Sunday, December 04, 2005

The Strange World Of College Financing

I came across a good article that I think every parent should read and especially those that have older kids that will be entering college in a couple of years (if you have a junior in high school, start reading NOW!)The article is titled The weird world of college financing and here are some of the highlights:

To qualify for financial aid based on family finances, parents need to understand a quirky formula that is as complex as the tax code.

Using the formula, colleges calculate what they believe a family can afford to pay for college. That calculation is called "the expected family contribution," and essentially tells parents and students what percentage of their income and assets should be devoted to college.

After a college has calculated what students and parents must pay, the financial aid office helps cover what families can't afford, frequently by providing low-interest loans, work-study jobs and grants.

This formula, while not easy to understand, can end up saving you thousands of dollars out of your own pocket so it's worthwhile to study up a bit on it. I have 18 years, but most of you probably have a shorter amount of time to do it, so start asap.

One common mistake is that tax accountants often encourage grandparents and parents to shift money to children by opening Uniform Gift to Minors Act accounts. Those accounts sabotage financial aid because they are in the child's name.

"If you are going to qualify for financial aid, you should never, ever put money in the child's name," Chany said. "It's like throwing money away."

For example, if a family has saved $40,000 for college, and the money is kept under the parents' name, the family will be required under the formula to use as much as $2,260 of that savings to pay for the first year of college, Chany said. If the family instead has kept identical savings in their child's name, they will have to spend $14,000 immediately.

This is often difficult for parents to understand because they assume college money will be treated the same regardless of the account it is in. But the quirky financial aid formula doesn't act with that logic. It looks at student income and assets differently from parents' income and assets.

I'm going to have to look into this closely and it may change my strategy on how I same. My hope is that I won't have to take out any loans, but I don't want to exclude myself from loans and financial aid if I can get it. Being the financially savvy nearly 5 month old that I am, if I can get low interest rate college loans that are have a lower rate than what can earn elsewhere with the money, it would make sense for me to take them out. I7m always trying to think ahead...

Parents also can make college affordable by discouraging a student from earning too much.

"It's a bizarre situation," Chany said. "The best way a student receiving financial aid can help his parents pay for college is by not working very much."

Under the formula used to compute a family's expected contribution, students must devote half of their income and 35 percent of their assets to college over a certain threshold.

A student who earned $2,761 would be required to spend $1,150 of it for college. But for every dollar over $2,761, the student would have to provide 85 cents for college.

Because parents typically are paying for most of the tuition and living costs, the child's job simply is decreasing financial aid and requiring parents to pay more.

Now that makes absolutely no sense to me, but since it is the system we are all working with, I guess it's important to take it into consideration. Since I hope to be making more than that before entering college, I will have to sit down and really work the numbers on the best way to approach this.

Parents also are surprised at what happens if they sell stocks, bonds or mutual funds during college to pay tuition bills. Selling the investments gives families income under the formula. So they may sell all their investments one year and use every cent to pay for tuition that year. But the college aid formula will indicate they have that money as income for tuition in the coming year, even though it already has been spent.

I've read this numerous times. The best course of action is to sell these investments before December 31 of the student's junior year in high school so that the money doesn't appear to be income. The article also list these strategies for those will kids in their junior year in high school:

Saving the maximum possible in 401(k) and tax-deductible individual retirement accounts before Dec. 31. When a student is in college, it won't hurt a family to save for retirement, but making contributions to 401(k)s and IRAs won't help cut your income. Under the financial aid formula, those contributions are deemed income - available to pay for college.

Don't take early distributions from IRAs or convert an IRA into a Roth IRA. If you do, your income will go up, and you will lose some financial aid.

Do not take out a second mortgage on your home to pay for college. If you do and stash the money in a savings account, your assets could be inflated substantially and reduce aid.

Instead of making charitable contributions during the college years, make a large contribution before Dec. 31 of your child's junior year. If you keep providing contributions during the college years, financial aid staff will consider that income you can use for college.

Medical expenses can help increase financial aid. So if you have a choice, you could push an expensive medical procedure into your child's senior year of high school.

Before doing any of this, make sure you will qualify for financial aid. If your income is too high to qualify, you could be interfering unnecessarily with your investments and taxes by using these strategies.

I think that last one is going to be important for me. It would be nice if they could develop a formula that made sense and was easy to understand, but maybe financial aid is the first test a student (and parents) receive when a child goes to college. Stick around and I hope we can all pass it with flying colors together!

No comments: