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How you may save big with right strategies for college and education funds?

Family Garden

High and raising educational costs

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Preparing for college expenses is a critical aspect of financial planning for families. With the rising cost of higher education, the significance of starting early and systematically saving for college cannot be overstated. The total cost of a four-year college education can vary significantly depending on factors such as the type of institution (public vs. private), residency status, and geographic location. On average typical costs for a four-year college education in the United States are: $106,160 to $113,160 for in-state public schools, $175,320 to $183,320 for out-of-state public schools, and $232,200 to $240,200 for private schools. Below is an estimated breakdown. 

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1. Tuition and Fees (for four years)

  • Public four-year colleges (in-state)​: $43,800

  • Public four-year colleges (out-of-state)​ : $112,96

  • Private non-profit four-year colleges​: $157,600

2. Room and Board: $49,400

3. Books and Supplies: $4,960

4. Personal Expenses and Transportation: $8,000 to $16,000​

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In addition, the cost of college education has been rising consistently. According to data from the College Board, the average cost of tuition and fees for in-state public four-year colleges has increased from about $3,190 in the 1990-91 academic year to approximately $10,950 for the 2023-2024 academic year. For private non-profit four-year colleges, the average cost has risen from around $12,350 in 1990-91 to $39,400 in 2023-2024. In recent years, the average annual increase in tuition and fees has ranged from 2% to 5%, depending on the type of institution and other factors. For example, the College Board reported a 4.2% increase in average tuition and fees for in-state public four-year colleges from 2022-2023 to 2023-2024.

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The high and raising costs of college education contribute to considerate burden to families. With this situation, many children may end up signing up in-state schools even though they can be admitted to their dream private schools. What are the strategies to save more and spend less for attending schools, even the best schools?​​

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Prepare early to boost college savings with the compound growth

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One of the most compelling reasons to start saving early is the power of compound interest. The earlier you begin saving, the more time your money has to grow. By saving $300 per month for 18 years (a total of $64,800 putting in) with an annual return rate of 8%, a family would accumulate approximately $144,030 by the end of the 18 years. Let's take the same input amount of $64,800 but calculate it for $1,080 per month with 5 years and the same rate of 8%, the family will only have $79,355 by the year of the 5th years. Do you see the magic? Spending the same amount of money but making time works for you is a no-brainer way to prepare for your children's future education. So, what are the major options for putting money to build children's education funds?

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Bank saving accounts and certified deposits (CDs)

 

These are the most commonly known way for putting away money for long-term saving. However, saving accounts and CDs have relatively very low interest and performance, compared with many other saving and investment approaches, and thus are not recommended by most financial advisors as tools for preparing college funds (read this page to learn more details).

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529 accounts

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A 529 account is a tax-advantaged savings plan designed to help families save for educational expenses (named after Section 529 of the Internal Revenue Code) The 529 College Savings Plans allow for a range of investment options, such as mutual funds and ETFs. The value of the account can grow over time based on the performance of these investments. The account's earnings are tax-free when used for qualified education expenses, which include tuition, fees, books, and sometimes room and board.​

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Advantages of 529 Accounts include:

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  • Tax Benefits: Contributions to a 529 account grow tax-free (without capital gain tax), and withdrawals used for qualified educational expenses are also tax-free. This helps maximize the amount of money available for educational purposes.

  • High Contribution Limits: 529 plans generally have high contribution limits (which vary by state) compared to other savings vehicles, allowing families to save a significant amount for education.

  • Estate Planning Benefits: Contributions to a 529 plan are considered gifts for tax purposes, but there are special rules that allow large contributions to be made without incurring gift taxes. Additionally, the account owner retains control over the assets, which can be beneficial for estate planning.

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Disadvantages of 529 Accounts include:

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  • Low flexibility: If the funds are not used for qualified educational expenses, withdrawals are subject to federal income tax and an additional 10% penalty on the earnings. Funds in a 529 account must be used for educational purposes to avoid penalties. If the beneficiary does not attend college or receives a scholarship, the funds may not be used for other expenses without incurring penalties and taxes.

  • Investment Risks: For 529 College Savings Plans, the account value depends on the performance of the market investments, which can fluctuate. This means there is a risk of losing money if the investments perform poorly.

  • ​State-Specific Rules: The benefits and restrictions of 529 plans can vary by state. For instance, state tax deductions or credits for contributions may only be available if the plan is purchased through the account owner's home state.​

  • Fees: Some 529 plans come with various fees, such as administrative fees, investment management fees, and enrollment fees. These can erode the growth of the investment over time.

  • Impact on Financial Aid: While 529 accounts are considered a parental asset for financial aid purposes, they can still affect eligibility for need-based financial aid. The assets in the account can be factored into the expected family contribution. This negative impact has made many family regret putting money in 529 accounts. 

Strategies to maximize financial aids

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There are two major types of college financial aids: Need-Based Aid and Non-Need-Based Aid. The Non-Need-Based Aids are either loans, such as Direct Unsubsidized Loan and Direct PLUS Loan, or Teacher Education Access for College and Higher Education (TEACH) Grant, which requires a teaching service obligation as a condition for receiving the grant. As such, Non-Need-Based Aids are not discussed herein.

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Need-based financial aids

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The need-based financial aid is designed to assist students who demonstrate financial need to cover the costs of their education. Unlike merit-based aid (e.g., scholarships), which is awarded based on academic or extracurricular achievements, need-based aid is based on the financial circumstances of the student and their family. The Financial Need is calculated as: Cost of Attendance (COA) - Expected Family Contribution (EFC). As such, minimizing the amount of EFC is the most straightforward strategy to maximize the need-based financial aid.

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Here is an example breakdown of EFC calculation:

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  1. Calculate Parental Income:

    • Adjusted Gross Income (AGI): Start with the AGI reported on the tax return.

    • Add Certain Untaxed Income: Include items such as tax-exempt interest, untaxed portions of pensions, and other forms of untaxed income.

    • Subtract Allowable Deductions: Deduct items like income taxes paid, certain medical expenses, and other allowable deductions.

  2. Determine Parental Income Contribution:

    • Parental Income Protection Allowance: This is a set amount that is not considered available for college expenses, based on income and family size.

    • Available Income: Subtract the protection allowance from the adjusted income. The remaining income is used in the calculation.

  3. Calculate Asset Contribution:

    • Parent Assets: Add up savings and investments (excluding certain assets like retirement accounts).

    • Asset Protection Allowance: Subtract a certain amount of assets from consideration based on family size and age.

    • Net Available Assets: The remaining assets are assessed at a specified rate.

  4. Combine Income and Asset Contributions:

    • Add the contribution from parental income and the contribution from parental assets to get the total parental contribution.

  5. The student contribution is usually little if not zero for most families. 

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Example of Simplified EFC Calculation

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  1. Parent Contribution:

    • Adjusted Gross Income (AGI): $80,000

    • Untaxed Income and Benefits: $2,000

    • Income Protection Allowance: $24,000

    • Available Income: ($80,000 + $2,000) - $24,000 = $58,000

    • Contribution from Available Income: (Assumed rate, e.g., 22%) = $12,760

    • Parent Assets: $200,000

    • Asset Protection Allowance: $10,000

    • Net Available Assets: $400,000 - $10,000 = $300,000

    • Contribution from Assets: (Assumed rate, e.g., 5%) = $15,000

    • Total Parental Contribution: $12,760 + $15,000 = $27,760

  2. Student Contribution:

    • Adjusted Student Income: $5,000

    • Income Protection Allowance: $6,000 (if the student’s income is below this, it's not considered)

    • Contribution from Student Income: $0 (if below the allowance)

    • Student Assets: $5,000

    • Asset Protection Allowance: $2,000

    • Net Available Assets: $5,000 - $2,000 = $3,000

    • Contribution from Assets: (Assumed rate, e.g., 20%) = $600

    • Total Student Contribution: $0 + $600 = $600

  3. Total EFC:

    • Parental Contribution: $27,760

    • Student Contribution: $600

    • Total EFC: $28,360

 

Some assets are exempted from EFC calculation, including:

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  • Primary residence: The equity in the home, or the difference between the home's value and the amount owed on it.

  • Retirement accounts: This includes 401(k)s, 403(b)s, IRAs, Roth IRAs, pensions, and profit-sharing plans.

  • Family-owned businesses: If the business has fewer than 100 employees and more than 50% of it is owned and controlled by the family.

  • Life insurance: The cash value of life insurance policies.

  • Personal possessions: The value of vehicles, art, jewelry, and electronics.

  • ABLE accounts: Achieving a Better Life Experience accounts.​

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An overall strategies to help family increase tens of thousands to over a hundred thousands of student financial aid is to transform the qualified items in the EFC to the asset forms in the exemption list. In addition, use of tax advantages to reduce the adjusted gross income is another effective approach.

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Book a free financial strategy consultation to learn more about how we can help you save big for your children's college education. 

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