By Brian Safdari, CCPS®
When you have a younger family as a client and their student is in 10th or 11th grade and beginning to look more seriously at what they want to study and which colleges interest them, those families may get sticker shock when they realize what this might cost over four years.
The sticker price on even a state university might be $30,000 to $40,000 a year with room and board, and a private school may be $300,000 to $350,000 if the parents are paying the full freight. How can they possibly have enough money to pay for college and still be able to retire in 10, 15 or to 20 years? How much longer will they work after the last child has finished college?
It’s not overstating it to say that panic often sets in for middle-income families.
The first bit of good news is that hardly anyone pays the sticker price, but it takes a couple of years of planning and exploration to ensure three important outcomes:
- The student will choose their best-fit college based not only on cost but also on how well the college suits their needs and prepares them for a career;
- The student and their family will maximize free money in the form of grants and scholarships to reduce the cost; and
- The family will retain the resources they will need in retirement.
The first step, though, is to acknowledge what they’re really facing. We must first look at the resources they have in the form of 529 college savings accounts and other savings. Let’s say they have $50,000 in savings; we subtract that from the anticipated cost, and that gives us the gap they have to bridge.
The next thing to look at is how much free money is available to start closing that gap. Here’s another bit of good news: By starting in 10th grade, or even 9th grade, families have two to three years to maximize need-based aid by repositioning assets and strategically applying for grants, scholarships, merit-based aid and institutional aid.
Most families don’t realize that a private college with a sticker price of $95,000 a year might offer very generous institutional aid to bring that cost in line with a state university, or even less.
The expected cost minus savings minus free money will likely still leave a gap. Once we have that number, we can start figuring out how to fund it over four years, while minimizing student debt and leaving enough money to retire.
There are basically five different ways of funding college.
1) Pay as you go.
Say there’s a $30,000 gap; most colleges will let the parents break that up into 10 monthly payments of $3,000. The upside of this approach is that the student graduates debt-free.
But there are significant downsides. If the school gave the family $20,000 in the form of a grant or institutional aid, but they see that the parents can cut a check for $3,000 each month, they may well reduce that grant aid in subsequent years.
Families also have to consider whether paying cash is feasible in case their income changes – a parent dies or loses their job. A plan to pay cash has to have an income-based stress-test.
Finally, paying cash means they are using after-tax dollars, and there’s no tax advantage in that.
2. Private loans. If a loan is part of the college’s financial aid offer, it will also send along its preferred lender list. Families want to be very careful in considering this for a couple of reasons: Colleges make money on these loans, and there’s usually a 5% origination fee. An example of a lender is Sallie Mae, which started life as a government entity, but went private and began offering private student loans.
3. Retirement loans. Some parents opt to borrow from a 401(k) or IRA. The money still has to be paid back, but what people like about this is that the interest rate is lower and you’re your own lender.
But if the loans aren’t paid back within five years, the family will pay (depending on their tax bracket) 30% to 40% in taxes on the balance, in addition to a 10% penalty.
There’s also an opportunity cost. The money that is taken out of the accounts is money that can’t be invested, so any potential market gains are lost.
4. Home equity loans: A home equity loan or home equity line of credit is an option for those who have substantial equity in their properties. It’s important to secure a fixed interest rate because we don’t know what interest rates and inflation will do in the future. The loans have a longer term, and the interest is potentially tax deductible.
However, if the family wants to pay off the house before they retire, this becomes another loan that has to be paid back. The terms may be better, but a loan is still a loan.
5. Federal loans. Students apply for federal loans using the FAFSA (Free Application for Federal Student Aid), and they’re responsible for paying back the loans after they graduate. Another type of federal loan is the Parent Plus Loan, which is taken out by the parent or guardian and has no borrowing limit.
The benefit of a federal loan is that it preserves retirement savings and doesn’t create an additional obstacle to paying off a mortgage. Money can stay in the IRA or 401(k) and continue to grow. Even though we have a $1.8 trillion student debt burden right now, used wisely, a federal loan can be a good solution if the student completes their education in four years and then is able to pay it back from their income.
Plus, a student or Parent Plus loan won’t jeopardize other financial aid, such as institutional aid, merit aid or scholarships. The loan also provides flexibility. If a parent dies, for example, the loan is forgiven.
It’s important to role play all of these options to design a funding plan that gets the most in grants, retains those grants over four years, provides flexibility with cash flow and lets the family stay in control of the money.
Finally, the family should have a financial expert like you and a college coach to help them reach their goals of paying for college, paying off the house and retiring when they’re ready. With a plan and a coach to hold them accountable, they are more likely to succeed.
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Brian Safdari, who founded College Planning Experts in 2004, is a Certified College Planning Specialist™. He and his team have assisted more than 7,500 students nationwide on their college journey using their exclusive My College Fit System. For more information, call 818-201-4847 or visit collegeplanningexperts.com.
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