Welcome to the first installment of ePrep’s coverage of college financial aid. I am excited to introduce Don Betterton as the site’s most recent guest expert. Don was the director of financial aid at Princeton University for thirty (30) years. During his time at Princeton, aid awards increased from $3.4 million in 1973-74 to $65 million in 2005-06. In this video, Don discusses the simple things you can do now, while your children are young, to help make paying for college easier when they are older and ready to enroll.
College Financial Aid Pre-High School Activities: Saving - The 12 Things You Need to Know
1. Putting aside money for college is a good idea, the earlier the better.
2. Saving beats borrowing hands down.
About 60% of all aid is in the form of loans, and increasing.
Saving: For example, if you start saving when your child is 5 years old, you will have 13 years to save before your child enrolls in college. If you can put aside $167 per month — that’s $2,000 per year — you will have saved $26,000 by the time your child begins college.
With a 6% return over the thirteen-year period, your $26,000 will have grown into $40,000. That $40,000 will be available to help you pay for your child’s college expenses like tuition and room and board.
Borrowing:If you choose not to save when your child is young, it is likely that your child will have to borrow to help pay for college. For comparative purposes, let’s assume you borrow $40,000 in increments of $10,000 per year for 4 years. Assuming a 6.8% interest rate and a 10 year repayment period, borrowing $40,000 will ultimately cost your child $55,200.
Difference: The difference between borrowing and saving is nearly $30,000 ($55,200 â”€ $26,000 = $29,200). Thus, saving beats borrowing hands down.
3. The tax system gives incentives to college savers.
Both state and federal laws allow families to earn tax-free interest on college savings. The following example illustrates the advantage of earning interest tax free:
Assume when your child is born you invest a one-time, lump sum of $18,000 in a state 529 plan (see Points 4 - 6 below to learn more about 529 plans). By the time your child is ready to enroll in college at the age of 18, you will have access to $63,000 in order to help pay for your child’s college expenses.
If the same $18,000 were invested in a taxable vehicle with the same rate of return as the 529 plan, after subtracting the federal and state taxes that would be due each year, you would have access to only $43,000 to help pay for college.
The difference, which is essentially a government subsidy to promote college savings, is $20,000, all else being equal. Furthermore, some states actually allow deductions for contributions, making the 529 plan even more attractive to college savers.
4. 529 plans are the most popular and convenient way to save.
There is approximately $100 billion currently invested in state 529 plans.
5. Not all 529 plans are alike.
Each state has its own 529 plan. Investment options and fees may vary from state to state, so it pays to shop around. A couple of useful sites for comparing the different state plans are savingforcollege.com and Morningstar.com.
Most state plans have websites that include free electronic college saving calculators to help you decide how much to save in order to meet your saving goals.
6. The money saved in a 529 plan is not forfeited if the beneficiary does not go to college or gets a full scholarship.
Money saved in a 529 plan may be used to pay the college expenses of other family members, including siblings, parents, cousins and stepchildren. The money can even skip a generation and be used for a grandchild in the unlikely event that became necessary.
7. There is no right amount to save. It depends on your financial situation.
8. Do not save for college at the expense of maintaining your normal lifestyle or your retirement.
You don’t want to short change the amount you set aside for retirement. If you run out of money, there is no such thing as a retirement loan. On the other hand, it is relatively easy to get a college loan.
9. Two ways to save are:
â€¢ Save what you can afford after taking care of family expenses.
As was stated in Point 5 above, most state 529 plan websites have free electronic college saving calculators. Other websites, like finaid.org, have them as well. By using these calculators you can periodically check to see how well your savings are keeping pace with college costs.
â€¢ Set a target figure. A number to shoot for is the tuition fee at the major public university in your state. For a more ambitious goal, you might use the out-of-state tuition charge. This higher figure would also allow you to accumulate enough savings to pay for a good part of the tuition cost at a private college.
Most college saving calculators found on state websites automatically include information on the current and projected (in-state and out-of-state) tuition rates for the state’s main universities.
10. If you save in a 529 plan and later apply for aid, you may be subject to a very light â€œpenaltyâ€ in terms of how much the amount you have saved will increase your expected family contribution.
If the child’s parents are the owners of the 529 plan, they may be asked to contribute some of that money under the rules of the need formula. (There is no such â€œpenaltyâ€ if the plan is owned by the child’s grandparents. See Point 12 below for more on grandparents.) Let’s look at the example in order to better understand.
If you, the parent, manage to have $100,000 saved in a 529 plan by the time your child is ready to start college, the first $50,000 will not be considered at all when calculating your child’s aid award. (This is one of the ways the system rewards you for saving.) Only 5% of the second $50,000, or $2,500, will be assumed to be available to pay for college. In other words, the amount of your need will decrease by that amount.
Thus, one could argue that by diligently saving $100,000, you are ultimately worse off by $2,500. However, if you consider that you are very likely to have earned around $35,000 in tax-free interest over the saving period, you will realize that by saving you are actually about $32,500 better off.
11. There are other ways to save besides 529 plans. To look into other options, it is best to consult with a financial advisor.
Remember to choose an advisor who in very familiar with all applicable aid rules. The need formula treats savings differently depending on whether the parent or the child is the owner.
12. Grandparents too can help through 529 plans.
Based on a recent poll, two-thirds of grandparents say they are interested in helping to pay for their grandchildren’s college education. It is worthwhile to know, that money saved in grandparent-owned 529 plans is not considered when calculating the grandchild’s aid award. Furthermore, grandparent-owned 529 plan savings are not counted as part of the grandparent’s estate for estate tax purposes.
College Financial Aid: Pre-High School Saving (transcript)
I’ve spent the last couple months videotaping myself giving advice on how to take the SAT, but I know that getting a good SAT score is not all that you need to do to get into a good college. There’s a lot you need to know about financial aid and admissions. While I’m not an expert in those fields I have some friends who are and I recently had the opportunity to sit down and talk to Don Betterton.
Don is the former financial aid director of Princeton University. He was there for 30 years in that position. I got to know Don back in the late 80s when he was one of the assistant soccer coaches and I was on the varsity soccer team. Don and I have known each other for a long time, he’s a great guy and I asked him what I could do today before my kids are even in high school to help make paying for college easier when my kids finally do get to college.
So I grabbed my video camera and sat down with Don and hopefully you’ll enjoy the conversation.
Karl: So Don I’m excited, I’m about to learn the twelve things I need to know about saving for college for my children. Your first bullet is called putting aside money for college is a good idea, the earlier the better. My question for you would be, who is it a good idea for: me or my children?
Don: Actually it’s a good idea for both. What I like to do is compare â€œSavings vs. Borrowingâ€ because if you don’t save now the chances are your child is going to have to borrow later on. So I have an example here, depending on how old your children are.
Karl: I have a 9-year-old, a 7-year-old, and a 6-year-old.
Don: Okay. Well my example is based on a 5-year-old. So let’s start with that. Thirteen years until college, you start putting aside money when your son is 5-years-old. You put aside $2,000 per year over that thirteen year period; you’ve set aside $26,000 dollars. The interest accumulation over that period of time means you’ll have $46,000 ready to go to college when he’s 18 years old.
Let’s say you don’t do that, you don’t put aside any money at all. You still need $40,000, now you have to borrow that money. He takes out a student loan, graduates with $40,000 worth of debt. He has to repay that at a 6.8% interest rate over a 10 year period. Guess how much he’ll have to repay?
Karl: $55,200. (laughs)
Don: I think you’ve been looking at that sheet! Anyway, so that’s a good point. Once you’re set with the savings, you put aside $26,000 for the $40,000. Borrowing, he borrows the same $40,000 and he has to repay $55,000. There’s almost a $30,000 difference in this example between savings and borrowing.
Karl: Right and I agree with you. I think that if you do the numbers it works out to be $167 per month for me right now. I think that if you start putting away that amount of money, you just get used to it, you learn to live without it, and before you know it you have this nest egg that’s ready for the children and their college education. So just to recap, you’re point number two was saving beats borrowing hands down — I agree with you 100%.
Can you explain for me point number three which is, the tax system gives incentives to college savers. What does that mean?
Don: Yeah it sure does, there’s something called the 529 Plan, which the government has set up and that’s the provision of the Internal Revenue Service. It says you do not have to pay taxes on money put in this particular college savings plan. Not only do you not have to pay federal taxes, but you don’t have to pay state taxes.
So what it means is this money accumulates without any tax payments over this thirteen year period we talked about. It’s a substantial difference if you accumulate money paying taxes every year versus not paying taxes.
An example I like to use would be, if you set aside at age 0 when your child is born, $18,000. If you have to pay taxes on that over a period of 18 years, you’ll have accumulated $43,000. If you do it in a 529 plan with all the advantages inherited in that, you’ll actually accumulate $63,000. So it’s quite a difference in your pocket, your out of pocket expense, and in savings in any way that’s taxable versus the 529 plan which are non-taxable in the federal or the state level.
Karl: So really what it comes down to is there is a $20,000 difference in your example that would go to me and my child’s education versusâ€¦
Don: Right, it’s a government subsidy for saving for college basically.
Karl: Okay, so your point number 4 is 529 plans are the most popular and convenient way to save. What are 529 plans?
Don: 529 plans are these government sponsored savings plan, which are now by far the most popular way to save for college. I think there’s like a hundred billion dollars in these plans as of the current time. They simply are I think the most convenient, easy way to save for college.
Karl: Now you say government plans, are they federal or state plans for the most part?
Don: The federal government puts in the rules as far as these tax advantages we talked about, but actually the plans are set up within each state, they establish their own. So when they look at 529 plans, you normally start looking at your own state plan because of certain advantages as far as state tax deductions, there may be some scholarship benefits. There’s also a very good website called savingforcollege.com and I think it’s worthwhile before one invests in one’s own state plan to at least go on that website and check some of the provisions of other state plans to see whether your state is offering the best deal for you or whether you might do even better by going to another state.
Karl: Okay, you just answered your point 5 which is not all 529 plans alike you should shop around. And the website was collegesavingâ€¦
Karl: Sorry about that! Savingforcollege.com. Number 6, what if the beneficiary doesn’t go to college or gets a full scholarship? Now you know all of my children are going to get full rides, so this is a complete waste of time for me, but let’s just pretend they’re not as special as I think they are!
Don: Well if you can’t use any of your children, do you have any nephews or nieces? I guess is my question.
Karl: I do, I do. Both of my sisters have kids, so I have two nieces and three nephews.
Don: Okay well, the way they’ve set up the rules is you initially establish a beneficiary. If he or she does not go to college, has a scholarship, you can then move the money around to other beneficiaries, including your whole family: your cousins, your first cousins, or if you want to go back to school you can use it yourself. You can actually skip a generation and it could even go to your grandchildren, but we won’t get into that right now!
Karl: Well speaking of different generations my parents have at times expressed an interest in helping me save for my children’s education. Is it first of all typical for grandparents to want to get involved? And if they want to, can they get involved?
Don: Yes. I read a recent pole that says two thirds of grandparents would like to help their grandchildren with college to some extent. A 529 plan is an excellent option for grandparents. We haven’t talked about the effect of the financial aid formula on these savings yet, but there’s kind of a light tax on savings that would be held in the parents’ name. If the grandparents save the money for college, they’re not part of the financial aid system at all. So one doesn’t even have to worry about that.
The other advantage of grandparents is as they’re building up their estate and they move this money, none of it counts even though their the owner in their estate. So it’s actually a good estate planning technique as well. And farther down the line, they’ll help their grandchildren, which I’m sure they really would like to do.
Karl: Okay now we talked a little before about what is the right amount to save. Now you threw out some examples of $167 a month and I asked you a question: what if I can’t save that much, what should I do? The other variable is I don’t know how expensive school is going to be when they get to that age. Is there sort of a right amount to save or how do you go about figuring out what the right amount is?
Don: The easiest answer to that is simply save what you could afford after you take care, as we talked about before your current living expenses and your retirement protection. If one wants to set a target figure, I think a reasonable one is the out of state tuition for wherever your flag ship public institution is. In New Jersey they use rectors as an example; the out of state tuition for a student that comes from out of state and attends rectors is about $17,000 a year currently. If you take that and you inflate it over a period of time that ends up being thirteen years using the same 5-year-old example. $168,000 is what you’re facing way down the line. You’d have to put aside about $450 a month to meet a target like that over that period of time.
So, some families can’t afford it. If you could afford that, it’s a very good number to shoot for because then if your student stays in state that amount of money would probably pay for tuition, plus room, plus board and if they go to a private institution, it will probably pay a good part of the private institutions tuition. So it’s a reasonable target figure. It can be expensive but if that’s not possible, any amount you save is better than not saving at all.
Karl: Don, one last question on a topic that we didn’t really cover I don’t think in the last segment. Will I ultimately be penalized if I’m a good person that saves and does everything I’m supposed to when I get to that financial aid award when my kids get to school?
Don: Yeah that’s a really good question and I hear that quite a bit. Am I penalized for saving? Whether it’s in a 529 plan or any other form of savings the financial aid formula is really fairly light on how they treat savings. Let me give you an example:
If by the time your son gets to college, you have $100,000 in some form or another savings, investments, 529 plans, the financial aid formula first said you can reserve $50,000 that we won’t even look at. So now they only look at $50,000 of your $100,000. What’s called a tax rate on that, the amount that’s added to your contribution is 5%. So going through the math 5% of $50,000 is $2,500. So you’re contribution is now going to be $2,500 greater because you have $100,000, so I think that’s fairly a light treatment of the savings. As a matter of fact, if the $100,000 gained some interest during the years, chances are you can simply pace some interest off the top of it and never actually have to touch the principal at all. So whether it’s 529 plans or any other form of savings, it’s a good idea enough that the financial aid system treats it fairly lightly.
Karl: Awesome! Thanks Don I really appreciate your time and your knowledge and your willingness to share with me.
Don: Thank you.
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