And now for the biggest college savings question of all!
How Are You Going to Pay for that?!?
Come college time, in addition to your savings, some of your child's costs may be covered by the items like financial aid; income - from both you and your child - during the college years; other borrowing options, such as a home equity loan; creative cost-cutting measures, such as encouraging your child to graduate in three years instead of four (good luck with that one) or convincing them to become an RA so that you can save on room and board costs. And finally, if you're lucky, maybe gifts from grandparents or other relatives. Even though these potential resources are off in the future, knowing they're out there might help you feel better as you start building your college fund now.
I'd like to talk for a bit about one of these resources: financial aid. Some parents assume that financial aid will cover a good portion of their child's college costs. But that may or may not be true.
Financial aid is a broad term, and your definition may not match the college definition. Actually, colleges are often not be on the same page as the parents (which you will come to realize), so it's important to understand exactly what it means.
Financial aid is money given to students, primarily by the federal government and colleges, to help pay for secondary education costs. This money can take the form of loans, grants, scholarships, or work-study. Keep in mind that loans must be repaid, so those will probably be your least favorite option. By contrast, grants and scholarships do not. In a perfect world, you want to maximize grants and scholarships while minimizing loans. In a really perfect world, you want to only have grants and scholarships and then have your kid become so successful that they buy you a beach house and offer early retirement. I cannot help you with the last part, otherwise, I would be writing to you from the Bahamas, but maximizing grants and loans is something we might be able to achieve. Here’s how:
The federal government offers two main grants: the Pell Grant and the Supplemental Educational Opportunity Grant, and you'll probably hear about them come college time. But these grants are limited to students with the greatest financial need. I'll talk more about how financial need is calculated in a minute. But suffice it to say that not only are these grants limited to those on the lower end of the income scale, they also are not that large; for example, the maximum Pell Grant for the 2021-2022 school year is under $6,345. This can certainly help, but since the price of a pencil in a university gift shop is the same price as a small TV, it will probably leave a lot of college costs for you to fund on your own.
For larger grant awards, look to individual colleges, where many awards can be in the tens of thousands of dollars. Colleges can award grants on the basis of need or merit. As college costs have soared in recent decades, the upper boundaries for need-based aid have climbed to levels that would have been unimaginable a generation ago, making many upper-middle-class families eligible for need-based grants. In the past, kids had to apply to and are accepted at a particular college to find out what their grant award might be. That was a little annoying, and it made it hard for parents to prepare. Today, there is a way to get an accurate estimate ahead of time.
Net Price Calculator
All colleges are required by the federal government to have a net price calculator on their website, which you can fill out before your child applies. A net price calculator asks for your family's income, assets, and general student information, and then provides an estimate of how much grant aid your child might expect at that particular school. The cost of the school minus this grant aid equals your child's estimated net price, hence the name net price calculator. It's a really valuable tool, and I hope you all take advantage of net price calculators in the future. Completing one only takes about 10 or 15 minutes, and it's a great way to compare the net price of different colleges. That definitely made me sound like some sort of net-price-calculator salesman, but I promise this isn’t an ad, they are just extremely useful.
How Is Financial Need Determined?
Now, how exactly is your child's financial need determined? Well, you might determine the financial aid your child needs as “please pay for the whole thing so I don’t have to”, but the federal government will probably come to a very different conclusion. Actually, they might decide that you should pay for the whole thing so they don’t have to - in that case, it wouldn’t be that different.
But believe it or not, the government helps you save money sometimes. Each year, the federal government looks at your family's income, assets, and personal information that you list on its aid application, called the FAFSA. It then runs this information through a formula and calculates a figure called your expected family contribution or EFC. The EFC is the amount of money the government deems you can afford to pay for college that year. Colleges typically do this same analysis using their own formula, which generally digs a bit deeper into your assets. Another important factor is the number of children you'll have in college at the same time.
Still, your income is the biggest factor in determining your EFC, and your EFC remains the same no matter what college your child applies to. The difference between your EFC and the cost of a particular college is your child's financial need. As a result, your child's financial needs will end up being different at every college.
When your child is accepted at a particular school, the financial aid administrator at that school will look at your child's financial needs and attempt to craft an aid package to meet that need. Sometimes, it can become a little bit like a grab bag of different aid opportunities. For example, it can be met with a combination of federal loans, grants, and work-study along with college grants and/or scholarships. Keep in mind, though, that colleges aren't obligated to meet all of your child's needs. If they don't, you're responsible for that portion too, in addition to your EFC. The beauty of having babies, right?
Assets Excluded from Consideration
Now let’s talk about assets. I want to point out that the federal government completely excludes some assets from its financial aid formula, including home equity, annuities, cash value life insurance, and all retirement accounts (such as Roth IRAs, traditional IRAs, 401(k) plans, 403(b) plans, and so on). Private colleges typically exclude retirement accounts too but may look at these other assets to get a full idea of your ability to pay. I warned you about the greedy claws of college, right?
Speaking of those, there's an important distinction to note when it comes to retirement accounts. While the federal government and colleges typically exclude your retirement balances from consideration, they usually factor in any contributions you've made in the year prior to the year you submit your aid forms. And some private colleges may expect you to apply some of these contributions toward college expenses. Nosy and greedy…wait, are we talking about the IRS?
Nope, still talking about college planning, and that means we need to talk a little bit about loans. When you file the FAFSA, your child becomes eligible for certain federal loans. Some of these loans are based on financial need, but one loan - the Direct Unsubsidized Loan - is open to any student, regardless of need. All loans have annual borrowing limits, and the student takes out the loan in his or her name - and thus is responsible for paying it back. You heard that right, parents. Your child will be the one responsible for repayment, which can make you nervous, excited, or both depending on your child’s track record of responsibility. Either way, it’s a great learning opportunity, and a great way to make sure you don’t catch the fall in case they forget to pay.
If you are really itching to pay for college, or if you feel responsible to do so (which is common), parents with good credit histories can take out a federal PLUS Loan for up to the full cost of their child's education. Beyond this, a parent might decide to co-sign on a private student loan, with the student as the primary borrower. If you cosign on a loan and your child can't pay back the loan after graduation, then you are on the hook.
How Much Should You Rely on Aid?
Welcome back! If you are ready to close out our conversation about college planning, you’re in luck. I’m almost done, but there are a few important things I want to reiterate before I end.
Of course, everything we have talked about so far is something that will happen well into the future, but it does illustrate why your college savings are so important. Students and parents who borrow too much for college can end up with a considerable debt burden that could last for years after graduation. The news is filled with stories of young adults with excessive student loan debt, and I don’t want your child to be one of them. The key is to save as much as you can before college to limit the amount you might need to borrow.
So, bottom line, how much should you rely on financial aid to cover your child's college expenses? The answer is don't expect it to cover everything, or even close to everything. That would quite literally mean you are relying on the government to help you save money, and we all know that that might not be the most realistic thing to do. While financial aid can certainly help cover some of the costs, remember that all financial aid isn't created equal – student loans need to be repaid.
The bottom line is to focus on your own savings.
Saving for College and Retirement
And speaking of your savings, I want to address a related issue that often comes up before I sign off. And that's how saving for college affects your retirement savings.
It's definitely a balancing act, but you should be saving for retirement at the same time you're saving for college. We all love our kids, but taking care of yourself can be just as important. There are no loans, grants, or scholarships for retirement as there are for college. And if you wait, you'll miss out on years of potential tax-deferred growth in your retirement accounts. And it can be very hard to catch up later. Then, you might have to rely on your kids to help you out which, again, might not be the most realistic thing to do.
One option is to allocate some funds toward retirement and some to college. But if you absolutely can't save for both college and retirement at the same time, it's probably best to err, for now, on the side of saving for retirement. Sorry kids.
I hope this month's information was helpful and if there is anything I can help you, as parents or grandparents, do to help your children achieve more, please ask, I'm here.
P.S. If you enjoyed what you've read here and found it beneficial, we encourage you to share it with your friends and family. I firmly believe that an educated investor is more confident, which leads to healthier finances and fewer sleepless nights.
Until next time...