Some parents view the need for student financial aid as a sign that they haven’t earned enough money or didn’t do a good job of saving for their child’s college education. It’s important for these parents to realize that the cost of college tuition has been spiraling upward much faster than other costs in the American economy. As a result, the majority of American families find that paying for college is a vexing task. Because tuition has risen so high so fast, families cannot afford to make mistakes.
Expected Family Contribution
One topic that you need to fully understand is the Expected Family Contribution (EFC), which is the calculation done by FAFSA that has a bearing on financial aid programs that are based on need. Mistakes can drive up your EFC, which may result in paying thousands of dollars more for a college education than necessary.
The EFC is the portion of your family’s income and assets, as calculated by FAFSA, that you’re expected to spend in any given year before public financial aid becomes available to you. [Note: In July 2023, the FAFSA will change because the EFC will be replaced by the new Student Aid Index (SAI) for award years starting in 2023-24. The SAI is functionally the same as the EFC with only minor differences.]
Families should understand that they’re expected to cover the cost of college up to their EFC. This can be accomplished by using such sources of funds as the family’s current income, savings, investments, gifts, and educational accounts such as 529 Plans. Other sources may include private and institutional (college-based) scholarships, grants, and loans. Families should start early to adopt EFC reduction strategies so that they won’t need to rely quite as heavily on other sources of funds.
Mistakes to Be Avoided
Determining how to pay for college is a complex problem. Common mistakes made by families in financing a college education are described below:
- Failure to File a FAFSA
The FAFSA is critical to qualifying for Federal grants, work-study programs, and loans. It’s the only way to gain access to Federal student loans, which have better terms than any other type.
Families should file a FAFSA as early as possible every year. State and institutional awards may be limited, so they’re awarded to those who file early and qualify. Even if you qualify, you won’t get an award if you don’t file early enough. The FAFSA has an 18-month cycle and you can file as early as October 1 You’ll also want to check for state and institution-specific deadlines.
- Not Applying For Scholarships Early Enough
Scholarships are an under-utilized source of funds for college because they can be hard to find and applying for them can be slow and tedious. The odds of winning an award can be long. The positive aspects of scholarships is that they are “gifts”, with no need to repay them and there’s plenty of scholarship money to go around. Students should devote time to finding and applying for a wide range of private and public scholarships.
Most students don’t apply to enough scholarships to give themselves a reasonable chance of winning. Students should apply to as many as possible, with a goal of 30 or more. Scholarship applications don’t all need to be submitted in senior year, so the earlier a student begins their scholarship hunt, the more time they’ll have to meet their goal.
- Ignoring Educational Tax Breaks
Tax breaks that assist in paying for college are among most beneficial incentives available to American families. These benefits, which are either tax deductions or tax credits, can save a family thousands of dollars.
The American Opportunity Tax Credit is open to individuals with adjusted gross incomes of $90,000 or less and to married couples filing jointly with $180,000 or less in income. It provides up to $2,500 per student annually. The Lifetime Learning tax credit pays up to 20% of the first $10,000 in college costs.
- Investing Too Aggressively
With 18 years or less until you’ll need your college funds, stick with simple, straightforward investments. Avoid investments that are inappropriate for a conservative purpose like funding a college education. IRS Section 529 accounts offer age-based asset allocations that automatically invest your funds in more conservative securities as you approach your child’s college age.
Investing should be inexpensive to foster long-term growth. High management fees, even on a well-performing portfolio, can significantly increase the amount of money you’ll need to save to reach your objectives.
- Using the Wrong Type of Account to Save for College
You can use any type of account as a college savings account for your child but be aware that not all of them are meant for this purpose. The wrong account type may substantially impair your chances of obtaining certain types of financial aid.
The first step in establishing a sound plan is to understand the features of alternative types of financial accounts. Accounts that are the best means of financing college educations include IRS Section 529 accounts, Coverdell ESA’s, Trusts, Uniform Transfer to Minors Act (UTMA’s), custodial accounts, and prepaid tuition plans.
- Using Your Retirement Funds to Pay for College
There is no longer a 10% penalty for early distributions from a retirement account if the funds are used to help finance a college education. As a result, many parents make a serious mistake by using part or all of their retirement funds to pay for college. Parents usually do this to avoid taking out student loans because they assume they can always play catch-up on funding for their retirement later.
This is a costly error. Parents typically do this between ages 40 and 60, leaving only a relatively short time to recoup the lost funds before retirement. Many parents don’t realize until it is too late that using or borrowing against their retirement funds may postpone their ability to retire for an extra 5 to 10 years. Taking out student loans works out better in the long run than depleting a retirement account.
- Miscalculating the Impact of Inflation
You need to understand how fast college tuition has been rising in order to plan for college expenses. While the broad “cost of living” index has inflated by a historical average of 2% annually, college tuition has been inflating by 5.5% every year for decades. Tuition rises three times as fast as average prices for goods and services in the American economy.
Understanding appropriate investment selection and using accounts that are designed to combat inflation, such as prepaid tuition plans, are essential to assuring that college education stays within your family’s reach.
- Assuming That You Aren’t Eligible for Financial Aid
Families with incomes that are higher than you’d expect can be eligible for financial aid. There is over $132 billion available every year from the Federal government, states, colleges, and private organizations for funding the education of college students. Many families don’t even try to access this massive reserve of funds because they assume they won’t be eligible. Don’t make this mistake. You need to know how to claim your fair share.
- Co-signing a Private Student Loan
Although parents want to reduce or eliminate the debt burden on their child, certain boundaries should be established in advance. Among these is that parents will not co-sign student loans.
Be aware of how co-signing a student loan could affect your financial well-being. A co-signer is a borrower. As such, they’re responsible for the payment of the debt. A co-signed loan affects the parent’s credit history as well as the student’s. So if your child is late with a student debt payment or defaults, it will impact just their credit score, but yours as well. Even if the student manages the co-signed loan responsibly, making every payment on time, the loan may still affect the parent’s ability to borrow. For example, if the parent wants to obtain a mortgage, the co-signed loan will count as part of their outstanding debt, which could potentially affect approval of the mortgage or the interest rate they must pay.
Obtaining a college education almost always leads to a more fulfilling and profitable career for your child — something all parents want for their children. However, the cost must be carefully considered. According to the College Board, the average student debt load for students graduating in 2017 with a bachelor’s degree was $29,000. That’s a heavy load for a young individual new to the world of full-time employment. Depending on your child’s profession, it may take decades to repay their indebtedness.