There are certain things in life that many of us know we should be doing more of, but for a variety of reasons, we don't -- like flossing. Or saving for college. While advances in dental medicine may help you overcome one of these shortcomings, if you haven't properly planned for college expenses, you may think an emergency root canal is a walk in the park compared to trying to pay for four years of college.
And when you consider that, on average, tuition tends to increase by about 6% per year, college could cost almost three times what it currently does for a child born today.
According to the College Board, average total charges (including room, board, tuition, and fees) for an in-state student at a public four-year institution for the 2007-2008 academic year are $13,589, a 5.9% increase over last year. For out-of-state students, that number jumps to $24,044 a year. Average total charges at private four-year institutions are $32,307 in 2007-2008, also a 5.9% increase over the previous year.
For a child born today, that could put the cost of attending a private school at about $92,000 a year by the time he or she enters college. A family with two children who both attend private four-year institutions would be facing total costs of more than $750,000, assuming annual tuition inflation continues at its current pace.
That's a frightening number for most families. In fact, a family with a two-year-old and a newborn would need to save about $1,300 per month through the time the youngest child graduates to fully fund the cost of a private four-year institution for both children. This assumes a 6% annual inflation rate for total college charges and an 8% annual rate of return on savings.
Some people who see projections like this simply freeze and do absolutely nothing because they assume there is no way to save that much for tuition while being able to afford everyday expenses and save for retirement. Fortunately, the majority of college students do not pay the full sticker price at the school they attend. This is largely due to financial aid packages doled out to students each year. The financial aid given by colleges and the federal government consists of loans, grants, scholarships, and work-study.
While it is important to engage in a disciplined savings program to accumulate funds to pay for college, it is equally important to become educated about the financial aid process. There are many misconceptions about the process of applying for and receiving financial aid, and there are key strategies you can employ to help you qualify for the best aid package.
Misconceptions About Financial Aid
Loans vs. grants and scholarships. One common misconception is an assumption about the type of aid a student will receive. Some families incorrectly assume that aid will come in the form of scholarships or grants, which do not need to be repaid. But of the $97 billion in financial aid given for the 2006-2007 academic year, 40% was in the form of federal loans, which have to be repaid. Only 21% of the total financial aid came in the form of grants from colleges and universities.
Parents also may assume that the college will design a financial aid package that makes the college affordable. This is not the case.
Loans, while certainly necessary, only serve to defer the payment of education expenses. Parents need to be aware of this and plan accordingly, especially if the repayment period of those loans encroaches on their planned retirement. Also, overreliance on student loans may compromise students' ability to achieve certain life milestones after graduation, such as marriage or a first home purchase, because they end up saddled with too much debt.
Private vs. public schools. Another misconception among families is that they can't afford a private school, and their child will have to attend an in-state public university. "A student should never limit their choice of school based on cost," says Sherri Avery, director of student financial services at Brandeis University, a private school in Waltham, Mass. "Public schools generally have less scholarship and grant money to give out than private schools, so the net cost of a private school may be less than a public school depending on the aid package." Avery encourages students to apply wherever they want to go, then see if they receive an attractive aid package.
Negotiating for aid. Avery also points out a misconception about negotiating with a school to receive a better aid package: "We will entertain appeals from a family regarding the aid package that was offered; however, we won't 'match' an offer from another school," she says. Parents often will try to play schools against one another to get more aid. This might work when buying a car, but it is not likely to be successful with colleges. Avery explains that Brandeis, and most other schools, will offer more aid only if a discussion with a family reveals a change in their circumstances after the aid application was filed, or clarifies something that wasn't clear on the application.
In other words, most schools are not going to beef up their aid package to compete with another school for a student. There has to be a legitimate reason for any change in the aid package, one that fits under the criteria of offering need-based aid. Avery strongly suggests that parents contact the financial aid office to see if there is anything they can do. "Maybe there has been a change in job status, or an ailing grandparent has moved in with the family," she says.
Brandeis offers an open-house session for parents to talk about circumstances that may not have shown up on the financial aid application. "If we don't know, we can't help you," Avery says. Her staff spends about 80% of their time on the phone with parents, so the process does not end once you submit your application.
Positioning Assets to Enhance Aid Eligibility
Financial aid is generally broken down into two categories: need-based, which is based on financial circumstances, and merit-based, which is based on merit only. The principal provider of need-based aid is the federal government, with colleges being the second leading provider. The federal government's application is called the Free Application for Federal Student Aid (FAFSA).
When the FAFSA is submitted, the parents' current income and assets and the student's current income and assets are applied to a formula. After certain deductions and allowances against income, and exclusion of assets from consideration, the result is a number called the expected family contribution, or EFC. The EFC is the amount the family is expected to pay before any financial aid is granted. A family's EFC remains constant, regardless of the institution the student applies to.
As a matter of planning, the goal is to lower your EFC, which will then increase the student's aid eligibility. A few legitimate strategies exist that can enhance the amount of aid that is offered to a family. Be aware that you want to implement strategies that are consistent with the family's overall financial planning goals and not make major changes solely for financial aid reasons.
The federal methodology looks at the adjusted gross income of the parents and student from the previous tax year, also known as the base year. The base year for the 2008-2009 academic year is 2007. To the extent possible, parents should try to avoid pension and IRA distributions in the base year and to defer employment bonuses until after December 31 of the base year. Regarding investments, families should try to avoid selling investments that will yield a taxable gain in the base year, or consider selling losing positions in the base year.
There are asset positioning strategies that can help with aid eligibility. For example, paying down consumer debt will reduce cash on hand and decrease your assessable assets. Assuming that your child will need a laptop for school, it is a good idea to spend cash in the base year on this purchase or on another larger purchase, like a car. Consider using the child's assets first -- perhaps for the laptop purchase, for example -- because under the federal methodology, the government expects the child to contribute 20% of his or her assets to college tuition, whereas parents are only expected to contribute 5.6% of their assets.
Lastly, it is important to be familiar with the assets that the federal methodology counts (assessable assets) or excludes (nonassessable assets) when figuring the EFC. As assessable assets increase, so does the EFC. Shifting assets to exclude them from the calculation can boost aid eligibility. The following assets are nonassessable for the federal methodology:
o Annuities
o Cash value life insurance
o Retirement accounts (401(k), IRA)
o Personal items such as automobiles, furniture, and household items
o Home equity in a primary residence (note that this is included in the institutional methodology).
There are two primary formulas for calculating a family's EFC: the federal methodology and the institutional methodology. The federal methodology formula determines eligibility for federal aid programs, while the institutional methodology calculates a family's EFC for the college's own financial aid offering. Some aforementioned strategies may work better under one formula than the other.
Always Apply for Aid
Higher-net-worth families who may think they will not qualify for financial aid are nonetheless encouraged to at least apply for it. Since a family's financial situation could change suddenly (e.g. job loss, unexpected disability), and because the criteria for receiving aid can change from year to year, it is still a good idea for a family to submit a FAFSA.
To capitalize on the planning opportunities, families should stay on top of the rules and regulations of the financial aid process and implement any income and asset positioning strategies in advance of applying for aid.
David Juliano, CLU, is an advanced planning consultant in wealth management at Commonwealth Financial Network. His focus is on financial planning software and executive benefit planning.
