So your student has been accepted to college – Congrats! Celebrate their accomplishments and then take some time to map out how to pay for all four years before your student gets the bill for freshman year. That is, unless you enjoy being suddenly faced with a college bill you aren’t sure how you’re going to pay! Bonus points for those that start this process using estimates during Junior year.
Add Up Total Funds Needed For the College Bill
Once you get your Financial Award Letter, you should have a pretty good idea of how much the first year is going to cost. You can use that to estimate cost for years 2-4 as well. When doing so, keep in mind that:
Identify Money Sources
You’re going to start by making a list of all of the college funding sources you have available so you don’t miss out on opportunities. This will allow you to take into account tax implications, federal student loan caps, and scholarship considerations. Most families will be paying for college in layers – a little bit from here and a little bit from there. Whether you have a lot or a little ready to use for college, you’ll benefit from being prepared. Some sources to consider include:
1. Scholarships, Grants, and Qualified Tuition Reduction
Use – all money available annually.
Free money is the best money – I think we all can agree with that. Your student may be awarded a Pell Grant from the Department of Education, a need-based grant from the institution or a merit scholarship from the Admissions Department. State based scholarships would fall into this category as well, and don’t forget to check for tuition reciprocity agreements if you are going out of state.
Hopefully, you’re applying for private scholarships as well, so include those if you’ve been lucky enough to be awarded money for school that way to reduce your college bill amount.
2. 529 Savings
Use – annually until gone.
To get the benefit from your 529 savings, you’ll need to make sure you use it on eligible expenses for college which you haven’t used to qualify for a tax credit such as the American Opportunity Tax Credit (AOTC), Lifetime Learning Credit (LLC), or other tax advantaged source. Otherwise, you have a few limited options for taking the money out penalty free and you would have to change the beneficiary to a close family member and then use it on eligible expenses to take the funds out tax and penalty free.
For the freshman year, this means taking funds out of a 529 in the parent’s or student’s name with the student listed as the designated beneficiary. As the law is currently written, a 529 in a grandparent’s name should be used in years 3 and 4 if you need to avoid the negative effect that untaxed income has on your family’s EFC or Expected Family Contribution as calculated by the FAFSA.
If your family EFC is already too high for you to qualify for any aid, then there is no need to distinguish between a 529 held in a grandparent’s or parent’s name. Starting in 2023 for the 2024-2025 school year, this treatment of grandparent 529 contributions to pay for college will no longer be a cause for concern when it comes to the FAFSA and EFC calculation.
If you are going to a school that requires the CSS Profile to be completed, you may still need to wait until Junior and Senior year of college to use this money depending on whether or not the CSS schools choose to mirror the FAFSA when it comes to this issue.
3. Student Savings
Use – ASAP.
If your student has been saving for college, add those funds in. Also, add in any money the student will contribute from working while attending school.
From an Expected Family Contribution (EFC) perspective, this is a great place from which to take funds for college because it has a positive effect when it comes to lowering your family’s EFC. If your EFC is too high already to qualify for need-based aid, then it may not make a difference.
4. Parent Savings
Use – Annually as needed after 529 depleted.
In addition to any 529 savings you may have, if you have funds in other savings accounts that you can safely use to pay for college without causing yourself financial hardship, then add that into the mix as well. Using your savings to pay for college will lower your EFC but not by as much as using your student’s savings.
5. Grandparent Savings
Use – Annually as available starting with the FAFSA filing for the 2024–2025 school year.
As with the Grandparent 529, assuming that you care about keeping your EFC as low as possible, this should be used for the 3rd and 4th year of school under today’s laws. This will be changing in 2023 for the 2024-2025 school year, and at that time it won’t matter any more.
That means, you’ll be able to use money from friends and family to pay your college bill without special timing considerations if your school only requires the FAFSA for financial aid considerations.
If they require the CSS Profile as well, then you may want to consider continuing to use a work-around to make sure payments from outside sources like a grandparent owned 529 don’t have a negative impact on your ability to receive financial aid.
6. On-Going Cash Flow
Use – Annually as needed.
If your family has been making monthly contributions to a 529 plan or other savings vehicle for college and plan to continue that habit during the college years, add in a conservative estimate for that amount.
If you live in a state that gives a state tax deduction for 529 contributions, check to see if you can continue making contributions while your child attends school and pull out the funds before they graduate so that you can continue to enjoy those tax benefits.
You also may be able to use some on-going cash flow towards the college bill that you would have otherwise used to pay for the student’s food or extracurricular activities during high school.
7. American Opportunity Tax Credit (AOTC)
Use – Annually, when applicable.
If your family income is below certain limits, you may qualify for the AOTC, which is good for a credit of up to $10,000 over four years. If you can get this credit and plan to build it into your payment plan, you need to be super deliberate about actually putting the money aside at tax time to save it until you get a school bill to pay.
If this money is likely to be absorbed into your regular family cash flow, you shouldn’t count on it to help pay for college. You know yourself best, so act accordingly.
There are special tax considerations you need to have in place to be able to claim the credit. Namely, you must be able to identify expenses against which you are claiming the credit. You need $4,000 in eligible expenses in order to claim the full $2,500 per tax year. You can not use expenses paid for with a 529 withdrawal, the tax free portion of a scholarship or grant, or just about any other tax free source of money. You can, however, use expenses paid for with a loan.
The tricky thing about using a tax credit to help pay the freshman year college bill is that you normally won’t see the benefit of it until the school year is almost over. The easiest way to manage this setback is to include this source of funds in your plan for years 2-4 of college.
8. The Lifetime Learning Credit (LLC)
Use – Annually, when applicable.
If you cannot claim the AOTC, you may be able to qualify for the LLC. You cannot claim both in the same year for the same student. The LLC is worth up to $2,000 per year, but it is worth 20% of eligible expenses, so it takes $10,000 of qualified expenses to support a $2,000 credit.
As with the AOTC, if you are using the LLC as part of your college funding strategy, be deliberate about setting the money aside someplace safe until you’re ready to send it to the school in payment of a college bill.
9. Student Loans
Use – Annually, starting with freshman year until no longer needed. Prioritize Federal Student Loans first and then fill in gaps with private student loans or parent loans discussed below.
There is a limit to the amount of student loans your student can take from the Department of Education each year while working toward their undergraduate degree. For that reason, if they’re going to need loans, they should start taking them in year one. Nobody wants to end up $20,000 short for senior year and find out that they can only borrow a maximum of $7,500 that year from the government. Here are the yearly maximums:
Year 1 – $5,500
Year 2 – $6,500
Year 3 – $7,500
Year 4 – $7,500
In typical government fashion, there are special cases for which you can borrow more, so take a look at the official webpage for all the details.
Many students will find they need to borrow more than they can get through the federal student loan program. That is where you’ll want to help them think through their options and decide as a family what makes sense for all of you. More on that below.
In the event that you determine additional student loans will be needed, help them decide up front how much they should reasonably borrow. Even for kids having no need for loans, taking a small amount can help them build credit as long as they are careful to pay it back on time.
Here is a structure that you may want to discuss with your student to help them determine how much to take in student loans.
Ideal – I don’t want to take any loans. I’m not comfortable with debt.
Great – I will borrow up to the amount I can borrow from the Government, about $27,000 for 4 years, because I want to stick to the most flexible debt I can access. It will be a significant monthly payment, but I should be able to afford it if I have a good job and I’m willing to make a few financial sacrifices.
Good – I’m willing to borrow up to the amount I expect to earn my first year out of college, because I’m ok with a pretty large student loan payment for 10 years or more after school ends, and I’m ok with making financial sacrifices to pay it off.
Caution – I will borrow more than I expect to make my first year out of college. I recognize that I will need to make substantial financial sacrifices for many years to pay for my college experience.
Any student loans needed over what the government will provide will need to be borrowed from the private student loan market or from the college if they offer that option. Students will typically need a cosigner for private loans, which is usually a parent. Remember that cosigning on any type of debt puts the cosigner at risk of default if payments are not made on time.
As with any financial obligation, remember to read all agreements carefully and make sure everyone involved understands the details and implications of the loans taken.
10. Parent Loans
Use – Annually, as needed, after other sources depleted.
Whether to take loans in the name of the student or parent is a personal/family decision that should be made after considering several factors. For example, if you, as parents, have very strong feelings about providing a college education for your child, you may lean toward taking out debt in your own name only.
Before deciding, research all of the options available between private loans taken in your child’s name and loans taken in your own name as described below. What interest rates and payment terms are available for each? How will the payments affect your/your student’s ability to meet other financial obligations and goals?
Remember to calculate the future payment amount including ALL loans that will be taken over the four years of college, not just freshman year. Then, compare total expected expenses including the loan payment to expected income at that time to decide if the extra loan payment is going to be feasible.
Parents who are willing and able to take out debt in their own name may want to consider the following types of loans:
11. Employer Provided Education Assistance
Use – Annually when applicable.
If your student is lucky enough to work for an employer that provides education assistance, count that toward your college fund balance. An employer can pay up to $5,250 per year in education expenses, tax free.
12. Education Savings Bonds
Use – Annually when applicable.
If you cash in Series EE or Series I Government Bonds, you may be able to avoid paying tax on the interest if your income falls within the applicable limits and you have enough qualified expenses. In this case, qualifying expenses do not include room and board but do include contributions to a 529.
13. Penalty-Free Early IRA Distributions
Use – Annually when applicable.
In the event that you have more than enough retirement savings and wish to use some IRA funds to help pay for college, there are some penalty exceptions that make it less costly for you to do so.
Distributions from an IRA typically incur a 10% penalty if taken before age 59 ½. One exception to this rule is when the money is used to pay for Qualified Education Expenses, in which case, you may be able to take advantage of penalty free withdrawals.
Keep in mind that you can withdraw your contributions from a Roth IRA anytime both tax and penalty free. Contributions are the amount you contributed and, thus, do not include any earnings. Therefore, if you are taking from a Roth IRA in an amount equal to or less than the amount you have contributed, you don’t have to worry about the double dipping rules and qualified education expenses.
A Note On Tax Preferential Sources Of College Funding
While the government does provide tax benefits to pay for college, they won’t be allowing you to double dip, and you must have eligible expenses to back up all tax advantaged sources including:
What that means is, if you are going to benefit from any of the sources above, you must have separate qualified expenses to back up each form of benefit. For example, you can’t use the same expenses to qualify for a tax free 529 withdrawal that you use to qualify for the American Opportunity Tax Credit.
Let’s Put It All Together
So, let’s look at a fictitious example.
Jayden has been accepted to Higher Ed University with a cost of $50,000 for his freshman year. During a conversation with the Financial Aid Department, he learned that the cost usually goes up by about 5% per year, so he has increased the cost by that amount for years 2-4.
Jayden was offered $15,000 per year in merit aid by the Department of Admissions and received need-based financial aid of $4,000, which he expects to qualify for in years 2-4 as well. He was also fortunate enough to win a renewable private scholarship that was advertised on his high school’s guidance page.
He knows that he will not be able to cover all four years of school without student loans, so he has included a plan to use the maximum amount of federal student loans available each year.
Jayden has saved up $2,000 to help him pay for college costs, but that has a bigger impact on his EFC than 529 savings his parents have for him, so he is going to go ahead and use that $2,000 in year 1. He is also planning to work as much as possible and expects to be able to contribute about $2,000/year from his income toward the cost of college.
Jayden’s parents have been paying a lot for groceries to feed him as well as sports clubs he is a part of. When those expenses go away, they think they can use those funds to contribute an additional $4,500 per year to help pay the college bill. They plan to proactively put the money in the 529 each month so they can continue getting a state tax deduction for the money they contribute to that account.
The money they currently have saved in the 529 increases their EFC each year, so they want to use that money to fully fund each school year until it is gone. Jayden’s grandparents haven’t saved anything for him, but if they had, he would use his parent’s 529 first and then start using the grandparents’ 529 since that is better for his EFC.
Following this strategy, Jayden is showing a gap in year 4 of about $20,500. He is trying to decide how to fill that gap.
One idea is to apply for as many private scholarships as he can find. Whatever he can not cover will have to be borrowed. Even if he has to borrow the full $20,500 in private student loans, he will still only have a student loan balance of about $48,000, which is a little less than he expects to earn in his first year after college as a nurse.
Though it will hamper his ability to start saving to buy a new car after college, he feels like the trade off is worth it to complete his education.
| Year 1 | Year 2 | Year 3 | Year 4 | |
| Cost | ||||
| Tuition | $35,000 | $36,750 | $38,588 | $40,517 |
| Room and Board | $15,000 | $15,750 | $16,538 | $17,364 |
| Total | $50,000 | $52,500 | $55,125 | $57,881 |
| How To Pay | ||||
| Merit Aid (tax free) | $15,000 | $15,000 | $15,000 | $15,000 |
| Need-based Aid | $4,000 | $4,000 | $4,000 | $4,000 |
| Private Scholarship (Renewable) | $1,000 | $1,000 | $1,000 | $1,000 |
| Student Loan | $5,500 | $6,500 | $7,500 | $7,500 |
| Student Savings | $2,000 | 0 | 0 | 0 |
| 529 | $16,000 | $19,500 | $21,125 | $3,375 |
| Parent On-Going Contribution | $4,500 | $4,500 | $4,500 | $4,500 |
| Student Employment | $2,000 | $2,000 | $2,000 | $2,000 |
| Gap | $0 | $0 | $0 | $20,506 |
| Total | $50,000 | $52,500 | $55,125 | $57,881 |
Your situation is probably very different from Jayden’s, so go ahead and reach out us to help putting together your family’s plan to pay for all four years of your college bill. Then you can rest easy, or more likely, start stocking up on dorm room necessities!
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