Each year, January becomes the timeline for many families to set new saving goals. Whether your goals are short-term or long-term, making them specific and measureable improves your chances of attaining them. Saving for college is normally high on the list for many parents and grandparents. A common question for many families is how 529 plans and financial aid come together in the college process.
In a recent Fidelity Investment survey titled, “College Savings IQ”, Fidelity listed that approximately 72 percent of families are saving for college. At first, I was encourage by this percent until I dug deeper and found that the survey also identified major problems for families saving for college. Specifically, these families are confused and lack financial literacy in several saving for college areas and feel that they could use more information on how to save and better plan for college.
The survey identified three specific areas where families need more financial literacy. They are:
- Projecting the future cost of college and determining how much to save
- Understanding financial aid eligibility in relationship to savings
- Understanding 529 saving plans
How do families solve these financial literacy concerns? To delve deeper into these three areas, I have listed information that highlights answers for families.
Projecting the future cost of college in Relation to Saving
Most families have the goal of sending their child to college. The first step in trying to figure out this puzzle is to develop a family timeline and project the number of years until each of their children attend college. The timeline will help parents understand how many years until the cost of college will be incurred, years where children will overlap and the number of years until retirement. For some families, having children overlap in college could improve their financial aid position.
The next part of the exercise is to do an estimate of their Expected Family Contribution or EFC. This is an important step since it will show how college savings, specifically 529 plans and financial aid work together.
Families trying to understand financial aid eligibility need to understand their expected family contribution or EFC. The EFC number will eventually be used to determine your financial aid. With the high price of college, many parents get frustrated and give up after seeing how much they need to save. A better goal is not the college cost but your EFC. Here is the link to our Free EFC Calculator.
I would also suggest that families sit down and contemplate a few long-term college goals. Decide how you plan to help your children with college. Discuss whether you are covering the whole tuition or only a percentage. Also, what type of school are your planning on saving for, a private or public college? The last item to consider is tied into how much disposable income you have available to save for this goal. Getting a ballpark of college expenses can better help families get a target of the amount they need to save.
Understanding Financial Aid Eligibility
Many families do not understand how their savings accounts will affect their financial aid position. Financial aid eligibility is determined by completing the FAFSA and understanding your EFC number. All federal need-based financial aid requires students to complete the FAFSA. Some colleges require a second financial aid process called the institutional method. The most common of these methods is the CSS Profile managed by College Board. Generally, colleges that use a secondary process have a significant endowment that they are trying to distribute to their targeted applicants. The institutional methods will ask additional question beyond the FAFSA, and there is often a fee to use these methods.
A big misconception regarding the EFC is that it is one number. The actual calculation is really four separate numbers that are summed together to create the Expected Family Contribution Number or EFC. The four components of the EFC are Parent’s Income, Parent’s Assets, Student’s Income and Student Assets. Each of these components has separate rules and allowances.
The most common college saving vehicle is the 529 plan. It allows parents and grandparents to save for education and the investment grows tax-free. Some states offer income tax incentives to make these saving contributions.
To create a college funding strategy, you need to understand the details of the four EFC quadrants. Understanding the details of each EFC component is important because it helps families clarify the appropriate strategy to lower their out of pocket cost of education.
The 529 plans and financial aid are directly related. The 529 Plan money is reported as a parent’s asset in the EFC calculation. The good news is these assets are calculated at 5.64% of the total number after an allowance based on the age of the oldest parent. In addition, the child owned 529 plans are considered a parents asset. The bad news is that all 529 plan money for the family needs to be reported as a parent asset in the FAFSA. The 529 Plan money owned by grandparents does not need to be report in the FAFSA but should be reported in the Institutional method.
Understanding 529 saving plans
The survey revealed that even though families are saving through 529 plans they do not truly understand them. Here is a quick explanation of this saving vehicle. A 529 plan is an investment plan operated by a state and designed to help families save for future college costs. As long as the plan satisfies the requirements, the federal tax law will provides special tax benefits to the plan participant and beneficiary of the plan. This means that all the contributions and earnings can grow tax deferred as long as the funds are used for qualified educational expenses.
Some states offer an income tax deduction for contributions to their plans. Different investment options exist within these plans both on a risk level and age based portfolio basis. These plans can be passed down among family members.
Federal guidelines for 529 plans typically let parents and grandparents to each contribute up to the gift tax limit, which is $15,000 a year per child for the year 2018. Parents can set up automatic monthly contributions through their 529 plans providers and gradually save for college. There is also a 5 year accelerated option.
Starting in 2018, the new Tax Cuts and Jobs Act allows for 529 plan money to be used for elementary and secondary school expenses at public, private and religious institutions. It is limited to $10,000 expenses annually.
Importance of Withdrawals
Even though this article focuses on the 529 Plans and financial aid, a missing part of the puzzles is the proper use of these plans in the distribution phase. Paying for college needs to include the financial aid positioning, college saving plans, educational tax strategies, student loans and student loan repayment.
Tax-free 529 plan withdrawal can only be used for qualified expenses. At the same time, a family cannot use the same qualified expenses for multiple tax savings. As an example, a family could not use tuition expenses paid with 529 money and then expect to use the same tuition dollars to claim the $2,500 American Opportunity Credit. These certain situations need advanced planning that is often overlooked by families.
529 Plans and Financial Aid Conclusion
Saving and paying for college is the second most common financial goal for most families. To solve the financial literacy issue regarding this topic, parents and grandparents need to do more research. Find qualified financial advisors that had the proper training to explain the various college funding strategies.
At EFC PLUS, we are trying to start the process of educating families about the college funding through our video library and monthly blog. Our free EFC calculator and periodic webinars are also available to help families determine the amount colleges expect them to pay and the best way s to accomplish this parental goal. We have also developed a training program for financial advisors. It is now listed on the FINRA website and the CFP Board approves the courses for Continuing Education Credits. The FINRA listed designation is called the College Funding and Student Loan Advisor (CFSLA).
As college cost and student debt continues to rise, we need to start taking steps in preventing this student debt crisis. Our children’s financial future is depending on it.