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.