4 Aspects of College Funding

 Source: collegedebt.com

Source: collegedebt.com

Paying for college expenses is one of the greatest concerns for parents. On a list of concerns for parents, college funding usually comes in at #2, just behind retirement funding. Depending on the parent’s background and goals, college funding may be the primary concern.

With college expenses increasing above and beyond the normal inflation rate, it is no wonder why this is such a concern for most parents. However, there are a few different ways you can greatly reduce the amount you and your kids pay for a college education.

Student loan debt is a growing crisis in our country today. With the total amount of outstanding debt quickly approaching $1.5 Trillion dollars, it is increasingly important for parents and students alike to make a plan for college funding.

Here are four different areas in which parents can fund their kids’ college education:

Financially Friendly Schools

Like buying a new car, the sticker price for colleges is often not what you will end up paying. You can bring down the sticker price by shopping for the schools that fit your family’s financial profile.

A few things to look for when searching for a school:

Outside Scholarship Policy: When applying for aid, colleges will require you to disclose any scholarships or grants you will be receiving from outside sources. Each school will treat these outside funding sources differently, so be sure to inquire about how this will affect you.

Endowment Level: Colleges with large endowments will have the ability to offer “institutional aid”, which is aid that comes from their own resources.

Financial Aid

When looking to apply to college, the first question on most kids’ minds is “Will I get in?” The first question on most parents’ minds is “How will I pay for it?”

There are two main types of financial aid available: Need-based and Merit-based

Need-based: The majority of financial aid is given to those with the greatest financial need. Eligibility is based on the student and parent’s financial situation and level of need. To receive need-based financial aid, you will need to submit your family’s financial information via Free Application for Federal Student Aid (FAFSA). An additional application may be required, which is the CSS/Profile. Colleges evaluate your need on an annual basis, which means you will need to reapply each year.

Merit-based: Colleges will provide financial aid to those students they feel will provide value back to the college. This is determined based on a student’s GPA and test scores. Merit-based aid also comes in the form of athletic scholarships, music scholarships, or other talents. To apply, you may be able to simply check a box on your application or the college may require other means of evaluation.

Personal Resources

This is where your diligent savings comes in. There are a few main funding options available to parents to save for their kids’ college education. The most popular option is the 529 Plan.

The 529 Plan is a tax-advantaged savings plan that is sponsored by states, state agencies, or educational institutions. When you invest in a 529 Plan, your contributions will grow tax-deferred, and withdrawals are tax-free when used for “qualified higher education expenses.” If you live in a state with state income tax, your contributions may be state income tax deductible.

Another personal resource often not considered is current cash flow. Parents overlook the fact that when their kids head off to college, their monthly budget will drop accordingly. Think of the amount parents spend on food, entertainment, and sporting activities for their kids. Conservatively, parents can estimate this amount to be $400 per month, but a thorough budget analysis should be completed to be sure. This $400 per month can now be put towards college funding, which can amount to $4,800 per year, or $19,200 over the next four years.

If the kids were to work a part time job throughout the year while in college, you could have them put $200 of their earnings per month towards the tuition bill. Over the course of four years, $200 per month adds up to $9,600.

Another way the kids can help with the college funding expenses is by taking out student loans. The Stafford Loan is available to students, for a maximum loan of $27,000 over the course of four years. These are federal loans with low interest rates and flexible payment plans.

As a rule of thumb, students should try to keep their total student loan balance less than their first year starting salary after graduation. For example, if the average starting salary in the student’s major is $40,000, they should not take out more than this amount in student loans. This helps keep the payment plan manageable in the years to come.

Tax Benefits

The final aspect of college funding is tax benefits. The American Opportunity Tax Credit (AOTC) is made available for qualified higher education expenses paid for the first four years of college. The maximum annual credit is $2,500, for a total of $10,000 in credits over the four years.

The AOTC amount to be received is calculated by 100% of the first $2,000 and 25% of the next $2,000 of higher education expenses paid for each eligible student. This means you will need to pay $4,000 in college expenses to receive the full $2,500 tax credit.

The Lifetime Learning Credit is a credit to help pay for undergraduate, graduate, and professional degree courses. Unlike the AOTC, there is no limit on the number of years you can claim the tax credit. The Lifetime Learning Credit will provide a credit of 20% of the first $10,000 paid for higher education expenses, for a total credit of $2,000 each year. The AOTC and LLC may not be combined, or doubled-up in the same year.

Parents may also receive an income tax deduction of up to $4,000 per return. The total dollar benefit of this deduction will depend on the parent’s tax bracket. For example, if you are in the 15% tax bracket the total dollar benefit will be $600 (4,000 x .15), and if you are in the 35% tax bracket your benefit will be $1,400 (4,000 x .35).

These various tax benefits will have a big impact on the amount parents are able to provide for college funding.

Make A Plan

Much like any big expense, paying for a college education requires a plan. Think of this plan like going through a mortgage approval process. If you are attempting to buy too expensive of a home, the bank will not allow it. Attending a school that is too expensive for the student will put them in a massive amount of debt that may take decades to pay off.

By putting together all of the available funding options, you will be able to confidently shop for a college within your family’s means, and not take on a large amount of debt to achieve your goals.

 

Source: College Debt, College Data, 529 Plan, AOTC, LLC

 

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