If you’re a parent, it’s never too early to start planning for your child’s college education. The cost to attend college is steadily rising every year. In fact, it’s not uncommon today to pay well over $30,000 annually for a public university and over $60,000 for a private university. That can be a scary prospect for parents, and college debt from student loans is a huge problem all in itself.
Luckily, there are several ways to pay for your child’s college education without putting them into debt. If you plan now, you can set your child up to attend college with plenty of money in place to cover the costs.
Even within these methods, however, there is plenty of margin for error.
Here are the five most common mistakes to avoid so that you can successfully save for your child’s education:
- Visiting colleges before developing a true budget.
- Only considering 529 plans in your home state.
- Putting assets directly into your child’s name instead of your name.
- Not understanding the importance of your income tax return during the PPY, or prior-prior year.
- Not taking advantage of tax credits.
Let’s take a deeper dive into each mistake and how to avoid it.
Mistake #1: Visiting colleges before developing a true budget.
As your child’s high school education nears the end, you’ll likely visit several colleges before deciding which one is the best fit. College campuses can be intoxicating to an impressionable high school student. They may be dead set on a choice that comes with a hefty price tag, and student loans can look like an easy fix. Your child may not yet understand the ramifications of their financial choices at this young age.
Before your child ever visits or makes a list of potential colleges, it’s important to map out exactly what assets and income will be available to help pay for their education. This includes having a smart lending strategy if student loans make sense for you. For instance, as a general rule of thumb, every $10,000 borrowed for college will have a monthly payment of around $100 per month. Have this discussion with kids early and shop for colleges once you’ve been “pre-approved”.
Similar to buying a home, college choice carries a lot of weight. It’s one of the biggest expense decisions you’ll ever make. Develop a plan. What assets are available to help with college costs? What income might be available? Do you want your child to work while in school? What about student loans? How much and what type of loans are reasonable? Once a list of resources has been determined, it’s important to develop a list of schools that would fit this budget. Looking for schools that offer scholarships at your child’s baseline ACT scores, for instance, can be helpful. If you don’t feel confident making a plan for this, our team can help! We work with clients on developing a one-page college funding and a list of schools so that parents and children can make smart decisions when it comes to college.
Mistake #2: Only considering 529 plans in your home state.
If you’ve looked into paying for your child’s college then you’ve likely come across 529 plans. In short, a 529 plan is a state-sponsored college savings plan that offers tax breaks and financial aid benefits. However, a 529 plan may not provide an advantage depending on which state you live in.
In Tennessee, for instance, there is no state income tax and, therefore, no tax incentive to use the Tennessee plan. However, you can get a 529 plan in another state, or even transfer your current plan to another state. Each state levies asset-based charges in their 529 plan and those charges can vary wildly from state to state. Also, each state has different investment options. Parents should search for a 529 plan that provides great, low-cost investment options and one with low asset-based plan fees as well.
Keep in mind, the state that administers your 529 plan has nothing to do with the state college system your child will ultimately attend. 529 plan assets can be used for any college in any state. The 529 plan decision should come down to which plan is going to give your assets the greatest opportunity to grow.
Mistake #3: Putting assets directly into your child’s name instead of your name.
If you plan on taking advantage of financial aid to pay for college, there are some important steps to take to make sure you get as much aid as possible. When determining financial aid, FAFSA (Free Application for Federal Student Aid) uses EFC, or expected family contribution, to calculate how much a family is expected to pay for college. Primarily, it looks at student assets, like UTMA/UGMA accounts or checking/savings accounts held in their name, and parent assets, like 529 plans and other parental-owned investment accounts.
With regards to FAFSA, assets of the parents are counted at a rate of up to 5.64%, while assets in the student’s name are counted at 20% in making the EFC calculation. If you are saving money specifically for college, keep that money into accounts that are owned by you, such as your 529 plan. If your child owns fewer assets, it will greatly improve aid eligibility.
Mistake #4: Not understanding the importance of your income tax return during the PPY, or prior-prior year.
When applying for financial aid, you will use your income tax return from your PPY, or prior-prior year. This is the calendar year coinciding with the spring of your child’s sophomore year and the fall of their junior year. If you show too much income on this tax return, it could negatively impact the amount of financial aid your child could receive.
So, during this particular year, you should work to keep your income as low as possible. There are several ways to do this without causing too much financial strain.
- Ask employers to defer bonus payments to the following year.
- Avoid selling real estate or realizing capital gains in this tax year.
- Make sizable contributions to retirement plans.
If your income is below $250,000 jointly during this calendar year, it is likely that, depending on school choice, need-based aid could be a factor. Keep this in mind when income planning during the PPY or baseline year.
Mistake #5: Not taking advantage of tax credits.
If you’re paying for your child’s college education, there are several tax advantages available to you, including tax credits.
Any year you spend $4,000 or more in education costs for your child, a $2,500 AOTC (American Opportunity Tax Credit) is available. It phases out for families with joint income between $160,000 and $180,000. However, for high-income families, it could still be claimed on the child’s income tax return if the child has earned income.
Working closely with a tax professional here might make sense. Claiming this credit by filing a tax return for a child can mean $10,000 ($2,500 over 4 years) towards the cost of college that wouldn’t otherwise be available.
Paying for college is an often overlooked area of financial planning. Student loan debt has become a real problem nowadays, and, as parents, you want to set your child up to succeed in life without debt following them.
There are several ways you can prepare now to cover the costs of college. However, follow this advice and avoid these costly mistakes along the way. Making smart decisions now will minimize the cost of college and set you and your child up to make this dream a reality.