Some parents may choose to help their children repay the student loans as they come due. This can be a reasonable strategy for parents who anticipate being richer in the future than they currently are.
Moreover, parents can ask for a PLUS federal student loan, as long as their children are undergraduates who go to a post-secondary school at least half-time. The parents, not the students, are responsible for repaying PLUS loans.
There are two kinds of student loan programs:
Federal Student Loans: These are provided by the federal government, and include Direct Unsubsidized Loans, Direct Subsidized Loans, Direct Plus Loans (for professional and graduate students or their parents) and Federal Perkin Loans.
Private Student Loans: These are non-federal loans offered by private lenders such as schools, banks, credit unions and state agencies.
Federal student loans offer several benefits that private loans don’t:
They do not have to be repaid while attending school at least half-time
The interest rates are low and fixed
Financially needy undergraduates currently going to school at least half time can qualify for subsidized loans in which the government pays the charged interest
No credit check is needed
Student’s don’t require a co-signer
Interest could be tax deductible
Loans may be consolidated to decrease monthly payments
There are a few different repayment options, including one linked to the student’s income
There is no prepayment penalty
Certain public service work can result in loan forgiveness
Students apply for federal student loans via the FAFSA.