Knowledge and Insights
As the weather turns cooler and leaves change color, we reflect back on the joys of summer vacation and look forward to next summer. Back-to-school brings the familiar routines of homework, school sports and other extracurricular activities. For parents of some high-school students, however, it also brings question- and decision-time about college: where to apply; what will it cost; how will we pay for it?
Planning to pay for impending college tuition is based on three types of families; those that:
- will unquestionably qualify for need-based financial aid;
- may qualify for need-based financial aid with proper planning; and
- will not qualify for need-based financial aid regardless of planning.
Families That May Qualify For Need-Based Aid
For these families, proper planning can increase the amount of need-based aid received, while poor planning may result in zero aid received. It is critical that these families understand the financial aid math in order to put their assets in the right places to maximize the need-based aid that they can receive. Here are some simple strategies you can implement:
- Financial aid assessment calculators include 20%-25% of student owned assets toward funds available for tuition, whereas only 5.64% of parent savings are included. Therefore, reduce assets in the student’s name by spending them on expenses other than basic support items that a parent must buy. Use the student’s assets to purchase big ticket items like a car, computer or other electronics.
- Focus your savings in areas that do not count as eligible assets for financial aid calculations. Retirement accounts are excluded under FAFSA (Free Application for Federal Student Aid) so you may be better off maximizing your 401k plan and making eligible IRA contributions instead of contributing to college or other savings accounts.
- Home equity does not count as an asset for FAFSA but does in a CSS (College Scholarship Service) profile used by many private schools. A strategy to consider is to apply extra funds toward your mortgage payments, creating equity that you can borrow against when it’s time to pay for college. There are, of course, market risks related to this approach that need to be carefully considered.
- The value of small business ownership of 51% or more of a business with less than 100 employees is excluded under FAFSA but included in a CSS profile.
- Life insurance cash surrender value is excluded under both programs; depending on the policy, this might be a good planning opportunity.
- Non-qualified annuities are excluded under FAFSA but included in a CSS profile. If this type of investment fits in with your personal investment style, it may be a good option to consider.
Using some of the above strategies may allow you to accumulate wealth without limiting your child’s chances of qualifying to receive need-based financial aid.
Families That Will Not Qualify for Need-Based Aid Under Any Circumstances
For these families, tuition planning should focus on tax-savings strategies, such as the following:
- Utilize the tax-deferral benefit of investing through a 529 education savings plan. Start contributing early and let the money work for you; growing tax-free until it is withdrawn. If it is used for qualified education expenses, it may be completely tax-free. Both parents and grandparents can contribute to 529 plans and maximize their contributions by electing to make five years’ worth of gifts in the first year. Utilizing the annual individual gift tax exclusion of $14,000 in this way generates a total contribution of $70,000 per donor/donee relationship.
- Transfer wealth to children or grandchildren via trusts or outright gifting.
- Make annual gifts in excess of the annual exclusion by paying tuition costs directly to the institution since these are not treated as gifts under the gift tax rules.
- Shift income, especially earned income, to individuals in a lower tax bracket. Small business owners can hire their children and pay them a reasonable salary for even simple office tasks such as cleaning or clerical. By creating earned income opportunities for children, you then create opportunities for IRA contributions which can then be withdrawn penalty-free (but not tax-free) to pay higher-education costs. Shifting unearned income is somewhat limited due to the “kiddie tax” rules, however, some benefit can still be achieved with careful planning.
Whether you have young children, teenagers or grandchildren, opportunities are available to either maximize the need-based aid for which you may qualify or minimize your tax burden and create “tax-savings” tuition funding by taking advantage of income or estate tax-planning strategies.