A college degree can lead to higher paying jobs in the future, but how do you pay for tuition?
What Will I Have to Pay?
It is expected that by 2030, that one year of education at an in-state public school will cost over $41,000. An out-of-state public school could cost $71,000/yr and a private school could be over $90,000/yr. But don’t panic! It’s very unlikely that your family will be footing that entire bill.
The formula for determining how much you’ll need to pay for college is determined using the following formula.
Cost of Attendance – Estimated Family Contribution = Financial Need
Here is a breakdown of that formula:
Cost of Attendance (COA)
A school’s COA is usually determined by the following factors:
- Tuition and fees
- Books and supplies
Expected Family Contribution (EFC)
The EFC is essentially the amount that the federal government thinks a student and his/her family should pay towards the Cost of Attendance. It is based on student assets and parents assets, which include:
- Savings and checking accounts
- Non-retirement investment accounts
- Investment property separate from the primary residence
- Farm property that is separate from the primary residence
- Net worth of a business with over 100 full-time employees
Also taken into account are student and parent incomes, your family size, and the number of undergraduate students in your family that are currently attending college.
When determining EFC, the following are counted as resources available for paying for college:
- 20% of a student’s assets
- 50% of a student’s income (after certain allowances)
- 2.6%- 5.6% of the parents’ assets
- 22%-47% of the parents’ income (based on a sliding income scale and after certain allowances)
The amount that remains when EFC is subtracted from COA is the student’s financial need. This cost may be met through private or institutional scholarships and grants, work-study, federal student loans, or private loans.
It’s Never too Early to Start Saving
The earlier you can start saving for your child’s higher education, the better. A great first step is opening a junior or student savings account in your child’s name. There you can deposit monetary gifts your child receives for birthdays and holidays.Down the road, as you get more serious about college savings and the financial aid process, you may need to rethink your strategy.
When a student applies for financial aid, assets (savings and checking accounts, non-retirement investments, property separate from the primary residence, etc.) in their name and in their parents’ names are taken into account. However, student assets are calculated at a much higher rate than parent assets (20% versus 5.6%). For this reason, you’ll want to investigate savings plans where a parent is the primary account holder and the assets are in his/her name, including 529 savings plans, Coverdell Education Savings Accounts, and even Roth IRAs.
529 savings plans are operated by individual states and designed as a way to save funds to cover the cost of college. They operate like a 401K or IRA, where your contributions are invested in mutual funds or other investment options and will go up or down based on the value of your investment choices. The child that you are saving the funds for will be listed as the account beneficiary.
529 plans also offer federal income tax advantages. Although your contributions are not tax-deductible, your earnings are tax-free and your distributions will not be taxed, as along as they are taken out to pay for qualified college expenses. These include tuition and fees, books, computer technology, and some room and board expenses.
Although savings in your 529 plan will affect a potential financial aid plan because they are considered a parent asset, the impact will not be as great as with student held savings accounts. And, if one child decides to forgo college, the funds can be transferred to another family member.
Coverdell Education Savings Account
Previously known as Education IRAs, these savings accounts work similarly to 529 plans. You contribute funds which are invested, any earnings grow tax-free, and your qualified distributions are federal income tax-free. But unlike 529 plans, the funds in a Coverdell account can be used for qualified K-12 expenses, as well higher education expenses.
A few other differences you’ll see with a Coverdell account:
- Coverdell accounts can only be utilized if your Adjusted Gross Income is under $110,000 (single tax filer) or $220,000 (joint tax filer).
- There is a $2000 annual contribution cap, per beneficiary.
- Funds in a Coverdell account must be used before the beneficiary turns 30 years old to avoid taxes and penalties.
It may seem unconventional to use a retirement account for college savings, but there is one strong benefit to this savings tool. Unlike a 529 or Coverdell account, which is still counted as a parent asset when determining a family’s Expected Family Contribution (EFC), a Roth IRA, as a retirement account, won’t count as an asset.
A Roth IRA offers the same tax benefits as traditional college savings plans. If you are over 59 ½ years old and have had your Roth IRA for five years or longer, the disbursements from your Roth IRA will be 100% tax and penalty free. And, those disbursements can be used for education expenses or any other purpose. If you need to cover the cost of education prior to turning 59 ½, the 10% early withdrawal penalty that a Roth IRA traditionally carries will be waived if the funds are used for qualified higher education expenses. Take note that IRA disbursements can jeopardize a student’s financial aid in the following year. The entire withdrawal, principal, and earnings, will count as income earned. For this reason, it’s suggested that IRA funds be used to pay for the final year of school.
Roth IRAs are subjected to contribution limitations. Up until the age of 50, you can only contribute $5,500 annually. This bumps to $6,500 annually once you turn 50 years old. Additionally, there are further contribution limits for single tax filers who earn between $117,000 and $132,000 and joint tax filers who earn between $184,000 to $194,000.
Applying for Financial Aid
To apply for financial aid, a student’s first step will be to complete and submit a FAFSA application (Free Application for Federal Student Aid). With this one form, your student will have access to loans, grants, and work-study from the federal government. The form is also used by most schools to prepare their own financial aid packages.
Once it’s submitted, your FAFSA is reviewed by the Office of Federal Student Aid. The schools you listed on the form will be notified so they can determine how much aid you can get at that school.
Your student will then receive a financial aid award letter from each school upon their college acceptance. This award letter outlines the types of aid he or she has received and the amount being offered. This will include federal student loans; gift aid, such as scholarships and grants; and opportunities for self-help aid, like work-study programs.
Federal Student Loans
The Benefits of a Federal Student Loan
If scholarships, grants, and work-study do not cover a student’s remaining financial need, federal student loans are an important part of a financial aid package.
Federal student loans are advantageous over private student loans for several reasons:
- They offer low fixed interest rates, meaning the interest rate will not change over the life of the loan.
- Multiple repayment plans are available, including extended payment plans, graduated payment plans, and income-driven payment plans.
- You have the options of deferring (postponing) payment for qualifying reasons or canceling your loan based on certain types of employment.
There are two federal student loan programs that are available to you: Direct Loans and Perkins Loans. With a Direct Loan, the U.S. Department of Education is the lender. Perkins Loans are school-based loans and your student’s school acts as the lender. Here is additional information to help you understand Direct Loans and Perkins Loans.
There are two types of Direct Loans available to undergraduate students.
Direct Subsidized Loans – These loans are only available to students who demonstrate financial need to help pay for the cost of higher education. Your school will determine the amount you can borrow, although the maximum annual reward can be up to $5,500. Repayment of the loan will begin six months after a student graduates, falls below half-time enrollment, or leaves school. The main advantage of a subsidized loan is that the U.S. Department of Education does not charge interest on the loan, as long the student meets these qualifications:
- He/She is in school at least half-time
- He/She is in the six-month grace period after leaving school
- He/She is in a period of deferment (postponement of loan payments)
Direct Unsubsidized Loans – Students do not have to demonstrate financial need to be eligible for an unsubsidized loan. The student’s school still determines the amount you can borrow, but you have the ability to borrow a maximum annual award of up to $20,500. Just like a subsidized loan, repayment of an unsubsidized loan will begin six months after a student graduates, falls below half-time enrollment, or leaves school. However, with an unsubsidized loan, interest will be charged on the loan during all periods.
Perkins loans are awarded to students with exceptional financial need. Perkins Loans are awarded throughout your school, meaning the school is the lender, although not every school participates in the Perkins Loan program. With a Perkins Loan, you have the ability to receive up to $5,500 annually. However, each school’s funds are limited, so not everyone who qualifies for a Perkins Loan will receive one.
A student has nine months after he/she graduates, falls below half-time enrollment, or leaves school to begin repayment on the loan.
Private Student Loans
If you still find yourself with college expenses that financial aid and savings won’t cover, you can also research private student loan options. For Lancaster Red Rose Credit Union members, this includes the Smart Option Student Loan by Sallie Mae®.
The Smart Option Student Loan allows a student to borrow at a competitive variable interest rate (2.87% APR to 9.91% APR) or a low-risk fixed interest rate (5.74% APR to 11.85% APR). The program also offers students three repayment schedules to meet their needs.
Deferred Repayment Option – you can choose to make no payments or you can choose to pay as much as you are comfortable with while you are still attending school.
Fixed Repayment Option – you pay $25 per month while you are in school. This option can save you an average of over 10% on your total loan cost, as compared to the deferred repayment option.
Interest Repayment Option – you pay the interest on your loan while you are in school. This option can save you an average of 20% on your total loan cost, as compared to the deferred repayment option.