As kids graduate from high school and prepare to move on to the next phase of their lives, many parents face a similar conundrum: How in the world are we going to pay for college?
Whether you have one child or several, the costs of college are simply daunting. With college costs rising approximately 7% each year, you could be out half a million dollars by the time you pay for a few kids to get a degree. That’s enough to destroy even the best-laid financial plan.
The solution may be in the acquisition of student loans and financial aid. However, unless you start viewing your personal finances the way a student loan officer does, you could be in for a surprise. You may earn too much, have too much money in the wrong places, or have too much equity in your home to qualify for much – or any – aid. Examine these issues beforehand to maximize your eligibility for loans and financial aid before it’s too late.
How Colleges Determine How Much Aid a Student Qualifies For
It is important to first note that you should never lie on a college financial aid application. There is an increasing effort to crack down on cheaters, so just don’t do it.
That said, understanding the rules and knowing how colleges determine a student’s ability to pay can help you make smart choices as to how and where to invest your money. Here are some of the factors colleges take into consideration:
- Money in Your Child’s Name. Money that is in an account strictly in your child’s name is viewed as available to be applied to college tuition.
- Your Household Income. Simply put, if you make a lot of money, you won’t qualify for much aid.
- 529 Plans. A portion of the money saved in 529 college savings plans are counted against your ability to qualify for aid.
- Your Non-Retirement Assets. Money you have sitting in non-retirement accounts – such as checking, savings, or investment accounts – hurt your ability to qualify for financial aid.
- Other Assets. Generally speaking, private colleges look at the equity you have in your home as a resource to pay for college. Public schools, however, typically do not.
How to Better Increase Your Chances of Receiving Financial Aid
1. Try to Reduce Your Income
You can reduce your income by contributing the maximum amount possible to your 401k and IRA. Also, avoid taking capital gains, as these will increase your income, and avoid exercising stock options unless you are required to. You may also want to investigate deferring bonuses until after your children have graduated from college.
2. Use Your Child’s Money to Pay for Necessities
Certain types of property – including automobiles, computers, furniture, appliances, books, clothing, and school supplies – do not count as assets. However, the money your child has to pay for these things can be seriously detrimental to their ability to qualify for aid. For this reason, it’s best to make purchases with your child’s money for the things they need instead of using your own. Make major purchases with your child’s funds by January of the year he or she begins college (referred to on financial aid forms as the “base year”).
Though it’s not advisable to go on a spending spree, it is wise to simply accelerate a few necessary expenses. For example, if your child needs a computer, automobile, dorm refrigerator, and microwave oven for school, buy these items prior to the start date of the base year. Since student assets count more heavily than parental assets, this strategy should apply mainly to items needed by your child and purchased using his or her own money. Also, if grandparents want to help pay for college, ask them to keep the money in their own name, and give it to the child following graduation to help repay loans.
3. Move Money Out of a Traditional Account
In addition to reducing the student’s assets, reduce parental “liquid” assets as well. Since money in regular checking, savings, and investment accounts is viewed by financial aid offices as liquid (meaning you could spend it on college), having large amounts of stocks, bonds, and cash in these accounts can be harmful.
Moving money into IRAs and other retirement accounts shields that money from colleges. Money in fixed annuities and permanent life insurance also is not be considered to be available for college. However, money put into most of these products makes the funds illiquid and irretrievable until you reach retirement age.
If you can, start moving your funds to a Roth IRA account a few years prior to your child’s college start date. Contributions to a Roth can be withdrawn at any time, but if you are less than 50 years of age, you can only contribute $5,000 per year to a Roth.
4. Pay Off Consumer Debt
It may be wise to pay off consumer debts such as high credit balances and car loans. When doing a needs analysis, college financial aid offices don’t count these burdens against your ability to pay for school, so there’s no benefit to having them. Using free cash to pay off loans will lower your balances in liquid accounts and reduce the high interest rates you pay. By lowering your liquid assets, you can help your child qualify for more financial aid.
5. Tap Your Home Equity If You Can
Taking out a mortgage or tapping a home equity line of credit will reduce the amount of equity you have in your home. Since private schools view home equity as an option to pay for tuition, utilizing this strategy can increase your chances of receiving financial aid if your child is attending a private college.
You could use the money you pull out of your home to pay down high interest consumer debt – but pay close attention to the interest rate. It probably wouldn’t make sense to take on a home equity loan at 8% to pay off debt at 5%. But if money is cheap, pulling it out of your house to pay off other debts can help you qualify for financial aid at a private institution.
The economics of education are very complicated and can overwhelm anyone. But bettering your child’s chance of receiving financial aid is only one step in the college planning process – complement these efforts by saving and investing money for college in a 529 plan or other tax-advantaged vehicle. And remember, it’s never too early to start planning.
What steps have you taken to plan for your child’s college education and increase your chances of receiving financial aid?