College Financial Aid: Pre-High School Saving

About 60% of all aid is in the form of loans, and increasing.

Saving: For example, if you start saving when your child is 5 years old, you will have 13 years to save before your child enrolls in college. If you can put aside $167 per month – that’s $2,000 per year – you will have saved $26,000 by the time your child begins college.

With a 6% return over the thirteen-year period, your $26,000 will have grown into $40,000. That $40,000 will be available to help you pay for your child’s college expenses like tuition and room and board.

Borrowing:If you choose not to save when your child is young, it is likely that your child will have to borrow to help pay for college. For comparative purposes, let’s assume you borrow $40,000 in increments of $10,000 per year for 4 years. Assuming a 6.8% interest rate and a 10 year repayment period, borrowing $40,000 will ultimately cost your child $55,200.

Difference: The difference between borrowing and saving is nearly $30,000 ($55,200 ─ $26,000 = $29,200). Thus, saving beats borrowing hands down.

3. The tax system gives incentives to college savers.

Both state and federal laws allow families to earn tax-free interest on college savings. The following example illustrates the advantage of earning interest tax free:

Assume when your child is born you invest a one-time, lump sum of $18,000 in a state 529 plan (see Points 4 - 6 below to learn more about 529 plans). By the time your child is ready to enroll in college at the age of 18, you will have access to $63,000 in order to help pay for your child’s college expenses.

If the same $18,000 were invested in a taxable vehicle with the same rate of return as the 529 plan, after subtracting the federal and state taxes that would be due each year, you would have access to only $43,000 to help pay for college.

The difference, which is essentially a government subsidy to promote college savings, is $20,000, all else being equal. Furthermore, some states actually allow deductions for contributions, making the 529 plan even more attractive to college savers.

4. 529 plans are the most popular and convenient way to save.

There is approximately $100 billion currently invested in state 529 plans.

5. Not all 529 plans are alike.

Each state has its own 529 plan. Investment options and fees may vary from state to state, so it pays to shop around. A couple of useful sites for comparing the different state plans are savingforcollege.com and Morningstar.com.

Most state plans have websites that include free electronic college saving calculators to help you decide how much to save in order to meet your saving goals.

6. The money saved in a 529 plan is not forfeited if the beneficiary does not go to college or gets a full scholarship.

Money saved in a 529 plan may be used to pay the college expenses of other family members, including siblings, parents, cousins and stepchildren. The money can even skip a generation and be used for a grandchild in the unlikely event that became necessary.

7. There is no right amount to save. It depends on your financial situation.

8. Do not save for college at the expense of maintaining your normal lifestyle or your retirement.

You don’t want to short change the amount you set aside for retirement. If you run out of money, there is no such thing as a retirement loan. On the other hand, it is relatively easy to get a college loan.

9. Two ways to save are:

• Save what you can afford after taking care of family expenses.

As was stated in Point 5 above, most state 529 plan websites have free electronic college saving calculators. Other websites, like finaid.org, have them as well. By using these calculators you can periodically check to see how well your savings are keeping pace with college costs.

• Set a target figure. A number to shoot for is the tuition fee at the major public university in your state. For a more ambitious goal, you might use the out-of-state tuition charge. This higher figure would also allow you to accumulate enough savings to pay for a good part of the tuition cost at a private college.

Most college saving calculators found on state websites automatically include information on the current and projected (in-state and out-of-state) tuition rates for the state’s main universities.

10. If you save in a 529 plan and later apply for aid, you may be subject to a very light “penalty” in terms of how much the amount you have saved will increase your expected family contribution.

If the child’s parents are the owners of the 529 plan, they may be asked to contribute some of that money under the rules of the need formula. (There is no such “penalty” if the plan is owned by the child’s grandparents. See Point 12 below for more on grandparents.) Let’s look at the example in order to better understand.

If you, the parent, manage to have $100,000 saved in a 529 plan by the time your child is ready to start college, the first $50,000 will not be considered at all when calculating your child’s aid award. (This is one of the ways the system rewards you for saving.) Only 5% of the second $50,000, or $2,500, will be assumed to be available to pay for college. In other words, the amount of your need will decrease by that amount.

Thus, one could argue that by diligently saving $100,000, you are ultimately worse off by $2,500. However, if you consider that you are very likely to have earned around $35,000 in tax-free interest over the saving period, you will realize that by saving you are actually about $32,500 better off.

11. There are other ways to save besides 529 plans. To look into other options, it is best to consult with a financial advisor.

Remember to choose an advisor who in very familiar with all applicable aid rules. The need formula treats savings differently depending on whether the parent or the child is the owner.

12. Grandparents too can help through 529 plans.

Based on a recent poll, two-thirds of grandparents say they are interested in helping to pay for their grandchildren’s college education. It is worthwhile to know, that money saved in grandparent-owned 529 plans is not considered when calculating the grandchild’s aid award. Furthermore, grandparent-owned 529 plan savings are not counted as part of the grandparent’s estate for estate tax purposes.

By: Don Betterton

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Karl Schellscheidt ePrep www.eprep.com Copyright 2006 – All Rights Reserved, ePrep, Inc