Ask Liz Weston

Get smart with your money

college costs

High incomes limit financial aid

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Dear Liz: As an avid reader for years I have never felt as compelled to write as I did after reading your column regarding college financing. I disagree that college financial aid is based primarily on income or that “typically [parents are required to] contribute less than 6% of eligible assets.”

We filed a Free Application for Federal Student Aid for our daughter, and our expected family contribution was calculated at $43,000. The school offered my daughter just $2,000 in work study, at a university with a $38,917 annual tuition. Our combined income is $175,000 and our liquid savings (not including retirement accounts) is $145,000.

We could pay 6% of our income (about $12,000) or 6% of income plus savings ($19,000) per year without taking loans, but not $38,000. I have attended several “paying for college” seminars and found their estimated contributions quite sugar-coated compared with the reality.

Rather than paying 6%, is the reality 25% of our income? Please let me know if we have done something wrong, and how to rectify it.

Answer: The 6% limit on eligible assets is not a cap on how much you’ll have to pay for college. As the original column said, income weighs more heavily in financial aid calculations than assets, and your income is high.

The federal financial aid formula assumes families with high earnings have more disposable income to pay for college than lower-earning families. The formula also assumes high-income families have had ample opportunities to save for college, whether or not they actually have.

You could use the net price calculator on the college’s website to see whether your liquid savings are having an effect on your expected family contribution. At some schools, using savings to pay down a mortgage or other debt could result in a lower expected contribution.

But you still might not get aid, even if you could move the needle on your expected contribution. Many colleges “gap” their students by not supplying enough aid to meet all their needs. And while some private colleges offer merit (rather than need-based) scholarships to attract the children of wealthier parents, top-tier schools tend not to, because they know they can attract excellent candidates without such help, said Lynn O’Shaughnessy, author of “The College Solution: A Guide for Everyone Looking for the Right School at the Right Price.”

Even if your family doesn’t have financial need according to the formula, your daughter is still eligible for federal student loans of as much as $5,500 in her freshman year. Federal student loans are flexible debt with fixed interest rates and many repayment options, so they shouldn’t be feared, especially in reasonable amounts. If, however, you would have to borrow much more, and that borrowing would interfere with your plans for retirement or other financial goals, you probably can’t afford this school and need to start looking for colleges you can afford.

Now available: My new book!

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Do you have questions about money? Here’s a secret: we all do, and sometimes finding the right answers can be tough. My new book, “There Are No Dumb Questions About Money,” can make it easier for you to figure out your financial world.

I’ve taken your toughest questions about money and answered them in a clear, easy-to-read format. This book can help you manage your spending, improve your credit and find the best way to pay off debt. It can help you make the right choices when you’re investing, paying for your children’s education and prioritizing your financial goals. I’ve also tackled the difficult, emotional side of money: how to get on the same page with your partner, cope with spendthrift children (or parents!) and talk about end-of-life issues that can be so difficult to discuss. (And if you think your family is dysfunctional about money, read Chapter 5…you’ll either find answers to your problems, or be grateful that your situation isn’t as bad as some of the ones described there!)

Interested? You can buy this ebook on iTunes or on Amazon.

Don’t put college savings into custodial accounts

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Dear Liz: I opened Uniform Transfers to Minors Act savings accounts for my two boys (now 7 and 10) when they were newborns. I chose not to go with the 529 college savings accounts because I didn’t like the restriction that the money had to be used for education. It has always been my intention to use these funds for college, but if they choose not to go to college, then it could be used to help them purchase their first homes, for example.

I’ve been squirreling away a couple hundred dollars each month in each account, but I read a few of your previous pieces and think maybe the UTMA accounts were not the best vehicle for this. Could they one day just demand the money and do with it whatever they want?

Answer: The short answer is yes. In most states, the money will become theirs at age 21 to spend however they want, although a few states let them have it at 18.

The other big disadvantage to custodial accounts such as UTMA and UGMA (Uniform Gifts to Minors Act) accounts is that they’re counted as the child’s asset in financial aid calculations. That can substantially reduce the amount of aid they get.

But even more important than the financial details is your attitude. You need to give up this notion that not going to college is a reasonable option for your kids. In the 21st century, some kind of post-secondary education is all but a necessity for a person to remain in the middle class, labor economists tell us. Your sons don’t have to study at a four-year school, but they are likely to need at least some vocational training beyond high school.

If you want to reduce the effect of these accounts on any future financial aid packages, you have a couple of options. One is to spend the money before they get to college, although that’s probably not the route you’ll want to take, given how much money you’ve already saved. If the accounts were smaller, you might just use them to buy a computer, pay for summer camp or cover the cost of tutoring. Such expenditures are allowed as long as the money is spent for the benefit of the child and doesn’t pay for expenses that are your obligation as a parent (food, shelter, clothing, medical care).

Another option is to liquidate the accounts and invest the cash in 529 plans. This would dramatically reduce the money’s effect on financial aid calculations, since it would be considered your asset rather than your child’s. The money could be withdrawn tax free to pay for qualified higher education expenses. If it’s not used for higher education, the contribution portion of the withdrawal won’t be taxed as income, but any earnings will be, plus there will be a 10% federal tax penalty on those earnings.

If you decide to transfer the money, the 529 account should be titled the same way as your UTMA accounts, said Mark Kantrowitz, publisher of the college planning website FinAid. Ownership of the account shifts to the child when he reaches the age the UTMA account would have terminated. That gives him control of the money if it’s not spent on education, but he would have had that anyway. You can read more about the details at http://www.finaid.org/savings/ugma.phtml.

New tool helps you compare financial aid offers

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You’ve gotten the college acceptance letters, and their accompanying financial aid offers. But how do you really decipher how much college will really cost you? More than 1.5 million students and their families are wrestling with these issues, and the Consumer Financial Protection Bureau wants to help. The bureau just announced a tool that can help you evaluate your options. From the CFPB press release:

The beta version of the Financial Aid Comparison Shopper has more than 7,500 schools and institutions in its database, including vocational schools and community, state, and private colleges. It draws information from publicly available data provided by government statistical agencies. With the prototype, students and their families can compare the following across multiple financial aid offers:

·         Estimated monthly student loan payment after graduation;

·         Grant and scholarship offers;

·         School-specific metrics such as graduation, retention, and federal student loan default rates; and

·         Estimated debt level at graduation in relationship to the average starting salary.

The Financial Aid Comparison Shopper also includes a “Military Benefit Calculator” that can estimate education benefits for servicemembers, veterans, and their families. The calculator includes military tuition assistance and Post-9/11 GI Bill benefits.

You’ll find a link to the cost comparison tool here. Take a look, run some numbers and give the CFPB your feedback.

How not to owe half a million in student loans

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Most college students graduate with manageable student loan debt, but there are plenty of exceptions. Marketplace Money highlighted one case last week: the medical student who expected to owe nearly half a million in loans by the time he graduated. I was in the studio with host Tess Vigeland and senior producer Paddy Hirsch to talk to this guy and discuss his options, as well as the choices he made that led him into such whopping debt. You can listen to our conversation here.

One point that Tess made, and that I’d reiterate to anyone thinking about student loans, is that taking on debt is a choice. No matter what your financial situation or education goals, you don’t “have to” borrow gobs of money to pay for school. You can go to a cheaper school, serve in the military and pay for school with the G.I. Bill, or work while you study, among other choices. You reasonably may choose to borrow some money to get through college, but if you borrow more in total than what you expect to make the first year you’re out of school, then you’re borrowing trouble.

Our caller was in a bind since he’ll need to start paying back his loans while he’s in residency. But with federal loans, at least for now, he has the option of an income-based repayment plan that will ensure he has enough money left over to eat. Once he’s in practice, he should make somewhere around $300,000 a year, which will ease the pain of paying back all that debt.

Far too many borrowers aren’t as lucky. They’re unemployed, or never got their degrees, or owe far more than they’re ever likely to earn. Nobody warned them when they were 17 or 18 and beginning to sign up for this debt that it could dog them for the rest of their lives. Private student loans in particular should come with warning labels, since they’re like paying for college with credit cards–except, unlike credit cards, the debt can almost never be erased in bankruptcy court. Read “Wipe out your student loan debt,” my column for MSN on this topic, for more details about the differences between federal and private loans, plus strategies that can help you deal with your education debt.

 

 

Saving for college: what parents need to know

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I’m giving a talk this morning to fellow parents about saving for college. I’ll be covering three important topics: why you need to save, how much you need to save and where you should put the money you’re saving.

Why you need to save

A college degree, or at least some post-high school training, is already important if you want your kids to remain in the middle class. That’s only going to become more true in coming years. Read “Should your kid skip college?” for more.

If you can save, you probably should. Financial aid formulas will expect you to have put aside at least something if you’re middle income or above. The idea that saving will hurt your kid’s chances for financial aid is the #1 myth I address is “3 college myths that will cost you.” (You also should read the second part of this series, “Costly college myths part 2.”)

To learn more about financial aid, visit FinAid.org and try out its estimated family contribution calculator. Another good site: TheCollegeSolution.com.

How much you need to save

The answer: A horrifyingly large amount if you expect to pay the whole tab. Even if you start when your child is born, you’d need to save:

  • Nearly $500 a month to pay for a public college
  • Nearly $1,000 a month to pay for a typical private college that currently costs $40,000 a year
  • Nearly $1,500 a month to pay for an elite private school such as Harvard or USC.

If you don’t start saving until your child is older, you’d need to put aside even more to cover the entire bill for tuition, books, room, board and living costs.

(A note: Harvard, like other Ivy League colleges, has committed to capping the cost for education. Families earning $65,000 pay no tuition. Families with incomes between $65,000 and $150,000 will contribute from 0 to 10 percent of income, depending on individual circumstances.  Significant financial aid also is available for families above those income ranges.)

Most families can’t save enough to pay the whole tab. But anything you can save likely will reduce your child’s need to take on debt. You can play with the numbers using SavingForCollege.com’s college savings calculator.

One thing you need to keep in mind: retirement savings must come first. Nobody will loan you the money you need to retire. But try to put aside at least $25 to $50 a month for college, and increase it as you can. Encourage grandparents and relatives to chip in as they can.

Where you should save

Three key points:

  • If your child stands any chance of getting financial aid, don’t put money in UTMAs, UGMAs or other custodial accounts, which are counted as the student’s assets and dramatically reduce financial aid.
  • Savings bonds have very poor returns and aren’t a great way for most to save for college.
  • State-run 529 plans are a good option for many families. The plans have limited impact on student aid awards. The money grows tax-free for college and the contributor retains control. There are estate-planning benefits as well. For more on which plan to use, read “The best and worst 529 plans.”

UPDATE: In my speech, I mentioned how Coverdells (Education Savings Accounts) were changing–I should have been clear that those changes haven’t happened yet. At the end of 2010, Coverdells were scheduled to revert back to their old version, where the limit on contributions was $500 (down from $2,000) and the money could be used only for college (instead of for K-12 as well). Congress actually extended the more favorable rules through 2012, so Coverdells aren’t scheduled to revert to their old form until the end of this year. Congress may extend the rules again, so anyone with a Coverdell may want to wait before they transfer the money to a different type of account.