Note: The following guest post comes to us from Jack Schacht, the founder of www.MyCollegePlanningTeam.com, a Wheaton, Illinois based organization that brings together experts from both the academic and financial services communities who work in coordination to help families find the right college for the right price. Contact him at [email protected].
As tuition costs continue to skyrocket, families can no longer afford to make any mistakes when it comes to paying for college.
Making mistakes can drive up your Expected Family Contribution (EFC) causing some families to pay thousands more for college than necessary. If they only knew the many rules that affect EFC, they could save money.
Here are the seven most common mistakes families can make when saving and paying for college:
1) Saving in a student’s name.
Not everyone knows that savings in a parent’s name (that is in excess of their asset protection allowance) is assessed at 5.64% in calculating the EFC. The asset protection allowance for a typical college family is around $45,000.
Savings in a student’s name, however, are assessed at 20% or 25%, depending on the methodology the school uses to calculate EFC. Accordingly, if Grandma gives your child $30,000 to put in his own college savings account, you have just added at least $6000 to your Expected Family Contribution.
To make matters worse, the student does not have an asset protection allowance. So never have assets in the student’s name.
2) Paying for college with a Grandparent-owned 529
Some financial advisors have actually recommended this as a strategy to reduce college costs. Make sense, right? If neither the parent or the child are holding the asset, what could possibly be the problem?
While it may be true that there is no assessment on either the parent or student’s assets, there is still an assessment—and it’s much worse. According to FAFSA rules, money paid out of the Grandparent’s 529 is considered untaxed income to the student. And the assessment on student income is a whopping 50%
While students don’t have an asset protection allowance, they do have a small income protection allowance. Currently, the student’s gross income protection allowance is about $6300. What this means, however, is that every dollar over the income protection allowance is assessed at fifty cents on the dollar. Accordingly, if Grandma sends $16,300 dollars to the college for your student’s first year’s tuition, you will be have raised your EFC by an additional $5000.
3) Using or borrowing Retirement Funds
Many parents make the mistake of thinking they are getting a break from the government when they pay for college out of their IRA funds. After all, the government waives the 10% penalty for funds withdrawn that are used for college.
What parents forget, however, is they are adding to their income when they withdraw funds from an IRA and parent income is typically assessed at 47%. It’s another very bad move.
4) Missing Important tax deductions & tax credits
Parents sometimes make an error in paying their entire college costs out of their 529s only to find out that they can no longer claim the American Opportunity Tax credit.
Because the parent has already received a tax benefit from the tax-free distribution from their 529, the federal government considers that claiming a $2500 tax credit would be “double-dipping” and that is not allowed. So work with your tax advisor on this one. You don’t want to miss $2500 in free money from the government.
5) Being unacquainted with EFC reduction strategies
Before parents figure out how they are going to pay for college, get a good book on the subject. One of the best books out there dealing with EFC reduction strategies is written by Kalman Chany and called Paying For College Without Going Broke.
Knowing the material and implementing the strategies yourself, however, may not be a wise move for everyone. Families are encouraged to seek the help of a college planning specialist . Just using your regular CPA can hinder your chances for financial aid.
6. Knowing the different methodologies for calculating EFC
A parent recently followed his accountant’s advice to cash out his $150,000 in stock funds and pay down the mortgage. He was told it would save a bundle on college.
While it’s true that this move could save him about $7500 a year in college costs, that’s not how it worked out.
Under the Federal Methodology, which most all public universities and a majority of private colleges use, this move could have achieved that result. That’s because under FAFSA rules, the equity in one’s home is not used to determine EFC.
This was not true, however, with all three schools their daughter was interested in attending. These particular schools used what is called the Institutional Methodology to determine EFC. Under that method, home equity IS assessed.
Note only did this move do little to bring down EFC, but the stocks the man cashed out would have increased in value by about 25% if he held on to them during that two year period!
7. Not Understanding How to Use the Appeals Process
Again, many people do not understand that there is still money that can be saved even after their receive their final award letters. Awards can be appealed. Obvious examples would be when there has been a change in family income or if the family was suddenly incurring some unexpected medical expenses.
What really is news to parents, however, is that an appeal can also be made because another college, which is not your student’s first choice, made your student a better offer. You do not want to try playing one school against the other, however, unless the other college has a similar ranking to the college to whom you are appealing.
Most important, read up on how to write a good appeals letter before you act. You can also seek out of a college coach in your area who does this kind of work.
There is a lot to navigate out there when planning for college. Next to your home, however, college is likely to be your second largest investment in your lifetime. Take the time to do it right!
This is great advice — I would have never thought about the grandparent-owned point. My kids have their own kids now, so I will keep this in mind when setting up funds for my grandkids.
Knowledge is power, especially when it comes to finances. I think that these tips are certainly overlooked by parents, especially those who just think saving money in any form is smart. There are smarter ways than others, as this post notes.
Interesting. As a college student who has received no help from my parents/grandparents, it is sort of fascinating to see how the “other side” save for it. I will certainly try to do better for my own kids, and keep these tips in mind.