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How to Choose the Best College Financial Aid Program

This episode dives into the pros and cons of the most common college tuition assistance programs available in 2023, as well as others options that may support or replace traditional tuition assistance.

Transcript

Hi everyone, welcome to the Wiser Financial Advisor show with Josh Nelson, where we get real, we get honest and we get clear about the financial world and your money. This is Josh Nelson, founder and CEO of Keystone Financial Services, and here is the transcript of me and Jeremy Bush giving a webinar on saving for college. Let the financial fun begin!

Jeremy: Today’s topic of conversation is college planning and how we are saving for that. There are lots of different ways to do this. How do we fit college savings into that budget, right? We need to fit it in with what we’re doing right now, and anybody who has kids knows that those kids are expensive already, so adding college expenses on top of that can be a lot.

Josh: Depending on where the kids are going to school, it can get quite expensive. Many expenses come into play besides tuition.

Jeremy: Yeah, especially with high school age kids. You’ve got cars, new drivers in the household and parents are still making mortgage payments, probably still saving for retirement. One question that we get quite a bit is: How do we save for college while still saving for retirement? People really want to save for college, but it can be detrimental to their retirement, so we’re trying to find that overall balance.

Josh: Yeah, by prioritizing, hopefully you can attack those simultaneously. It’s important to figure out what’s most important right now, and sometimes when push comes to shove, one thing does take precedence over the other. Every situation is different when it comes to clients and the advice we would give on how to deal with this.

Jeremy: Absolutely. But really what it comes down to is the cost of college. Whether it’s a public or private college, they are expensive. We tend to say that there’s anywhere from 5 to 6% growth rate in the cost of college per year, which is a pretty big bump.

Josh: It is, yeah. College inflation is usually more than normal inflation. About double.

Jeremy: So, even at a public college you might be spending, $22,000 or $23,000 a year just to have your kid attend. And private college is double that at the very least. Then you throw 5 or 6% inflation on that, and if you have a young child, you’re thinking about what that will mean over the next 17 or 18 years.

Josh: Here in in Northern Colorado, we’ve got lots of universities in pretty close proximity. Colorado State University is about $30,000 a year right now if you figure everything including room, tuition, fees, books, supplies, laptop, everything that a typical college student would need. And that’s in-State tuition.

Jeremy: And then you’ve got a four year degree. That’s a chunk of change, which brings up the question, How are we going to pay for it? We have various things available: college savings, financial aid, work-study income. I did work-study every year that I was in college. There are various ways of borrowing, and sometimes there are gifts from grandparents, which are nice to have but you don’t really want to count on that. As with any kind of savings, it comes down to setting that savings goal, and then breaking it down into something that fits into the budget. Is that $100 a month? $300.00 a month? What do you need to be saving now in order to meet that timeline.

Josh: And you might feel like, “Hey, that’s too much. I’m not able to afford that right now.” One thing to consider is that the more you do now, even if it’s not enough to cover 100% of it, will mean that much less that you’ll pay out of pocket or your student will pay out of pocket when they get into college.

People have different values regarding this. Sometimes people say, “Wherever my kid can qualify to go, I’ll pay for it, no matter how expensive it is.” That’s fine if that’s what you want to do and you can afford it. Other people say, “I had to pay my way through college and they will too.” It’s all over the board, as far as people’s values.

Jeremy: Sometimes one spouse comes from one side of that and the other spouse comes from the other side. It all comes down to asking, “What are we gonna do? Are we gonna pay for all of it? Half of it? Do we want some buy-in from our kids so that they don’t take their education for granted?” And it’s different for everybody. You just need to figure out what works best for you.

So what are your options for college savings? The one that comes first and foremost to most people’s minds is a 529 plan, because it is the best tax savings tool. Sometimes people say, “Why do I want to put those savings into a 529? I’ll use mutual funds or something.” And that could be okay but with the rate of college inflation costs, you might not really grow your money beyond inflation.

Roth IRA’s is another one out there with some benefits to it; there is a provision within Roth IRA’s that you can take X amount of dollars out for education costs in a tax free way.

If you have a whole list of different types of vehicles to save for college, what makes one better than the other? It comes down to taxability. If you use a 529 for higher education expenses, (which is a pretty broad category of expenses), all those expenditures are basically tax free. So everything you put into it and all of the interest earnings on top of it, are all tax exempt. Plus, while you’re putting money into a 529, you get a State tax deduction. That’s true in Colorado, but each State is a little bit different on that.

So, as opposed to, for instance an individual account with mutual funds and ETF’s, any time you place a sale inside of those, there’s a capital gains tax, which is true of any dividends or interest, too.

So what is a 529 plan? It’s a tax advantage plan sponsored by States. Each State pretty much has their own plan. There are some Federal laws they have to follow in order to be called a 529, but really it’s up to the States to create them.

Josh: It’s like a 401K for college, and we think it’s one of the best ways to save for college because of those tax advantages. There are a lot of rules, and we want to make sure that you understand that a 529 is not for everybody. But for many, it works out. In our family, we’ve used 529s extensively. Thankfully, they’ve been around for a while, so for both our oldest and youngest kids, we’ve had those 529s open since they were teeny tiny. And even if it’s a small amount that you start with, you can always put more money in overtime.

Jeremy: And it’s the one thing that’s really built for college expense specifically.

Josh: Once in a while, Congress does something really effective and flexible. And when they put that into place back in the 90s, they created something that’s worked out very well in hindsight.

Jeremy: Another option which is a little less known was created around the same time as the 529 Plan was prepaid tuition. You don’t really hear a lot about prepaid tuition plans anymore since 529s came about and people realized the flexibility with a 529. It doesn’t matter which State you have it in; doesn’t matter in which State the school is. You can use it for any of those, whereas with prepaid tuition, you’re picking a school and saying, e.g., “I want my kid to go to my alma mater. I’m going to lock in some rates and prepay that tuition.” But what if that kid doesn’t want to go to their school or wants to become a welder and doesn’t want to go to college at all? What happens to that tuition?

Josh: And I would add that the State administers these prepaid tuition plans and in a lot of States, (Colorado included), they figured out that it’s a big risk to guarantee that the money you put in today is going to be enough to cover that same expense in the future. They decided they didn’t want to take on that risk, so they pretty much squashed them.

Jeremy: Right. Most States have just gone to the normal 529 college savings plan. And they say, “You guys save up for whatever you want but do it on your end, and you take all the risk.”

Josh: And because it’s like a 401K for college, just like your 401K at work, you’re going to be selecting some type of investment option. None of those investment options are guaranteed, and they’re always going to have some level of risk associated with them.

Jeremy: Any time the government can put the risk on you, they will definitely do so. So, what are the advantages to 529 plans? Anyone can open one. It doesn’t matter if it’s Grandma, Mom, Uncle, whoever. There are high lifetime contributions. This can be different depending on the State that you’re in, but typically what you see is you can control the funds inside of the 529. There are various funds, just like a 401K. You can do age-based portfolios, which are based on the year that your kid was born. These start out more aggressive and then as the kid gets older and gets closer to actually using it, say age 18 or 19, it becomes more conservative so that you’re not really risking the bank on that last year in case there’s a bad turn in the market with stocks and bonds which is typically where these things are going to be invested.

Another nice thing about 529 plans is what’s called accelerated gifting, which is one of the lesser known benefits. There are federal gifting guides. Right now you can give $17,000 to a person per year, and your spouse can do the same thing, and you don’t have to fill out a gift tax receipt or anything like that. You don’t get taxed on it and the person you gifted doesn’t get taxed on it. It’s an allowable gift. Then, with a 529, what you have is a 5-year lump sum gift that you can give in one year. So if two people give 5 times $17,000 in one year, you’re up there at $170,00 and you can drop that into a 529 in one year. You can say, “Here’s your gifting for the next five years, (son or grandson, daughter or granddaughter).” Doesn’t have to be a parent or grandparent, either. Doesn’t have to be someone related to the student. Anyone can do it.

But of course, like we were saying, returns aren’t guaranteed. You are limited to the plan’s investment portfolio. So just like a 401K, it’s not the entire market that you have out there. There are specific investments within each plan that you can choose from. There is a slight limit on how many times you can change the investments within the plan. It’s about two times a calendar year that you can make adjustments to that.

And current rules say that if you do take withdrawals and they are NOT for qualified education expenses—which a really broad category—then you are subject to income tax and some potential fees.

Josh: The more you dig into the 529, you figure out how many kinds of strategies you can use. You can only make two investment option changes per year, but the owner of the account, which is whoever opened it originally, is in control of the account. So let’s say I wanted to day-trade my kids’ 529. Not suggesting that, but let’s say that we wanted to make more changes than the rules allow. Well, the owner of the account can change the beneficiary as often as they want. And every time you change the beneficiary, you can change the investment option.

Jeremy: And at the end of last year, Congress passed another way out of that withdrawals section that says if your 529 account has been opened for 15 years and your kid did not use this up, they can use any remaining 529 funds towards their own Roth contributions. It’s subject to whatever Roth contribution limits there are and you still have to have income, if I’m not mistaken, but you can use the 529 funds for a Roth contribution.

Josh: Yeah, there’s a lot of gotchas on that, so you want to be careful that you follow the rules to do that. But yeah, it definitely makes things more liberal as far as a lot of people’s worry as they put money into the account, asking, “What if they don’t go to college?” So that’s one more way that the money can be used if it doesn’t get used for higher education expenses.

Jeremy: A little while back the Feds came out and said, “We’re going to allow you to use some of your 529 funds for elementary school, up to a certain dollar amount.” They did leave it up to which States wanted to participate in that, and some, like Colorado, opted out. So if you’re still in Colorado, you can’t use your 529 for any elementary costs.

Josh: Regarding whether saving for college or saving for retirement is more important, your values are your values and so we’ll never tell you, “Here’s what you gotta do.” We’re here to give you options to help educate you and guide you. But in my personal opinion, there’s a reason why on an airplane they say, “Put on your own oxygen mask first, and then put it on your kid.” There’s no loan for retirement. Nobody is coming to bail you out and cover your retirement. Social Security will only go so far, and most people don’t have a pension fund. So, you may really want to consider whether you want to reduce your retirement funds for college expenses.

Jeremy: Yeah. So, what about financial aid? If you’re not familiar with it, what you do is fill out the FAFSA free application for federal student aid. They’ve come out with a new one. This is the first year for the new FAFSA, and I have not seen it yet, but it’s supposed to be a lot more simple. What they do is to figure out what you qualify for based off your income, your parents’ income, etc. Federal grants, college grants, all kinds of calculators get determined. They will look at what they expect your family to contribute. Those are the rules. We’re operating within the law and what the rules will allow. Things that are excluded from the family side are home equity, retirement accounts, life insurance, cash values. So it’s not like they’re trying to rob you blind or anything. Anyway, if you’re not going for grants and you’re not going for scholarships, the avenue is going to be those federal loans.

Josh: Jeremy, we’ve sat down with hundreds and hundreds of people and seen a lot of financial situations. We’ve seen some big student loans, especially if someone went to medical school or law school or something like that. And it takes a long time to get out of that debt.

Jeremy: So we recommend being aware of how much you’re accumulating in debt and to have a plan for getting out of it. How much you should rely on financial aid is different for everybody. We all come from different means. If possible, I wouldn’t rely too heavily on a loan package. The more time you give towards focusing on savings and doing things proactively, the better off you’re going to be.

Josh: Something to consider that’s a bit outside the box is that these days, because of the low unemployment rate, some big companies will pay your tuition, or part of it, as long as you work for them. For example, after 90 days of employment, they’ll start covering up to up to 100% of tuition. That’s something to consider if your kid’s going to be working in college. You might have them look into that because not only will they get paid something but also they could get their tuition.

For those of you who feel like your budget is pretty tight, especially with inflation the last couple of years, consider that most 529s have very low minimums to get the account open. So maybe just get something opened right now. Some of them will allow you to go as low as $25.00 a month for an automated pull from your checking account.

Our team is here to serve you. We are fiduciary. We’re here to work in your best interests. We wish you a great day. We love feedback and we’d love it if you would pass it on to me directly at josh@keystonefinancial.com . Also, please stay plugged in with us by subscribing to get updates on episodes and help us promote the podcast.

The opinions voiced on the Wiser Financial Advisor show with host Josh Nelson or for general information and are not intended to provide specific advice or recommendations for any individual to determine what may be appropriate for you. Consult your attorney, accountant, financial or tax advisor prior to investing. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.