The College Payment Puzzle for High-Earning Families
It is amazing the path my family has been down sending my own children to college and experiencing the rollercoaster ride of emotions and financial decisions that needs to made. Thankfully this experience has taught me many lessons which I hope to share with others first experiencing this process. No one prepares you for this and the scariest part for parents can be figuring out how to pay for it. It can be tempting to put your own goals on hold while you shoulder the big-but-temporary new burden. This is what I often see as a Ramsey Master Financial Coach. One of the ways I serve clients is in guiding them through the Dave Ramsey 7 Baby Step Process, and it is often people don’t follow the Baby Steps in order. Saving 15% for Retirement is Baby Step 4, but parents often want to skip to Baby Step 5 – Saving for your Child’s education. The problem with this is you may not be able to delay retirement and paying for college may be one of the most expensive costs you may incur. This is why it is important to have a strategy in place prior to agreeing to attend any particular college.
A better strategy for paying for college while keeping your goals on track is to build the right short-list of colleges together with your child and maximize financial strategies. We utilize a process called the College Pre-Approval Process. It is essentially knowing in advance how to Pay for 4 years of college down to the Penny and coming up with a budget for how you will pay for college. For families that make too much to qualify for financial aid, college funding likely won’t come from just one source. It’s about putting together a plan that draws from several buckets:
- Merit-based aid, scholarships, and grants
- Tax-advantaged savings
- Federal tax credits
- Cash flow planning
- Federal student loans
It’s a process, but building a plan that keeps family finances on track and debt low pays off now and in the future for you and your eventual graduate. The watchwords are information, flexibility, and negotiation.
Your College Money Report™ gives you answers to 3 critical things every family needs to know before entering the college funding maze.
- How much colleges think you can afford.
- If you will qualify for grants and/or scholarships.
- How much you will be expected to pay out of pocket.
Reality and Transparency Are Key
Cost should be included in the top criteria for deciding on a school. Setting an upper bound of what is affordable should be the starting point, and don’t just look at tuition. Factor in cost-of-living where the school is located, transportation costs for the student and the parents, and anything else you’ll have to pay for.
Unless a costly college also offers an excellent aid package – it shouldn’t even be on the list.
This will eliminate a lot of colleges from consideration, but it may also avoid tears and bad decision-making.
State schools are a great place to start, and you may not be limited to your state of residence. Many state universities also participate in regional programs that cap out-of-state tuition.
Your goal is to determine where your child will most likely get the biggest merit package. This is primarily a function of your child’s academic or sports record, but you should also be strategic and consider what your child’s interests are and if there are schools where they will be
For instance, a daughter in a STEM program will be very attractive to universities seeking to diversify their programs. Once you’ve come up with a list of schools where your child has a good chance of a solid award – apply, compare the awards, and negotiate. That’s right – don’t take the first number, even if you know the school is your child’s first choice.
There are many online-based services that can help you sort through all the college options. Two good places to start are College Scorecard, run by the United States Department of Education, and Big Future, created by the College Board. There are also search engines that can help you find scholarships.
Merit-based scholarships from local sources can make a significant part of your package. You’ll have to find these on your own, but it can be worth it. Start with your child’s high school guidance office. One time-saver is to ask for the previous year’s awards, which will list local resources that provided scholarships. The Chamber of Commerce, other business organizations, and places of worship may also have lists of available scholarships.
Don’t Neglect the FAFSA
The Free Application for Federal Student Aid is important even if you don’t think you are eligible for federal aid or grants. Many colleges and universities require it for consideration for merit-based scholarships or grants.
If you intend to apply for federal student loans, you’ll need to fill out the FAFSA anyway. If your child is considering a career working for the federal, state, local, or tribal government, or a not-for-profit organization, these loans may be forgivable under the Public Service Loan Forgiveness Program.
Take Advantage of the American Opportunity Tax Credit
The AOTC is a tax credit of up to $2,500 per child, per year. The income limit for the full credit is $160,000 for a married couple filing jointly. If you make over $160,000 but less than $190,000, the amount of the AOTC may be lower. It’s based on your MAGI, so maxing out 401(k) contributions may help you lower taxable income to a level that can qualify.
Even if college is imminent, saving in a 529 plan may still make sense. Many states offer tax benefits that essentially amount to a discount on tuition. You can contribute $16,000 per year and stay under the gift tax exemption, and you can contribute up to five years’ worth of exemptions at once. When you’re close to the time you’ll need the money, you want to be thoughtful about the equity allocation and not take on too much risk.
Cash Flow Planning
Thinking through college expenses as part of your cash flow planning can shift spending and save money. Quantify the total costs over four years after all aid/scholarships are determined. Then add up contributions from all sources – savings, family, student loans, student work, etc. Don’t forget about the amount you spend on the child when they live at home for food, clothes, gas, etc. This amount should be added to your contributions.
Subtract to figure out the total amount you’ll have to pay and then divide by the number of months. Breaking it down into a monthly number can help you keep a handle on the amount and help you identify budgeting sources to stack against it.
Many colleges offer payment plans with 0% interest. Instead of paying tuition all at once, you make a monthly payment. Over the course of four years, this can lower costs and make it easier to pay.
The One Exception to Using a Retirement Plan
If you have a deferred compensation plan as part of your executive compensation, you may be able to divert some of those funds to pay for education costs now, without paying taxes on them. You’ll need to talk to your company about how that will be structured, and it should be thought through carefully in the context of your entire financial plan.
Gifting Appreciated Stock
If you have appreciated stock, it may make sense to gift the asset to your child and have them sell it. Married couples can gift up to $32,000 worth of assets annually and stay under the gift tax exemption. The student must be at least 18 years old at the time of the sale to qualify for the capital gains rate based on their income. The long-term capital gains rate is 0% for those with taxable income of $40,400 or less in 2022.
The Bottom Line
Creating a plan to pay for college that maximizes all potential sources is a project – but it can pay off handsomely. And the benefits created by keeping loans to a minimum and ensuring retirement savings stay on track are lifelong for both student and parents.
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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.