College financial planning: two different paths

How can you follow a map if you don’t know which road to take? College financial planning is like that. The destination is lowest possible out of pocket costs. But the route to take depends on where you’re starting from.

The key question you need to answer is whether or not you might be eligible for financial aid. I gave you a method for a very imprecise estimate in my previous post. Another way to try this out is to use one or both of these website estimators: FAFSA4caster for calculating your Expected Family Contribution and Princeton’s estimator for guessing at what a top private school might award your family.

Once you do that, you’ll have some idea of where you are: eligible, borderline, or dream-on. If you are eligible, then your strategy should be to search for ways to make your family MORE eligible for the good stuff: grants or scholarships that don’t have to be repaid; work-study; and lowest-possible interest loans.

Ditto if you’re borderline. This is perhaps the most nerve wracking position to be in because you just might be able to lower the treatment of your income and assets by reordering and tweaking the way you are holding and receiving them. Is this ethical? Well, most people (and the tax courts) have taken the position that citizens are entitled to order their affairs to pay the minimum income taxes possible under the law. I think the same standard applies to student aid.

What about if, clearly, you are wealthy enough to pay for your kid’s ticket? Well, first, congratulations. I always think about how happy I would be to pay a million bucks in income tax—after all, it would mean my take home would be (ahem!) a lot higher than it is now. I think any parent who can easily afford the tab should take some enjoyment in their success. However, nobody likes to be rooked or pay retail, and there are still plenty of strategies to reduce your out of pocket costs. These are mainly what planners refer to as “tax strategies”—ways to transfer some portion of your income to your student, both to take advantage of the student’s presumably lower tax rate, and to provide legitimate deductions for your business. Then, they use this money to pay the bills. Also, this is an area where having a student with get-up-and-go can really help—the kid who garners AP credit, outside scholarships, and earns money in side and summer jobs can make a big contribution here without fear of reducing school-granted aid.

None of this is easy, and all of it is highly individual based on family circumstances, to what school the student is headed and what their policies are, and how much effort the family wants or needs to devote to the process. That’s what college financial planning is all about.

College financial aid: estimating how much

How many times have you mentioned a college to someone and gotten the response, “Oh my gosh, Prestige University is SO expensive—how are you ever going to afford it?” Too many families decide not to apply at all when they see a sticker price of $58,000. Wrong!

The first number you need to pay attention to is not tuition cost, but cost of attendance (which can be found on the college’s website). This includes not only tuition, but also books, fees, room and board, which can all jack up the price considerably (but remember, you won’t be feeding the child for the school year, which in the case of some teens can be a substantial cost savings in itself). Okay, now you’ve picked yourself off the floor. Just for entertainment, pick one Prestige U. that your child probably isn’t going to get into, and find the cost of attendance at your State U. State U is going to be cheaper, but probably only because of in-state tuition.

For example, at an anonymous but real Prestige U. this year’s (2011-2012) cost of attendance is $58,955, of which $41,853 is tuition. At the University of Illinois, in-state cost of attendance is $28,204, with $11,104 of that going to tuition. Now, at “sticker price”, where do you think you might get a higher dollar amount of aid? Probably, Prestige U. What’s important to consider is not the sticker price, but the actual OUT OF POCKET cost. The out of pocket cost is the sticker price minus the amount of aid offered.

Here’s the big mystery: how much will that aid be? Future blog posts will discuss the factors that affect aid at private universities, but for now I’m going to offer a quick and dirty way to get a wildly inaccurate (but useful) estimate of what the parental unit will be expected to kick in for junior, otherwise known as the Expected Family Contribution (EFC). Take the total cost of attending, subtract your EFC, and voilá, that’s what you have a chance at getting (although there are a lot of ifs and buts on that).

However, since too many parents do conclude right away that they won’t be eligible, and just what the EFC might be is always shrouded either in mystery or in 95 pages of paperwork more complicated than your tax return, I’m going to give you this wildly INACCURATE method that takes into account none of the adjustments or strategies that a college financial aid planner (ME!) would suggest. But it’ll get you started. Here goes:

1. Add up your assets. Don’t include your IRAs, Roths, 401(k)s or any other retirement funds. Also don’t include the value of your primary home (but do include vacation homes or investment property). Multiply this total by .0565.

2. Next, grab your tax return and look at the number on line 22 of your 1040 (not line 37 as you won’t get deductions from college financial aid for many of these items). I’m going to presume this number is over $30,000. Take 47% of the amount over $29,300 and add $7926 to that sum.

3. Add together the answers you got in #1 & #2. That is a gross, inaccurate estimate of your EFC, but it does give you a starting point to think with.

So, let’s take a look at how this might work in two situations. Family number one—parental combined income is $100,000, and they have a stock and bond portfolio of $100,000, and $500,000 in an IRA but who cares because that’s not going to be considered. So, under my seat of the pants formula, their EFC would be $41,155 from income and $5,650 from assets totaling $46,805 (PER YEAR). Probably aren’t going to get any money from State U. as their EFC exceeds the cost of attendance and according to the formula, they can pay for it. However, they’re $12,150 short at Prestige U, so it’s definitely worth an aid application.

Now let’s look at another family. Recently divorced single mom is trying to get her career restarted, but with “unallocated maintenance”, her income is $50,000. However, the property settlement also gave her $500,000 in assets (again, not including the house or retirement accounts). Under my “bad” estimator, she’d be nicked for $17,655 out of income, and $28,250 from assets for a total EFC of $45,905. She’s going to feel pretty stressed when she sees that figure, but it still puts her in the ballpark for aid at Prestige U.

Of course, every situation is different, THERE ARE LOTS OF WAYS TO ADJUST THESE FIGURES, Prestige U may use a different methodology called the institutional method (my “estimator” is based on the federal formula) and don’t rely on this—enough caveats? Nevertheless, it does give you some idea of how even relatively affluent families might be eligible for financial aid. Don’t give up, and give me a call to take a look at your individual situation!