This is often a scary time for parents of teens who will be heading off to college soon. Add to that the uncertainty that the pandemic has unleashed, and you’ve got quite a challenge.
This is especially true given that the cost of college has skyrocketed in recent years. Many of the most popular private universities now charge more than $300,000 for a single bachelor’s degree! In fact, the most expensive college in the U.S., which incidentally is not an Ivy League school, has an official cost of attendance at more than $80,000 for this school year! So, what should parents of college-bound teens be doing now? Check out the suggestions below.
1. Understand the Types of Financial Aid Available
A good starting point is to first learn about the different types of financial aid that is available. There are four main types: grants, scholarships, loans, and work-study. Grants and scholarships are types of financial aid that you don’t have to pay back and is often referred to as “gift aid.” Work-Study is a federally funded program that enables students to earn money to pay for college expenses through part-time employment, typically on-campus. The money earned does not have to be paid back. Those in need of additional funds can turn to federal and/or private loans, which must be paid back. Private loans usually come with higher interest rates that are based on your credit. Work-study and loans are often referred to as “self-help” aid.
2. Know when the Financial Aid Clock Starts Ticking
The financial aid system requires parents to use their two-year-old tax returns (referred to as prior-prior tax return or base year) instead of their most recent. For example, the base year for students entering college for the 2023-2024 school year is 2021. This means that you will be required to submit your 2021 income and tax information on the financial aid applications, which will help determine your financial aid eligibility. One of the best ways to maximize your financial aid eligibility is to begin developing your funding plan before your base year, as there may be strategies that you can implement to reduce your Expected Family Contribution (EFC) (more on this below).
3. Determine your Financial Aid Eligibility
Ideally, before a family starts seriously looking at colleges, there are two terms that they should be familiar with: Cost of Attendance (COA) and the Expected Family Contribution (EFC). The COA is a figure calculated by financial aid offices that represents the average cost of attending their college for that academic year. Think of it as the sticker price, then understand you may end up paying less once you subtract the financial aid awarded. It not only includes tuition and fees, but also estimates of the costs of books, supplies, room and board, transportation, personal expenses, etc.
The financial aid system presumes that parents and students are able to contribute some money towards educational expenses. How much the family is expected to pay is determined by complex formulas. The EFC represents what a household should be able to contribute towards a student’s college education for that particular year of college. Said another way, it’s what the federal government thinks you can afford for college. Factors include the parent’s and student’s income and assets, number of kids in college, age of oldest parent, among others. Keep in mind, the EFC helps to determine if you qualify for financial aid and it’s not the actual dollar figure you will pay – it may be less (although rare), it may be more. The EFC will also help families determine whether they should target schools that provide merit aid or need-based aid.
The difference between the amount the family is expected to contribute (EFC) and the total cost of attendance (COA) represents the student’s financial need (COA – EFC = Financial Need). This formula establishes the family’s eligibility for financial assistance and must be re-calculated each year the student is in college.
It is important for families to have a realistic idea of what colleges will expect them to pay before ever submitting one college admissions application. Parents MUST lead the college selection process (with the child as the co-pilot) because you have the most to lose. Unbeknownst to many parents, the college list is the most important factor in college affordability. STARTING with the RIGHT list of candidate schools is essential to an outcome that is aligned with your pocketbook!
4. Create a College Funding Plan
Parents need to identify where the money will be coming from to pay for college and the sooner, the better. This is especially true if their sights are set on an expensive private college or university. Most parents aren’t going to be able to pay for four or five years of college exclusively from their savings for one child, let alone two or more. Thus, it is very important for families to assess their funding sources, which can include:
- 529 savings plan balance
- Continuing monthly 529 contributions
- Estimated total 529 savings at start of college
- Custodial accounts (UTMA/UGMA)
- Parental pledged assets for college (beyond 529 assets)
- Parental pledged monthly contribution for college during college years
- American Opportunity Tax Credit (up to $2,500 per college student, subject to income restrictions)
- Student pledged assets for college
- Student pledged monthly contribution to college (is the student planning to work while in school?)
- Help from grandparents or others
Add up all your funding sources and divide that amount by four (or five) to determine the amount that will be available for each year of college.
5. Identify Ways to Close the Funding Gaps
After conducting the exercise above, parents need to address any potential funding gaps. One way to reduce a gap is to target schools that have a history of being generous in providing merit aid or scholarships. Every school is required to publish a Net Price Calculator (NPC) on their website, which aids in determining what the net cost would be for a specific college. When money is an issue, and it almost always is, parents should not let their child apply to any college without running the calculations. However, beware – not all net price calculators are accurate, but its’ a good first step.
Loans are also another way to fill a funding gap. The best loan is the federal Direct Loan, which is exclusively for students. This loan only allows a dependent student to borrow up to $27,000 for four years and up to $31,000 for five years. The federal government also allows parents to borrow to pay for college costs through the Direct PLUS Loan. Home equity lines of credit or private loans are other possibilities.
If borrowing will be necessary, parents should understand how much the monthly payments would be before signing on the dotted line. During a 10-year repayment period, every $100 that is borrowed will require a roughly $100 monthly repayment for federal student loans and slightly higher for the parent loan. For example, if a student borrowed $27,000 in a federal Direct Loan over a four-year period in college at the current interest rate of 3.73%, the monthly payment would be approximately $270 per month over a 10-year repayment period.
Grandparents may also help pay for college, oftentimes from a 529 plan that they established. If this is the case, explore whether they could get a tax deduction or credit by first steering the college payment through a 529 plan. In roughly two-thirds of states, 529 contributors can capture a quick tax benefit. However, there are important strategies that families should be aware of then using grandparent owned 529 funds. The money that grandparents use to cover college costs is considered the child’s untaxed income and this income is assessed at up to 50%. That’s a very stiff penalty! To avoid jeopardizing a child’s chances for financial aid, the timing of when to use these funds is very important.
There is also a recent development (thanks to the CARES Act) that parents and grandparents need to understand—529 plan assets can now be used to pay off a certain amount of a student’s college debt.
If you need help with creating a funding plan, obtaining your EFC, determining your financial aid eligibility or understanding the rules around grandparent-owned 529 plans, schedule your complimentary consultation to learn more about how we may assist you.