Paying for College: A Comprehensive Guide for Parents

Planning for college is an exciting milestone for both students and their families. From choosing the right school to deciding on a major, there are plenty of options available to help parents and students approach paying for college in a way that is financially smart and sustainable. Most parents pay for college using a combination of savings plans, income, financial aid, and student loans. Scholarships and grants are another popular way to fund education, as are gifts from friends and family. This article explores various strategies and resources to help families navigate the complexities of college financing.

Saving Early and Often

Saving for college early is one of the biggest ways to help pay for your kids’ college education. Compound interest is a powerful tool, and the more money you can invest earlier in your child’s life, the more those funds will grow over time. High-yield savings accounts and certificates of deposit (CDs) are excellent long- and short-term tools for growing your money, but they’re not the only ones. Remember, even small contributions can add up.

529 Savings Plans

A 529 Savings Plan is a tax-advantaged investment account designed to help families save for future education expenses. Each state sponsors a plan, and the money you contribute grows tax-deferred. Qualified withdrawals (for tuition, room and board, books, and supplies) are tax-free at the federal level. Many states also have a state income tax credit to encourage savings. So, when you make a donation to a 529 plan to benefit your niece or nephew, for instance, you personally can take an income tax credit in many states. There are usually some limits on those, but worth considering.

Key features of 529 plans:

Tax Advantages: Assets grow tax-free, and there’s no tax on distributions out of the 529 plan for the benefit of the beneficiary when he or she eventually goes to school, and those monies are used for college costs.
State Sponsorship: Each state sponsors a plan, but you’re not required to stick with your home state’s plan.
Contribution Flexibility: You can make one-time deposits or schedule automatic transfers to grow the savings steadily over time.
Frontloading: You can frontload five years' worth of annual exclusions. When you’re contributing to a 529 plan, that amount is $80,000 a year or $160,000 for a married couple, which can go a long way toward solving college expenses.
Estate Planning Tool: If a couple has multiple grandchildren, this tax-free amount can quickly add up to a substantial sum.
Family Bank for Education: In essence, a 529 can be used to create what’s effectively a family bank for education right through great-grandchildren and great-great-grandchildren!

How to Maximize a 529 Plan:

Compare plans: While many people choose their home state’s plan, you’re not required to stick with it.
Set up contributions: You can make one-time deposits or schedule automatic transfers to grow the savings steadily over time.
Start early: The earlier you invest, the more time your savings have to grow tax-free.

Coverdell Educational Savings Accounts (ESA)

Coverdell accounts are very similar to 529s. They’re not state-run programs, but they are found at any bank or financial institution. And it’s a similar idea so far as appreciation can grow free of tax. There are some limitations on who can contribute to a Coverdell account, and what types of contributions can be made in terms of the size. Coverdell accounts are generally designed for the middle class and the upper-middle class individuals, and so if a person’s adjusted gross income for any year is above $110,000 or $220,000 for a married couple, if it’s above that then you can’t contribute to a Coverdell account. If it’s below that amount you can contribute, but only up to $2,000 per year. There are some other rules and limitations if a beneficiary also has a 529 plan, so you’ve got to be really careful when you’re making contributions to a Coverdell account.

Financial Aid and Scholarships

Speaking of financial aid, scholarships are a great resource to help parents pay for college. Free money in the form of scholarships and grants doesn’t have to be paid back and can significantly reduce your student’s college expenses each year. Grants and scholarships are one of many different ways to pay for college.

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FAFSA (Free Application for Federal Student Aid)

The FAFSA isn’t just a resource for low-income families. It’s the gateway to federal grants, work-study programs, student loans, and many state and institutional scholarships. Submitting it early can increase your student’s chances of receiving the maximum financial aid and avoid overpaying for college. You should submit the FAFSA as soon as it opens, usually on October 1 each year.

Tips for Completing the FAFSA:

Start Early: Submit the FAFSA as soon as it opens to increase your student’s chances of receiving the maximum financial aid.
Gather Information: The FAFSA does require a lot of information.
Utilize Resources: There are tons of resources available on studentaid.gov to guide you and your child through the application process.

Scholarships and Grants

To improve their chances of qualifying for scholarships, encourage your student to build a robust resume with strong academic performance or extracurricular activities. Colleges often award money to high achievers to attract top talent, but they aren’t the only providers of scholarships. Various civic and fraternal organizations, professional associations, and affinity groups award money, too.

Student Loans

If free financial aid and savings still leave a gap, parents paying for college often turn to student loans to help cover the remaining costs. Not all loans are created equal, though. Understanding your options is important to help avoid long-term financial strain.

Federal Direct Subsidized and Unsubsidized Loans

Taken out by the student, these loans tend to offer the lowest interest rates and flexible repayment options.

Parent PLUS Loans

Another type of federal loan, Parent PLUS loans are student loans for parents (biological and adoptive) of dependent undergraduate students.

Private Student Loans

If federal loans aren’t an option, lenders like Ascent offer a wide range of private loans with (or without) a creditworthy cosigner, typically a parent. Some lenders also offer parent student loans designed specifically for parents or guardians looking to take out a loan on their student’s behalf.

Before signing the dotted line for any student loan, it is important to compare loan terms, interest rates, and repayment options.

Tax Benefits for Education

Tuition payments aren’t generally tax-deductible, but there are some tax credits available. College tax credits and deductions can significantly reduce what you pay in taxes, making higher education more affordable for your family. Smart use of education tax credits and deductions can save your family thousands of dollars.

American Opportunity Credit (AOTC)

The credit can be up to $2,500 per eligible student and is available for the first four years of post secondary education. Forty percent (40%) of this credit is refundable, which means that you may be able to receive up to $1,000, even if you owe no taxes. Qualified expenses include tuition and fees, course related books, supplies and equipment. The AOTC typically provides the most value for undergraduate students. The AOTC is available ONLY if the student hasn’t completed the first 4 years of postsecondary education. You can claim both the AOTC and LLC on the same return only if they are not for the same student and the same expenses.

Eligibility for AOTC:

The student hasn’t completed the first 4 years of postsecondary education.
You can claim both the AOTC and LLC on the same return only if they are not for the same student and the same expenses.

Lifetime Learning Credit (LLC)

You may be able to claim a Lifetime Learning Credit of up to $2,000 for qualified education expenses paid for a student enrolled in eligible educational institutions. Note: This is a nonrefundable credit which means the credit is limited to the amount of tax you must pay on your taxable income. For the LLC: Any tertiary education qualifies, including career development courses, with no minimum enrollment and no limit on years of study. The LLC offers flexibility for part-time students and graduate education. Only one LLTC can be claimed per year, and income limits determine eligibility.

Student Loan Interest Deduction

Generally, personal interest you pay, other than certain mortgage interest, is not deductible. However, if your modified adjusted gross income is less than $85,000 ($175,000 if filing a joint return), you may be able to deduct interest paid on a student loan used for higher education during the year. You can deduct up to $2,500 per year in student loan interest paid on loans for yourself, your spouse, or a dependent. Note: This deduction can only be claimed once.

Tax Credits vs. Tax Deductions

Tax credits directly reduce the amount of tax you owe, while deductions lower your taxable income. As a parent paying for your child’s education, you can access two powerful tax breaks. The AOTC is generally the more valuable option, offering up to $2,500 per year per dependent child. The LLC offers up to $2,000 per year (20% of the first $10,000 in eligible expenses).

Important Considerations:

For each student, you can choose to claim only one of the credits in a single tax year. However, if you pay college expenses for two or more students in the same year, you can choose to take credits on a per-student, per-year basis.
Both you and your child cannot claim credits for the same expenses.
You cannot claim a credit for education expenses paid with tax-free funds.
Use Form 8863 with information from your student’s Form 1098-T (sent by the school).

Direct Payment for Tuition to a College

Payments made directly from a person to an educational institution that are used for tuition, not room and board, just tuition, those payments are not deemed a taxable gift. Sometimes these are called 2503(e) gifts. I reference that only because you might see it as you look around on the Internet. There’s an Internal Revenue Code section that authorizes those gifts, but a lot of folks use those direct transfers to the institution to pay tuition, because those are not deemed a gift.

Gifting Strategies

One of the best gifts you can give to people you love is the gift of education. When you gift educational expenses, you’re not only providing someone with the tools they need to succeed, but you’re also investing in their future. There are right and wrong ways to go about it, especially from a tax exclusion perspective.

Direct Gifts to a Student

Giving gifts directly to the student is always an option for college expenses such as room and board, supplies, and so on. However, the current GST and gift tax exemption is $17,000 per donor per student. Within these limits, even filing a gift tax return isn’t required. There’s more to the “per donor per student” rule for gift tax exclusion. For example, a married couple can give gifts of up to $34,000 per college-age kid. Other donors, such as grandparents, can also give up to $17,000 annually per donor tax-free. Because the gift owner becomes the student, direct gifts from anyone, including grandparents, impact financial aid qualifications.

Business Owners Can Put Students on Their Payroll

If you’re a business owner, you have another way to help your college-age kid financially. Many of our clients put their children on payroll and have them earn money for school and bills, or earlier, college savings. You could pay your high school-aged or college-aged kid $30,000 a year just to use their likeness on marketing materials. Putting them on the payroll will impact their financial aid eligibility. The child must also, of course, pay income tax on that money, though at their lower tax rate.

Trusts and 529 Accounts

Long-term trusts might be a good planning opportunity for larger gifts. The biggest problem is that if you establish a trust fund for your child or grandchild, they will have to report that as their own money when they fill out the FAFSA. That will likely reduce their aid eligibility.

Choosing the Right School and Major

Where your student goes to school-and what they plan to study-is just as important as how you pay for it. Bright Futures Engine index, which is a number that translates to the anticipated ROI of attending that school for said major. The Bright Futures Engine doesn’t take into account financial aid amounts on its own, but you can input your expected financial aid to help increase the Bright Futures Engine index. Ultimately, the school choice depends on what kind of experience your child wants.

Additional Expenses to Consider

Tuition is the lion’s share of what students have to pay for, but it’s not the only expense. Expect to budget for room and board, books and supplies, transportation, activity fees, and other personal expenses.

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