You’ve probably heard us say over and over again how important it is to understand your priorities in financial planning …
The latest report on college costs published by the College Board brought some good news: The increases in tuition and fees for the 2014-2015 academic year were lower than the average annual increases in the past 30 years across all sectors included in the study.
Yet even though college price increases are not accelerating, the report’s authors affirmed that, in real terms, college costs have been rising for decades. For instance, the report, “Trends in College Pricing 2014,” revealed that the inflation-adjusted average published price for in-state students at public four-year universities is 42% higher than it was 10 years ago and more than twice as high as it was 20 years ago. In the private nonprofit four-year sector, the increases were 24% over 10 years and 66% over 20 years.
Given this reality, it is easy to see why devising a plan to pay for college is a major stressor for many American families. Underlying that anxiety are numerous misconceptions about the financial aid process and how a family’s savings might affect a student’s eligibility to receive aid.
Further, there also seems to be a general lack of knowledge about college savings vehicles, specifically 529 college savings plans – how they work, and the many benefits they have to offer families struggling to juggle multiple financial goals.1
529 plans have altered education planning in much the same way that the 401(k) altered retirement planning. A unique combination of features – high contribution limits, professional asset management, account holder control of assets, flexibility in transferring the money, and perhaps most important, generous tax advantages – have solidified the 529 plan’s position as a leader in the education planning world.
Test Your Knowledge
Here’s your chance to test your knowledge about college planning and 529 plans. We hope that the information shared here will shed new light on some of the details of the process.
1. What form do all colleges require of students applying for financial aid?
_____ CSS Financial Aid PROFILE
Answer: FAFSA. Any college or university that awards federal student aid requires the Free Application for Federal Student Aid (FAFSA). For the majority of colleges this is the only aid application required. The CSS Financial Aid PROFILE is required by some private colleges for assessing eligibility for the specific college’s institutional aid dollars. The Expected Family Contribution (EFC) is a number calculated by the financial aid forms.
2. Saving for college in a 529 college savings plan negatively impacts eligibility for financial aid.
_____ Maybe, but often the effect is minimal in the financial needs-analysis process
Answer: Maybe, but often not enough to worry about. The value of a 529 savings plan account set up by a parent or legal guardian is reported as a parental asset on the FAFSA and only increases the EFC by a maximum of 5.64% of the total account value. 529 plans and Coverdell Education Savings Accounts tend to be two of the better options for saving for college without jeopardizing financial aid. Income is generally more of a determinant of need-based financial aid eligibility or lack thereof.
3. Assets held in a 529 college savings plan can be used to pay for what type of school?
_____ Four-year college or university
_____ Two-year community college
_____ Qualified trade school
_____ All of the above
Answer: All of the above. With a 529 savings program, you can use your account at any accredited college or university in the country (and some outside of the country).
4. What happens to the 529 college savings funds if the student does not go to college?
_____ The money can be used by another family member to pay for qualified expenses
_____ The federal government will seize the account
_____ The plan will be declared void, and the money returned to the plan owner
Answer: You may generally change the beneficiary. That money can be used by a sibling, cousin, or other family member for qualified higher education expenses, without penalty.
5. 529 assets held in the grandparent’s name are shielded from the needs-analysis process.
Answer: True. Assets saved in the name of a grandparent are not reported on the FAFSA and do not typically count toward the EFC.
Caution: Distributions from a grandparent-owned 529 plan used to pay for a student’s college expenses generally weigh heavily in the federal needs-analysis process and are typically counted as student income on the following year’s FAFSA form, with an assessment rate of 50%.2
6. 529 plan distributions from a parent-owned 529 account do not increase the family’s EFC.
Answer: True. Unlike distributions from a grandparent-owned account, distributions from a parent-owned 529 plan that are used to pay for a dependent student’s college expenses are not reported on the FAFSA and do not typically count as income in the federal needs-analysis process.2
7. What is assessed most heavily in the federal financial aid formula for dependent students?
_____ Student’s income
_____ Parent’s income
_____ Student’s assets
_____ Parent’s assets
Answer: Student’s income is generally assessed at the highest rate. The federal formula considers up to 50% of a dependent student’s income as being available to pay for college. Here are the approximate rates for the primary financial resource categories that are assessed in computing an EFC:
• Student’s income Up to 50%
• Parent’s income 22% to 47%
• Student’s assets 20%
• Parent’s assets 2.6% to 5.64%
8. Federal loans tend to be the most common type of financial aid used for the education of dependent undergraduates.
Answer: True. For many families, the lion’s share of financial aid is in the form of federal loans often supplemented by private loans, particularly when incomes are above a certain level and many need-based grants have been ruled out.
Important caveat: If you combine all grant/scholarship aid dollars from all sources for all undergraduates, the amount would exceed the total federal loan dollars. Federal loans constituted 34% of total undergraduate student aid in 2013-14, according to the College Board.
How did you do? Hopefully this information has helped you to better understand the financial aspects of college planning – in particular the powerful but somewhat complex 529 college savings plan. To learn more about 529 plans and selecting the right plan for your situation, contact a qualified financial advisor.
For more on the financial aid process, the following organizations offer ample, free information:
• The College Board: Call your regional office or visit collegeboard.org
• FinAid: Visit http://www.finaid.org
• U.S. Department of Education, Federal Student Aid Information Center: Call (800) 433-3243 or visit www.fafsa.ed.gov
1 Investing in 529 plans involves risk, including loss of principal. Before you invest in a 529 plan, request the plan’s official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state’s plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.
2 Note that some private colleges may treat the needs-analysis process a little differently from what is reported here, and generally the comments in this document apply to the federal needs-analysis process. Individual situations will vary.
The College Board, “Trends in College Pricing 2014,” November 13, 2014.
Wealth Management Systems Inc., “Increasing 529 Sales & Savings Rates: The Role of Personalized Planning Tools and Education: Part 2,” June 2015.
The College Board, “Trends in Student Aid 2014,” November 13, 2014.
Forbes, “How Much Do You Know About a 529 Savings Plan? [Quiz],” June 23, 2015.
Provided by the Financial Planning Association
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If you’re saving for a child or grandchild’s college education, brace yourself. The annual cost at the typical private university now exceeds $38,000, and the annual cost at the typical public college is greater than $17,000.1 Multiply those figures by four, and you might wonder if it’s worth it to send Junior to college. In most cases, the answer is yes. Fortunately, there are ways to make your college savings work harder for you.
Developing Your Plan
The hefty price tag of a college education means families need any help they can get when saving and investing for this important financial goal. Consider 529 College Savings Plans. These increasingly popular plans allow you to invest in professionally managed portfolios of stocks, bonds, and other securities.
Most plans let you invest in portfolios that are based on a child’s age. As the child ages, the portfolio’s mix of securities changes. Some plans also let you choose individual mutual funds and assemble your own portfolio. The best part? Earnings can accumulate without taxes, and distributions are currently tax free if used to pay for qualified higher education expenses.2 Many plans have lifetime contribution limits of more than $200,000 – an important consideration given the pace at which college costs are rising. And you, as account owner, control withdrawals.
Another factor for some families: There are no income limits for contributors. And if your designated beneficiary chooses not to attend college, you may be able to transfer the accumulated contributions to the beneficiary’s sibling, first cousin, or other qualified, college-bound family member – even yourself. Contributions, which are treated as gifts for estate and gift tax purposes, qualify for the $14,000 annual gift tax exclusion ($28,000 per married couple) for each beneficiary. If you prefer, you may make a lump-sum contribution of $70,000 ($140,000 per couple) in the first year of a five-year period without owing federal gift taxes. If you choose this approach, you can’t make additional tax-free contributions to the same beneficiary in the following four years.3
The main point? Begin investing as soon and as much as possible. If you later decide to use a different savings vehicle, rules may allow penalty-free transfer of assets.
^1^Source: The College Board, October 2012. Cost includes tuition, fees, and room and board.
^2^Nonqualified withdrawals are subject to regular income taxes and a 10% penalty. State tax rules vary.
^3^If the contributor dies before the end of the five-year period, the portion of the contribution allottable to the remaining years would be included in his/her gross estate.