Are you expecting or a new parent? College might not be on your radar yet, but maybe it should: it’s never too early to start saving. Annual tuition and fees are constantly on the rise, making smart and early savings imperative.
Jack Schacht from My College Planning Team answers your questions on saving for college, the mechanisms available, and – more importantly – where not to save.
Daniela: We have with us today Jack Schacht from My College Planning Team, here to help all those dreaming of baby decipher the long-term financial side of parenthood. Good morning Jack, and welcome to Dreaming of Baby. Before we start with our discussion today, it would be great if you could introduce yourself to our readers.
Jack Schacht: Of course. I’m Jack Schacht, the founder of My College Planning Team. We are an organization of independent consultants who work with families on both the academic and financial side of college planning. I head up the financial team.
What to take into consideration when planning for college
Daniela: Thanks for that overview. To start our discussion today, what should parents-to-be take into consideration in their financial planning for college?
Jack Schacht: Since we are talking to very new parents here, my first suggestion is to start early with their savings.
Daniela: What are the benefits of starting college savings early?
Jack Schacht: First of all, college costs have been rising at about twice the rate of inflation over the last 15 years. At that rate, the cost of a private college could easily run close to six figures per child by the time that child reaches college age.
Jack Schacht: Secondly, to really afford the college of their choice is going to require consistent, disciplined savings over time. Otherwise, a lot of parents are going to come up short.
Jack Schacht: Thirdly, time allows for growth and compounding. They need a long timeline with steady growth to pay for college.
Jack Schacht: “College costs have been rising at about twice the rate of inflation over the last 15 years. At that rate, the cost of a private college could easily run close to six figures per child by the time that child reaches college age.”
Mechanisms for college saving
Daniela: Thanks for this insight. What kind of mechanisms are available for college savings?
Jack Schacht: 529s remain the most popular vehicle to save for college because the growth is tax-free and the distributions are also tax-free. Some 529s, however, are better than others and we always recommend that parents do their homework in that regard.
Jack Schacht: “529s remain the most popular vehicle to save for college because the growth is tax-free and the distributions are also tax-free.”
Daniela: You mentioned there are different 529s, how many types are there and what are the main variables between one 529 and another?
Jack Schacht: The standard 529 plan contains mutual funds and are sponsored by each state. Like any mutual funds, some funds perform better than others. Accordingly, they should do their homework carefully and try to find a fund with the best returns. Also, some states offer a state tax deduction on contributions made to their 529s which can be a further benefit to some families.
Jack Schacht: There is also a pre-paid 529 which allows guarantees that their state universities tuition will be covered after so many payments into the plan, no matter how much tuition rises over time. We normally don’t recommend the pre-paid plans though because they are not financially stable.
Daniela: Thanks for that overview. Prior to the interview, you mentioned that some financial advisors recommend a Grandparent held 529. What are the benefits and pitfalls, if any, of this option?
Jack Schacht: Only if handled carefully are grandparent-owned 529s a good option. They are good because they don’t have to be reported as a parent asset on the FAFSA. They can be bad, however, if a grandparent sends the distributions from their plans directly to the college on behalf of their grandchild. The colleges treat such distributions as income to child which is assessed at 50%. Accordingly, a distribution of $20,000 sent to the college could substantially raise college costs.
Jack Schacht: “Only if handled carefully are grandparent-owned 529s a good option.”
Jack Schacht: That being said, under the new FAFSA rules, there is a two-year look-back on income. Accordingly, if the grandparent sent funds to the college to pay for their junior and senior year it would not affect the EFC. In other words, timing those payments correctly is essential.
Daniela: Speaking about the EFC; prior to our interview you also mentioned EFC strategies that you were willing to share with our readers. Before we dive in; what are EFCs and why should parents-to-be know about them?
Jack Schacht: It’s an important term and means “Expected Family Contribution.” It’s the amount the government thinks your family can afford to pay for college based on income and non-retirement assets held by both parents and the student.
Jack Schacht: It’s also important that families know their EFC and learn about the various strategies they can use to reduce it. The lower the EFC, the less they will pay for college.
Daniela: So, EFC effects college tuition prices and aid offered by the state?
Jack Schacht: It affects overall costs because it determines how much need-based financial aid you are eligible for from the college. Different colleges use different formulas to determine financial aid eligibility. The elite schools will usually fill close to 100% of your demonstrated financial need, but other private colleges may only fill 60% to 70% of your demonstrated financial need. That leaves a further gap, meaning that you will pay your EFC (Expected Family Contribution) plus the financial need the college doesn’t fill.
Where not to save for college
Daniela: Thanks for clarifying, this will be very helpful to our readers. With the aim of presenting a complete picture, what would be the other college saving options and vehicles that parents can avail of?
Jack Schacht: I would prefer to discuss where parents should NOT save for college. Some make the mistake of stuffing as much money as they can into Roth IRAs, thinking they won’t get the income assessment when they take distributions to pay for college. What they don’t know is the all “untaxed” income has to be listed on their FAFSA, even though it doesn’t affect their taxable income.
Jack Schacht: Another way NOT to save would be in mutual funds that are not held within a 529. Mutual funds not only are assessed as an asset but the dividend and capital gains that are triggered every year are assessed as income and income has a much higher assessment than the asset assessment: 47% versus only 5.64%.
Daniela: In this case then, the best option would be to go for a 529? Are there limits on how much you can contribute into a 529?
Jack Schacht: Normally – unless you think your child may be heading to one of the elite schools. These schools often give unfavorable treatment to 529 schools.
Daniela: Are there limits on how much you can contribute into a 529?
Jack Schacht: Yes. Families should talk to their own accountants about the current limits as well as the tax benefits applicable to their particular state.
Daniela: With regards to taxes, what important tax deductions and tax credits should parents be aware of early on?
Jack Schacht: They should always take, if eligible, the American Opportunity Tax Credit, which is $2500 per year per child in college. Currently, parents making under $160,000 per year are eligible for the full credit. Over that income, it starts phasing out and is completely phased out at $180,000 in income.
Daniela: So unlike the 529, the American Opportunity Tax Credit does not vary from state to state?
Jack Schacht: No.
Daniela: Great, thank you for confirming. On a final note, is there anything you would like to add on this subject and which you feel we haven’t tackled but would be an important consideration for parents in their planning?
Jack Schacht: “Never save for college in a child’s name. Savings accounts held by the child are assessed at either 20% or 25% versus the parent assessment of 5.64%.”
Jack Schacht: One thing! Never save for college in a child’s name. Savings accounts held by the child are assessed at either 20% or 25% versus the parent assessment of 5.64%. Also, the child has no asset protection allowance! The asset protection allowance given to parent non-retirement savings and investments is determined by the age of the oldest parent. Currently that asset protection allowance for the average college parents is only about $20,000. This simply means that there is no EFC assessment on the first $20,000 of savings and investment. The student, however, has NO asset protection allowance. This means that every dollar of savings is assessed at either 20% or 25%, depending on the methodology used by the college to calculate the EFC.
Daniela: Excellent, thank you for this addition. I wish to thank you for your time today and for the information you have shared with our readers; it will be helpful to many. It’s been a pleasure discussing this important subject with you.
Jack Schacht: Thank you! Glad to spend the time with you.
Planning for College? Learn more, here.