Effective since July 1, 2009, a 529 account is now regarded as an asset of the student if the student is an independent student and an asset of the parent if the student is a dependent student under the federal financial aid rules.  

An independent student generally includes an individual who:

·      is age 24 by December 31 of the award year,

·      is an orphan, in foster care or a ward of the court (other rules may apply),

·      is an emancipated minor,

·      is a war veteran,

·      is a graduate or professional student,

·      is married,

·      has legal dependents other than a spouse,

·      is homeless (other rules may apply), or

·      has special and unusual circumstances which can be documented to his or her financial aid administrator.

Prior to July 2009, a 529 plan was considered a resource of the student if a pre-paid tuition plan and an asset of the student if a savings plan.  While an asset is considered in the EFC formula, a resource directly impacts eligibility dollar for dollar.    

Why is this important?  As an independent student, only the student’s (and spouse if married) income and assets are considered when determining need-based financial aid eligibility.   The parent’s financial information is not required when calculating the student’s Expected Family Contribution (EFC).

The formula counts the following financial resources as being available to pay college expenses:

o  20% of a student’s assets (money, investments, business interests, and real estate)

o  50% of a student’s income (after certain allowances)

o  2.6%- 5.6% of a parent’s assets (money, investments, certain business interests, and real estate, based on a sliding income scale and after certain allowances)

o  22%-47% of a parent’s income (based on a sliding income scale and after certain allowances)

Then need-based eligibility is determined as follows:

COST OF ATTENDANCE (COA)

-          EXPECTED FAMILY CONTRIBUTION (EFC)

=     FINANCIAL NEED

-          RESOURCES OF THE STUDENT

=     ADJUSTED FINANCIAL NEED

One can readily see that treatment as a parental asset is much more favorable (2.6% to 5.6%) as compared to a student asset assessed at 20%.  However, if the owner of the 529 plan is neither the parent nor the student, the savings account is not included in the calculation.  Anyone can contribute to a 529 College Savings Plan on behalf of the student and the owner need not be the parents.    

Consideration should be given to the ownership of such accounts in regards to their impact on the student’s ability to receive need-based financial aid.   Doing an estimated EFC calculation will help determine this as you compare the results to the cost of the colleges and university the student is considering applying to.

If you want to make even the most stalwart investor weak in the knees, calculate how much four years of education will cost ten years from now. 

That’s what traditional college savings calculators do.  It’s fairly simple.  First, the future cost of college when your child reaches age 18 is determined.  Second, based on the current rate of return, the future value of your investments and savings is calculated.  Then future investment value is subtracted from future college costs which gives you the amount you’ll need to save in the given time period. 

Based on what you need to save, how long you have to save it, and what your investments are returning, a monthly figure is calculated.  That’s when the well-intentioned parent faints, realizing that they will have to save some huge monthly sum, totally beyond the family’s budget to absorb. 

So what’s a parent to do?  Create options, by investing both educationally and financially.  Educationally, parents need to invest their time to insure their child is given every opportunity to excel in school, provided the opportunity to explore the world and broaden their horizons, and encouraged to participate in activities that develop teamwork and leadership. Maximize their strengths and help them compensate for their weaknesses.  Yes, parents may feel like taxi drivers and might even have to read that text book along with their child, but that small investment in time will be returned ten fold when admissions officers start separating the sheep from the goats.  If they’ve done a good job preparing their student educationally, he or she has many more options in shopping for the right college or university.  The student might even qualify for merit scholarships and grants.

Financially, traditional college savings calculators are too simplistic, often resulting in an unreasonably high investment figure.  But consider whether most folks paid cash for their home—probably not.  So they shouldn’t expect to pay cash for college.  If they have four years of college expenses saved by the first day of college, they are, in effect, paying cash for college.  That’s unnecessary and unrealistic. Most families simply cannot save that amount of money, nor do they need to. 

Furthermore, the government doesn’t expect the family to pay the entire cost of a college education, only their fair share based on their financial circumstances.  Thus enter the financial aid formula for calculating Expected Family Contribution (EFC).   This is the method the Department of Education uses (or The College Board via the CSS Profile) to determine the student’s fair share of one year’s cost of education, and then their financial aid eligibility. 

There are two basic types of financial aid: Self-Help Aid, which consists of interest subsidized loans and work study, and Gift Aid, which consists of grants and scholarships.

The amount and type of financial aid is based on two factors: the merit of the student  (scholarship, athletic achievement, musical or artistic ability, etc.) and the financial need of the student.

Need is by far the most important factor in determining financial aid, but that

is slowly changing.  Most of the financial aid given by the federal and state governments is based on the financial need of the student, while most of the

financial aid given by colleges is merit-based.

How is the financial need of a student calculated?  “Needs Analysis” is the process of determining the financial need of the student. It is calculated using the following formula:

1         Cost of Attendance (COA)

      -     Expected Family Contribution (EFC)

      =    Financial Need

2         Financial Need

      -     Resources of the Student

      =    Adjusted Financial Need

Example: If the cost of attendance at a particular college was $12,000 and the expected family contribution was calculated to be $4,000, the financial need of the student would be $8,000. In this case the student would be eligible to receive $8,000 in financial aid. Whether he receives a financial aid award for the entire $8,000 is up to the discretion of the individual college. Nonetheless the financial aid eligibility of the student is directly related to the financial need.

If the student had other resources to help pay for the college cost, the financial need would be reduced on a dollar-for-dollar basis for these resources. In this example assume the student had received a $1,000 private scholarship from the local Chamber of Commerce.  Since private scholarships (scholarships which are not given by the college) are considered a resource, the $1,000 scholarship would reduce the financial need down to $7,000. This means the student would now be eligible for only $7,000 in financial aid from the college.  Merit-based scholarships may be added to the mix as well.

The bottom line is parents don’t have to save the whole enchilada, but they need to invest something.  If they can have a year or maybe two of college expenses ready when the student begins college, they’re in good shape.  They have options–choose to pay for college from loans, from the investment account, from your income or a combination of all three.  They can also take advantage of the monthly installment plans.

How can parents use this information?  They should combine the traditional savings calculator with the needs analysis process.

­­­

1  Using the traditional calculator, determine what college is going to cost X number of years from now  (figures will be different depending on whether one uses a current public or private college dollar figure).  It would serve to use both for planning purposes.

2  Determine, based on a given annual cost of living adjustment and appreciation rate, what the parent’s income and assets will be at that same time in the future. If they are going to use the institutional method (used by the College Board), they’ll need to figure out what your home equity will be worth as well.  The student’s income and assets will also have to be fabricated ($1,500 to $2,000 is a good estimate of a high school senior’s current income who is working part time.)

3  Using a EFC estimator (Finaid.com and collegeboard.com have these available),determine what the student’s  EFC will be (see Appendix B).  This is assuming that today’s rules will still apply in the future.

4  Compare the future cost of education to the EFC.  If the EFC is less, subtract it from the cost.  The difference is need-based financial aid eligibility, the remainder is the family’s cost.  If the EFC is greater than the cost, there is no need-based aid in the student’s future.

This information allows us to make some judgment calls.  First, the remainder would be their dollar goal in terms of investing—the family’s cost after aid.  Based on this they can go back to the traditional calculator to determine their monthly savings goal.  And it is just that, a goal; they should not put retirement savings at risk.  What parents want is to have financial options when it comes time to pay for college.  Even a small educational nest egg is better than none.

Second, and most importantly, it gives parents the guidelines they need to determine where best to invest their college savings.  It’s important for

parents to remember that whatever investment strategy they choose will ultimately have consequences in terms of taxes, rate of return vs risk, and financial aid eligibility.

Whether or not need-based financial aid eligibility is established dictates whether or not the parents should concern themselves with looking for options to shelter assets from the needs analysis formula.  If there is no need-based aid then parents need only concern themselves with the tax and rate of return questions of investing.  However, if it appears that need will be established, then parents should make every effort to shelter assets from the formula, divert income, and so on to lower the EFC as much as possible, thus increasing the amount of need-based aid they are eligible to receive.

There is no magic formula.  No one college saving strategy will work well for every family because the right approach is dependent on several variables including, tax bracket, the student’s age, anticipated financial aid (both need

and merit) and how much control parents wish to retain over their investments. 

The goal of young parents should be to invest in their child, both educationally and financially, so when the reality of college stares them in the face, they have the latitude to make decisions.  “Creating Options” is what we want to achieve and given a good job of planning, the next phase of the process could more pleasantly be referred to as implementing rather than reacting.  

“You can pay me now or you can pay me later” was the tag line to an automotive maintenance commercial that aired a number of years ago.  Its meaning was quite obvious–pay a little now for maintenance or pay much more later for a major repair.

We should heed the same warning in regards to college planning, the financial consequences of which could be much greater than a $2,500 transmission job. 

Yet, research conducted in the summer of 2006 by AllianceBerstein College Savings Crunch study, revealed, that while 95% of parent surveyed intended to pay some or all of their children’s college expenses, even though one-third of those parents hadn’t started saving yet, and 64% had saved less than $10,000.

A recent report from The College Board showed that tuition and fees at public colleges and universities rose 6.3 percent for 2006/2007, an average of $5,836 a year, while private institutions saw a 5.9 percent annual increase to $22,218 on average.  That doesn’t include room and board, books, etc., which you can count on costing another $7,000 to $8,000 a year.  If you want to make even the most stalwart investor weak in the knees, calculate how much four years of education will cost ten years from now. 

That’s what traditional college savings calculators do.  It’s fairly simple.  First, the future cost of college when your child reaches age 18 is determined.  Second, based on the current rate of return, the future value of your investments and savings is calculated.  Then future investment value is subtracted from future college costs which gives you the amount you’ll need to save in the given time period. 

Based on what you need to save, how long you have to save it, and what your investments are returning, a monthly figure is calculated.  That’s when the well-intentioned parent faints, realizing that they will have to save some huge monthly sum, totally beyond the family’s budget to absorb. 

So what’s a parent to do?  Create options, by investing both educationally and

financially.  Educationally, parents need to invest their time to insure their child is given every opportunity to excel in school, provided the opportunity to explore the world and broaden their horizons, and encouraged to participate in activities that develop teamwork and leadership. Maximize their strengths and help them compensate for their weaknesses.  Yes, parents may feel like taxi drivers and might even have to read that text book along with their child, but that small investment in time will be returned ten fold when admissions officers start separating the sheep from the goats.  If they’ve done a good job preparing their student educationally, he or she has many more options in shopping for the right college or university.  The student might even qualify for merit scholarships and grants.

Financially, traditional college savings calculators are too simplistic, often resulting in an unreasonably high investment figure.  But consider whether most folks paid cash for their home—probably not.  So they shouldn’t expect to pay cash for college.  If they have four years of college expenses saved by the first day of college, they are, in effect, paying cash for college.  That’s unnecessary and unrealistic. Most families simply cannot save that amount of money, nor do they need to. 

Furthermore, the government doesn’t expect the family to pay the entire cost of a college education, only their fair share based on their financial circumstances.  Thus enter the financial aid formula for calculating Expected Family Contribution (EFC).   This is the method the Department of Education uses (or The College Board via the CSS Profile) to determine the student’s fair share of one year’s cost of education, and then their financial aid eligibility. 

There are two basic types of financial aid: Self-Help Aid, which consists of interest subsidized loans and work study, and Gift Aid, which consists of grants and scholarships.

The amount and type of financial aid is based on two factors: the merit of the student  (scholarship, athletic achievement, musical or artistic ability, etc.) and the financial need of the student.

Need is by far the most important factor in determining financial aid, but that

is slowly changing.  Most of the financial aid given by the federal and state governments is based on the financial need of the student, while most of the financial aid given by colleges is merit-based.

How is the financial need of a student calculated?  “Needs Analysis” is the process of determining the financial need of the student. It is calculated using the following formula:

1         Cost of Attendance (COA)

      -     Expected Family Contribution (EFC)

      =    Financial Need

2         Financial Need

      -     Resources of the Student

      =    Adjusted Financial Need

Example: If the cost of attendance at a particular college was $12,000 and the expected family contribution was calculated to be $4,000, the financial need of the student would be $8,000. In this case the student would be eligible to receive $8,000 in financial aid. Whether he receives a financial aid award for the entire $8,000 is up to the discretion of the individual college. Nonetheless the financial aid eligibility of the student is directly related to the financial need.

If the student had other resources to help pay for the college cost, the financial need would be reduced on a dollar-for-dollar basis for these resources. In this example assume the student had received a $1,000 private scholarship from the local Chamber of Commerce.  Since private scholarships (scholarships which are not given by the college) are considered a resource, the $1,000 scholarship would reduce the financial need down to $7,000. This means the student would now be eligible for only $7,000 in financial aid from the college.  Merit-based scholarships may be added to the mix as well.

The bottom line is parents don’t have to save the whole enchilada, but they need to invest something.  If they can have a year or maybe two of college expenses ready when the student begins college, they’re in good shape.  They have options–choose to pay for college from loans, from the investment account, from your income or a combination of all three.  They can also take advantage of the monthly installment plans.

How can parents use this information?  They should combine the traditional

savings calculator with the needs analysis process.

­­­

1  Using the traditional calculator, determine what college is going to cost X number of years from now  (figures will be different depending on whether one uses a current public or private college dollar figure).  It would serve to use both for planning purposes.

2  Determine, based on a given annual cost of living adjustment and appreciation rate, what the parent’s income and assets will be at that same time in the future. If they are going to use the institutional method (used by the College Board), they’ll need to figure out what your home equity will be worth as well.  The student’s income and assets will also have to be fabricated ($1,500 to $2,000 is a good estimate of a high school senior’s current income who is working part time.)

3  Using a EFC estimator (Finaid.com and collegeboard.com have these available),determine what the student’s  EFC will be (see Appendix B).  This is assuming that today’s rules will still apply in the future.

4  Compare the future cost of education to the EFC.  If the EFC is less, subtract it from the cost.  The difference is need-based financial aid eligibility, the remainder is the family’s cost.  If the EFC is greater than the cost, there is no need-based aid in the student’s future.

This information allows us to make some judgment calls.  First, the remainder would be their dollar goal in terms of investing—the family’s cost after aid.  Based on this they can go back to the traditional calculator to determine their monthly savings goal.  And it is just that, a goal; they should not put retirement savings at risk.  What parents want is to have financial options when it comes time to pay for college.  Even a small educational nest egg is better than none.

Second, and most importantly, it gives parents the guidelines they need to determine where best to invest their college savings.  It’s important for

parents to remember that whatever investment strategy they choose will ultimately have consequences in terms of taxes, rate of return vs risk, and financial aid eligibility.

Whether or not need-based financial aid eligibility is established dictates whether or not the parents should concern themselves with looking for options to shelter assets from the needs analysis formula.  If there is no need-based aid then parents need only concern themselves with the tax and rate of return questions of investing.  However, if it appears that need will be established, then parents should make every effort to shelter assets from the formula, divert income, and so on to lower the EFC as much as possible, thus increasing the amount of need-based aid they are eligible to receive.

There are several different financial vehicles for educational savings.  Each has it own unique requirements and financial consequences.

A recent report from The College Board showed that tuition, fees, room and board at public colleges and universities rose 7.1% in 2005, an average $12,127 a year, while private institutions saw a 5.9% annual increase to $29,096 on average. If you want to make even the most stalwart investor weak in the knees, calculate how much four years of education will cost ten years from now.

So what are parents to do? Where and how much does a family need to save?

Financially, traditional college savings calculators are too simplistic often resulting in an investment that is an unreasonably high figure. But consider whether most folks paid cash for their home–probably not. So they shouldn’t expect to pay cash for college. If they have four years of college expenses saved by the first day of college, they are, in effect, paying cash for college. That’s unnecessary and unrealistic. Most families simply cannot save that amount of money, nor do they need to. In that regard, the government doesn’t expect the family to pay the entire cost of a college education, only their fair share based on their financial circumstances. Thus enter the financial aid formula for calculating Expected Family Contribution (EFC). This is the method the Department of Education uses (or The College Board via the CSS Profile) to determine the student’s fair share of one year’s cost of education, and then their financial aid eligibility.

The bottom line is, parents don’t have to save the whole enchilada, but they need to invest something. If they can have a year or maybe two of college expenses ready when the student begins college, they’re in good shape. They have options–choose to pay for college from loans, from the investment account, from your income or a combination of all three. They can also take advantage of the monthly installment plans.

Yet for parents with college bound children, it seems that it’s a choice, more often than not, between saving for college or saving for retirement. Without thought as to the long term effects, parents open 529 plans and begin dutifully investing for their child’s education. While their intentions are good, it would serve them to consider exactly what they are trying to accomplish and the tax, investment and financial aid implications of their choices, because a sound strategy for one area of financial interest may not be compatible with other areas.

Every investment vehicle has a purpose, but every investment vehicle is not appropriate for every investor. We’d all agree that a hedge fund would probably not be a good idea for a senior citizen on a limited budget. But what about college savings plans? Is a 529 Plan appropriate for every college investor? There a number of things to consider before answering that question.

Is there another sibling or family member intending to pursue a college education? Are there estate planning considerations? How much is the family actually going to be able to save on an annual basis? What is the age of the student, and once they reach college age, will he or she qualify for student financial aid?

A 529 plan locks up your money for qualified educational expenses at accredited institutions. If you don’t spend it for this specific purpose, you can either pass it on to another family member or remove the money at which time you will be penalized by the IRS. A single child family should seriously consider this before heading down the 529 path, unless there are other considerations at play such as estate planning for the parents or grand parents with larger sums of money being deposited for the use of the college-bound beneficiary.

Based on your anticipated cost of living raises as compared to the rate at which college costs are increasing each year, a projection of the student’s financial aid eligibility would be prudent. The latest tax laws stipulate that a 529 Plan is to be considered an asset of the owner (parents in most cases) and as such, will impact the outcome of the parent’s contribution from assets when calculating the student’s Expected Family Contribution (EFC). Using today’s rules and tomorrow’s projections, financial aid eligibility can be quickly estimated and a determination made as to whether or not, a reduction in the parent’s assets would positively affect the EFC. If so, a 529 may not be the most practical alternative for college savings. Consider that a family whose child could not qualify for financial aid today because mom an dad make too much money, may vary well qualify ten years from now as the cost of college outpaces one’s salary increases and asset accumulation. What was the last cost of living increase you received? Was it any where close to six or seven percent?

Based on the family’s budget, how much can practically be put aside each year for college — $5,000 or $10,000? For most middle-income families, investments are mom and dad’s 401k plans at work and the monthly budget allows for very little wiggle room. Starting early is certainly a wise decision and savings becomes a habit and that contribution to the college fund is not missed. Borrowing against a 401k may be an option, but because the loan must be repaid in a given amount of time or be considered a distribution for tax purposes, taking from pension plans should be the last resort. Not only does it affect retirement, it can potentially create a tax penalty.

The fact of the matter is parents can save for college and retirement at the same time. Current tax law allows both the husband and wife (even if they have pension plans at work) to each contribute $4,500 a year in after-tax dollars to a Roth IRA if their combined modified AGI is less than $150,000 a year (between $150,000 and $160,000, the amount they can each contribute decreases). If they’re over 50 years of age, $5,000 a year can be contributed, given the AGI parameters. The money grows tax-free, like a 529 plan. Withdrawals from Roth IRAs can be made without penalty to pay for qualifying higher educational expenses in the year that the expenses are incurred. Sound very much like a 529 plan, except that if the money is not used for college expenses, it’s still there for the parent’s retirement. One caveat, for persons who are not yet 591/2, withdrawals from a Roth IRA fall under the 72T provisions, which mean principle is withdrawn first which is tax free, then deferred earnings which are taxed as ordinary income. Withdrawals from a 529 plan, principle and earnings are tax free.

Having control of your investments is also a major consideration. Using 529 Plans, unless there are other over-riding reasons, takes control away from the investor. You are forced to invest in set series of portfolios, or you can only change your investments once a year. Since most 529 Plans use only one mutual fund company as the manager, you are limited to that array of funds as well, and your college investment is dependent on the success or failure of their fund managers. Using a Roth IRA housed in a brokerage account, you have the entire universe of securities to invest in and you can change your portfolio any time you wish.

529 Plans have certainly provided families a convenient means to save for college, but educational savings plans are no different than any other purchase. Before you jump in, do your homework. We can help.