Do you know what financial aid optimization is or means? Or, what about the tax and financial aid implications that taking money out of a retirement account could cause?
In part three of our three-part series focused on our college planning process, we dive deep into the financial aspects of sending your child off to college. Specifically, we will address saving, how schools optimize financial aid packages, loans, and much more.
Enrollment Management & Financial Aid Optimization
- The financial aid office may decide how much money your family needs, while the admissions office decides much merit aid you deserve (or what they think it will take to get you to commit).
- Think about an empty classroom seat or a dorm bed the same way you would an airline seat: Both are useless when a plane pushes back from the gate or a semester begins. Enrollment management calls for using data to figure out which students to recruit and how to woo them.
- Put another way; the colleges call this financial aid optimization.
- Schools only want to discount as much as they need to have someone to say yes, but not one dollar more.
- For people living in affluent zip codes, a mere $ 10,000 is probably enough to make them feel good about not having to pay full price.
If you want to learn more about merit aid than what the school posts on its financial aid web pages, the best place to look is at the common data set. The CDS is a standardized form that schools use to collect all of the data that various college guides and ranking publications request. It is a treasure trove of information, but it’s a rare college that encourages applicants to check it out.
You can find it by doing an internet search for the school’s name and the phrase “common data set,” and the right landing page should pop up. All sorts of information are available in the CDS, and you should read every bit of it if you are even remotely interested in applying.
TuitionFit is another excellent resource that I have partnered with at TAMMA. TuitinFit is a free exchange where you share your financial aid offer. By using actual data from actual students’ financial aid award letters, you can compare college costs. Think of it as the Kelly Blue Book of college pricing.
Saving Creates Options
It is a rare family that regrets putting some money away for a child’s higher education and an even rarer one that wishes it had saved less than it did.
Making a plan and saving some money can create an emotional boost. Making some commitment can feel good. Doing it bit by bit regularly reinforces the fact that you are, at least, doing something. Doing something, however small, feels better than doing nothing. Saving can become habit-forming, and any progress helps bring on a slow-growing feeling of well-being.
As I noted in Part I, What Families are Up Against, families are trying to balance multiple financial and lifestyle priorities. So what do I tell families when it comes to savings: save as much as you reasonably can. Remind yourself that few among us can save enough to pay for four years of college in full.
But won’t saving hurt me when it comes time to prove that I’m eligible for need-based financial aid?
- The government “expects” your “family” to “contribute” 5.64 percent of your non-retirement savings each year to the cost of college. That includes money in a 529 plan. So, if you have $10,000 saved, the formula will put you on the hook for $564 the first year of college.
Options that Could Hurt Your Family
What about pulling money out of my retirement accounts for college?
- I would think twice about this unless you’re certain you have more than enough saved for retirement or don’t have some other, better way to help pay for college.
- Suppose you pull money from a Traditional or Roth retirement account for college. In that case, that withdrawal will count as income for financial aid calculation purposes. Income is the primary subject that financial aid officers examine most carefully when determining eligibility for need-based aid.
- There is also a plethora of tax consequences to consider when taking funds out of a Traditional retirement account. Consequences that could lead you into a higher tax bracket, having to pay even more taxes.
What about taking a 401(k) loan?
- You would likely be taking funds out at a time when the power of compounding would be working the most in your favor. As your assets build over time and balances become larger, they create a snowball effect where they can build faster.
529 Plans Are The Best Savings Vehicles
There are multiple significant advantages to 529 Plans
- You pay no federal taxes—neither income taxes nor capital gains taxes—if you use the savings for education expenses.
- There are often state income tax deductions or credits for putting money into a 529. If you save in a regular brokerage account, you’ll not only pay taxes on capital gains, but those gains will count as income when the financial aid administrators examine your ability to pay.
- Psychological – Having some money in reserve gives you more options, and more options mean less stress. Again, something is reassuring about having the 529 money there, knowing that you’ve set it aside for this specific purpose. I personally find this helpful.
- Flexibility– 529 plans offer the ability to contribute whenever you want, virtually any amount you wish to, and anyone can contribute. I encourage parents to set up a 529 plan even if they do not make contributions themselves. Why? Typically grandparents and other families and friends are likely interested in helping out rather than buying toys that will be discarded in a short period.
Understanding Student Loans
A reasonable amount of student debt isn’t going to ruin people’s lives if they finish college. If debt gets undergraduates to a school where they learn a lot, find kinship in abundance, and stand a decent chance of getting a job in the field they think suits them, they should by all means borrow.
However, everyone needs to understand how the student loan system works.
- Federal or Direct Loans – money that undergraduates, themselves alone, borrow from the federal government.
- Private Loans – money that students borrow from a financial institution such as Sallie Mae or a bank or credit union. Today, it’s nearly impossible to get one without a parent or other adult cosigning the loan. In effect, you promise that you will make good on the debt if the applicant doesn’t agree to have your credit score tarnished if the student cosigner does not pay or pay on time and in full.
- Parent loans – money that parents borrow from the federal government, called Direct PLUS Loans, or through private entities, which have their own version.
Depending upon a family’s level of financial need, a school will offer the applicant two types of federal loans, subsidized or unsubsidized.
- Subsidized debt – the federal government covers interest payments while the student is still enrolled.
- Unsubsidized – the interest starts adding up immediately; however, you can make interest and other payments during college if you want to.
People can qualify for a federal unsubsidized student loan no matter how much money their parents make or have. You are required to complete the FAFSA to get access to the program. Currently, the federal government will allow undergraduates to borrow up to $27,000 during their first four years of college and $31,000 total. Independent students, who are generally older or have no parents in the picture, can borrow up to $57,500.
If families feel compelled to take on debt, they should ask themselves the following questions:
- Is this the only way that our kids can get the education that they need?
- Is the school, who is putting PLUS loans into the “award,” something they want more than anything else they have ever desired?
- Is the classroom experience or the income outcomes at the chosen school clearly superior?
- Is the quality of the lived experience on campus will worth the cost?
- Does school represent a necessary degree or just an upgrade in lifestyle?
What Kind of College Do You Want?
There isn’t a pamphlet that reads, “This is why this place is worth $ 50,000 extra each year.”
There is no algorithm that can tell you how to measure value, especially when a school’s price tag for the four years is $200,000 or $300,000 or more than another school. Just as every teenager is different, all schools are as well, even if they aren’t always so good at articulating why.
There are institutions that make their students smarter, help them find the people they could not otherwise imagine existing in the world, and send alumni out into the working world with real skills that employers value.
There is hope for families trying to find the best fit for their kids, tackling the cruel optimism effect, and making smart financial decisions. This hope comes from knowing what to ask, understanding how the schools pull financial levers behind the scenes, and most critical, putting in the work to put a plan together.
Through our college planning process at TAMMA, we
- Get to know and understand your families to understand what you want from a college.
- Develop and work through a list of questions for you, your kids, and the schools they may be interested in attending that help to determine what is the best fit for them.
- Develop various projections based on when you start saving, how much your investments may earn, and what college may cost.
- Review award letters and financial aid packages and compare them to other schools and families in similar situations to yours to make the most informed decisions possible.
We take the guesswork out of planning for college to help create peace of mind for your family.
Connect with us at our website tammacapital.com to schedule a complimentary discovery meeting to see how we may help your family