Smart financial planning for college: a parent’s guide
Smart financial planning for college: a parent’s guide
As parents, we all want the best for our children, including the opportunity for a higher education. But with the ever-rising costs of college, many families are concerned about how to afford it, especially those who are unlikely to qualify for need-based financial aid.
We all know that a college education is a significant investment. Even in 2024, the average cost of a four-year public in-state degree can easily exceed $100,000. And that doesn’t include textbooks, supplies, and other incidental expenses.
Our goal today is to explore how to effectively plan and save for your child’s education so they can pursue their dreams without being overwhelmed by debt. Whether your child is 5, 10, or 15 years away from starting college, it’s never too early or too late to start preparing. By developing a solid financial plan, you can ensure that when the time comes, your child has the opportunity to attend college without financial worry.
In this article, we’ll provide step-by-step instructions to help you maximize your financial resources and support your child’s educational journey.
Understand student aid and expected family contributions
Federal student aid eligibility is determined by various factors without a specific income cutoff. When you fill out the Free Application for Federal Student Aid (FAFSA), the information you provide determines the Student Aid Index (SAI). The SAI estimates how much your family is expected to contribute to your child’s college education based on your income, assets, family size, and the number of family members attending college.
Here’s a rough breakdown of how it works:
Family income: the SAI calculation considers your family’s AGI along with untaxed income and benefits like tax-exempt interest income and deductible retirement contributions.
Allowances against income: several allowances are subtracted from your income for necessary expenses like federal and state taxes, payroll taxes, essential living expenses, and an employment allowance.
Assets: the calculation also considers assets such as cash, savings, checking accounts, investments, business net worth, trusts, and education savings accounts. Child support received is also considered an asset. A nominal asset protection allowance is subtracted, which is based on the age of the older parent and whether the household has one or two parents.
The total expected contribution is then assessed, much like taxes, at rates ranging from 22% to 47%. Some students can qualify for zero expected family contribution if their parents’ combined income is $29,000 or less. However, for many families, there is little likelihood of qualifying for zero expected family contribution.
In a nutshell, most parents can expect to pay tens of thousands of dollars per year to send a child to college. Expected contributions are relatively high because non-liquid assets like business and investment net worth can affect your expected contribution. And the thresholds and requirements for need-based financial aid are particularly hard to meet.
Consider a college savings plan as early as possible
With the cost of education steadily increasing, starting a dedicated savings plan early can make a substantial difference. Early savings benefit from compound interest, easing the financial burden when college bills start arriving. Even if you save more than needed, there are some ways to use excess funds.
Types of college savings accounts
There are two main types of college savings accounts: Coverdell Education Savings Accounts (ESAs) and 529 plans. Both types of accounts allow your money to grow and be withdrawn tax-free, provided the funds are used for qualified educational expenses. If the funds are not needed for education, you can change the beneficiary to another family member.
Coverdell ESAs
ESAs have a lower annual contribution limit of $2,000 per year per beneficiary. Contributions are phased out for joint filers with an AGI between $190,000 and $220,000. You cannot contribute to an ESA if your income exceeds that threshold.
However, ESAs are versatile and can be used for a wide range of educational expenses, including K-12 schooling. Withdrawals are free from federal taxes if used for qualified expenses like tuition, books, tutoring, supplies, room and board,and even computer equipment and internet service. If funds are used for non-qualified expenses, the earnings are taxable and subject to a 10% federal penalty.
If your child earns a scholarship, the amount of the scholarship is deducted from allowable expenses. For example, if they have $10,000 in qualified expenses and receive a $4,000 scholarship, $6,000 can be withdrawn tax and penalty-free to cover remaining expenses.
ESAs must be distributed by the time the beneficiary reaches age 30, but you can change the beneficiary to another family member under age 30 if excess funds remain.
529 plans
529 plans have much higher contribution limits, varying by state. Generally, parents can contribute up to $18,000 per year in 2024 without triggering the federal gift tax and can front-load up to five years’ worth of contributions.
Many states offer tax deductions or credits for contributions to their own 529 plans. Some states provide benefits for any plan, not just in-state plans. These states include Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, and Pennsylvania.
529 savings can be used at any eligible college nationwide, and you can withdraw up to $10,000 per year for K-12 tuition.
If your child receives scholarships that cover their education costs, you can withdraw an equivalent amount without penalty, though taxes will apply to the earnings.
The good news is that your child can be the beneficiary of both a 529 plan and an ESA, allowing you to contribute to both accounts in the same year.
Set goals to increase the chances of receiving merit-based scholarships
It’s not just about how you’re going to pay for college; it’s also about finding ways to reduce expenses so less money has to come out of your pocket.
It’s important to get your child involved in the college planning process early. Their active participation is key to securing scholarships and managing future college expenses.
Strive for high grades
Encourage your child to aim for high academic performance. Merit-based scholarships often depend on GPA and standardized test scores. Emphasize that their efforts in middle and high school can greatly impact their college funding opportunities.
Participation in extracurricular activities
Participation in clubs, sports, and community service also enhances scholarship applications. Colleges look for well-rounded individuals who show leadership, commitment, and a willingness to give back to the community.
Parental support and motivation
As parents, your role is crucial in motivating and supporting your child. Work with your child to set achievable academic and extracurricular goals. Offer resources like tutoring, test prep courses, and access to extracurricular activities. And stay involved in your child’s academic life because faculty can often provide key information to ensure your child excels and has the best chance of receiving merit-based scholarships.
Start the scholarship search early
Start looking for scholarships early in high school. This can give your child a competitive advantage by allowing more time to find and apply for various opportunities.
For local scholarships, check with your child’s high school guidance counselor, community organizations, businesses, and civic groups. Local scholarships are often overlooked and have fewer applicants, increasing your child’s chances of winning.
You can also search for national scholarships using online databases like Fastweb, Scholarships.com, and the College Board’s Scholarship Search. These platforms allow you to search for scholarships based on your child’s qualifications and interests.
Junior year: consider a range of educational institutions
As your child reaches their junior year, it’s a good time to explore educational options and plan for college credits and costs. Encourage your child to take AP courses. These classes look good on scholarship applications and can earn your child college credits, saving time and money.
Also, look into the financial benefits of staying in-state for college. In-state schools typically offer lower tuition rates, and some offer scholarships or grants for in-state applicants.
Another cost-effective option is to have your child attend a community college for the first two years to complete general education requirements. Afterward, your child can transfer to a four-year institution to finish their degree. This pathway can offer significant savings on tuition and other expenses.
Senior year: application and financial aid process
When your child enters their senior year, it’s time to focus on college applications and securing financial aid. Be sure to complete the FAFSA, even if you think your child won’t qualify for need-based aid. Many schools require the FAFSA for scholarship eligibility, including merit-based scholarships. Submitting it ensures your child is considered for all possible aid.
At this point, your child should have identified several other scholarship opportunities. Keep them on track to ensure they finalize each application. It may help to create a checklist of all scholarships and their deadlines and gather necessary documents, like transcripts and letters of recommendation, in advance.
Post-acceptance: understand and utilize available tax benefits
Once your child is accepted to college, it’s time to explore tax benefits that can help reduce the cost. Two key tax credits are the Lifetime Learning Credit (LLC) and the American Opportunity Tax Credit (AOTC).
Lifetime Learning Credit
The LLC helps offset the cost of higher education for students in undergraduate, graduate, and professional degree programs, as well as courses to improve job skills. There is no limit on the number of years you can claim the credit.
It’s worth 20% of the first $10,000, up to $2,000. For 2024, the credit is reduced if your AGI is between $160,000 and $180,000 if filing jointly. It cannot be claimed if your income exceeds these limits.
American Opportunity Tax Credit
The AOTC offers more tax savings but can only be used by students in their first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student. Up to $1,000 of the credit is refundable even if you owe no tax. Like the LLC, the credit is reduced if your AGI is between $160,000 and $180,000 if filing jointly.
Plan ahead to ensure your child’s education is financially manageable
This article provides an overview of strategies for paying for your child’s education. If you’d like more personalized information and advice, please contact our office. We’re here to help you plan effectively and ensure your child’s college journey is financially manageable.
