With college tuition continuing to increase at more than the annual rate of inflation, my best advice for parents saving for college is not to get paralyzed by the staggering grand total for four years of tuition, room and board, books, etc. Simply, begin to save what you can as early as you can. These twelve tips can get you moving in the right direction:
- Uncle Sam to the rescue. Passed in conjunction with the health care reform law last month, the new student loan legislation is the most significant college financial aid reform since the Pell Grant was introduced in the mid-1960s. Injecting $61 billion into higher education programs over the next decade, the law will help students before, during and after college. It goes into effect this July.
Starting in 2013, the federal government will inject $36 billion into the Pell Grant Program, steadily increasing the award from its current level at $5,550 a year to $5,975 over a five-year period. Equally important, students paying back federal loans starting in and after 2014 will have the option of capping their monthly loan bills at 10 percent of their discretionary income—defined as any income above 150 percent of the poverty line—and dismissing all remaining debt after 20 consecutive years of payment.
- Good News/Bad News for scholarships. Fallout from the recession cost many colleges millions of dollars from their endowments, forcing cuts to financial aid budgets and a shift away from grants and scholarships to loans. However, today more colleges are strategically employing “tuition discounting,” a term used to describe the process of awarding college scholarships to shape student bodies in specific ways. These funds are awarded not on the basis of financial need, but are driven by an institution’s desire to shape their enrolled class with their strategic goals. So if you don’t qualify for aid, but have a physics genius on your hands, try to match your student up with a college looking to excel in that area.
- Tap your Roth. In a tuition pinch, remember that your contributions to a Roth IRA account can be distributed tax-free at any time, for any purpose. And the earnings can be distributed tax-free after you reach age 59½, provided your account was established more than five years before. If your Roth IRA withdrawals for college bills exceed your contributions, those earnings would normally trigger a 10% penalty, unless you are 59½. However, the penalty is waived to the extent you pay qualified higher education expenses for yourself, your spouse or your child or grandchild. These expenses include tuition at most accredited, post-secondary institutions, along with mandatory fees, books, supplies, equipment, room and board, and certain additional expenses if the student is a special-needs beneficiary. Note that the 10% early distribution penalty on an early distribution from traditional IRA would also be waived. However, unlike the Roth, regular income tax would also be due on assets taken from a traditional IRA.
- Prepay tuition. Some schools will allow you to pay all four years upfront, at this year’s prices. College tuition costs have been going up by about 6 percent a year, so locking in a lower rate for four years can make a big impact.
- Stay in-state. Even if your student wants to go out of state, staying in state for just a year, or planning to return home for graduate school, can improve your bottom line.
- Don’t miss deadlines. Missing the deadlines colleges establish for submission of financial aid forms can have dire consequences. Not every college operates on the same schedule and many require submission of previous year’s income tax forms, so pay careful attention. Once you’ve missed the aid window, you’ll likely see a profound shift away from grant money, which will have been awarded earlier on schedule, to loan money.
- Take another look at 529s. More and more, 529 plans are offering investor-friendly features for difficult markets. These include guaranteed investment options as an alternative to age-based funds, drops in management fees, and more flexibility – like the ability to change investment options twice a year.
- Make it a family affair. Suggest to grandparents and other family members to make contributions for college in lieu of other gifting. Another option worth exploring is the growing selection of credit cards that allow spenders to contribute to a college savings plan. Wealthy grandparents who want to make contributions to a 529 plan have the ability to frontload those contributions without paying a federal gift tax. You can contribute $13,000 a year without filing a gift tax return with the Internal Revenue Service, or as much as a $65,000 contribution in one year, which covers the current year’s gift and four more years, without incurring gift taxes.
- Apply to a financial “safety school.” Everyone has that “safety school” on their list where they are reasonably sure to be admitted. However, you need to be sure you can afford that school, without aid, or it doesn’t function as the “safety” you intend it to.
- Cash in Advanced Placement credits. If you earn a high score on an AP exam, you may be able to waive some introductory college courses. If you go to a college where you pay tuition based on credit hours, those credits can save you money. If you have enough credits, you might be able to graduate early, or go to school part-time while working part-time.
- Take Advantage of Tax Credits. The Hope Scholarship Credit (aka American Opportunity Tax Credit) allows you, in 2010, to claim a tax credit for 100% of the first $2,000 and 25% of the next $2,000 of a dependent child’s college tuition and mandatory fees, for a maximum $2,500 annual tax credit per child. The credit is phased out for incomes between $80,000 and $90,000 (between $160,000 and $180,000 for married taxpayers filing jointly). It may make sense not to claim your student as a dependent so he/she can claim the credit. The credit is allowed only for students who are attending a degree program at least half-time and who have not completed their first four years of academic study before the beginning of the taxable year. It cannot be claimed in more than four tax years for any one student.
With the Lifetime Learning Credit, a taxpayer may claim a tax credit for 20% of up to $10,000 in combined tuition and mandatory fees for himself, his spouse, and his dependent children. This equates to a $2,000 tax credit. In 2010, the credit is phased out for incomes between $50,000 and $60,000 (between $100,000 and $120,000 for married taxpayers filing jointly). Claiming the American Opportunity Tax Credit described above means that you may not claim a Lifetime Learning Credit for any of that student’s expenses in the same tax year. There is no requirement that the student be studying towards a degree or be enrolled at least half-time, and there is no limit on the number of years the credit may be taken.
- Reconsider a Roth conversion. With the $100,000 income limit lifted for conversions from a traditional IRA to a Roth IRA, many investors are interested in diversifying their retirement portfolio from a tax standpoint. That’s a terrific idea, but there is a possible negative consequence—losing financial aid for your college-age children. Remember, anything that is pulled out of an IRA and converted is considered income and that will affect your financial aid. Accordingly, rather than convert all at once, it may make sense to consider a phased conversion approach that won’t impact aid as much. The Department of Education has asked colleges to take into account one-time increases in income from these conversions, but you may want to contact the colleges’ financial aid offices directly before making a decision to covert to a Roth.
Remember, although your children’s childhood may seem fleeting, 18 years is a long time in the evolution of investment products and strategies. For example, everyone’s favorite college funding tool, 529 college savings plans, gained their prominence and tax advantages with the Economic Growth and Tax Relief Reconciliation Act of 2001. Particularly if you save in a 529, it’s important to stay tuned in to rule changes that could impact how often you can re-allocate your investments or what constitutes a qualified withdrawal. Joe Hurley, the nation’s “529 guru” (www.SavingForCollege.com) has even suggested bigger changes, such as the inclusion of student loan repayments as qualified higher education expenses, the ability to transfer funds between 529s and IRAs, and the flexibility to donate your leftover 529 account to a charitable scholarship program.