How Will You Fund Your Child’s College Expenses?
Neil Krishnaswamy, CFP®
Many of our clients share the common goal of paying for their children’s college education. It’s indeed an ambitious goal: A recent survey (source CollegeData.com) from the College Board indicates average annual costs are around $25,000 and $50,000 for in-state and private colleges, respectively.
It can be challenging to determine what colleges fit into your budget given the number of considerations involved, such as location, type of college and choice of major. You and your college-bound children must navigate a maze of applications for college admissions, financial aid and potential scholarships to find a price tag you are willing to pay. This piece explores the solutions you can use to fund this investment in your children’s future.
1. Savings and cash flow: Saving as early as possible is usually the most efficient way to fund future college expenses. A number of different accounts can be used for this purpose, including the commonly recommended 529 college savings plan (source U.S. News). In these accounts, earnings grow tax-deferred, and future distributions for qualifying education expenses are tax-free. If the ownership and distributions are structured properly, 529 plans can be efficiently used even when qualifying for financial aid (source Kitces.com). They have high contribution limits as well, but make sure to properly navigate the gift and estate tax rules (source SavingForCollege.com).
For most families, dedicated college savings accounts like 529s are ultimately not sufficient to meet the full costs of college. Oftentimes, there is a gap that must be filled with either cash flow or loans.
Ideally, having the discretionary income available to contribute during your children’s college years will greatly help offset the long-term costs. Any income you dedicated to savings prior to your child entering college might be redirected toward current-year college expenses. You could also redirect other savings, even if temporarily, toward college. Your advisor can help you evaluate the trade-offs involved. Often, the largest consideration is whether a reduced savings rate might impact your retirement goals.
2. Traditional college loans: For every year your child is in college, you can submit a FAFSA application (source FAFSA). Colleges will use the results to determine how much federal aid you qualify for and what you will be expected to pay. Such aid might include grants and Federal Work-Study, but much of the heaving-lifting often comes from loans.
One loan you could qualify for is a direct subsidized loan (source StudentAid.gov). These are available to undergraduate students and might be the most attractive option, as the government pays the interest as long as the student is in school at least part-time and during other special grace periods.
If you don’t qualify for a direct subsidized loan, you can still receive a direct unsubsidized loan. These are available to both undergraduate and graduate students. The key difference is you are responsible for paying the interest during all periods, even while the student is in school. There is a cap on the aggregate amount of subsidized and unsubsidized loans you can receive in a given academic year.
Direct PLUS loans (source StudentAid.gov) can also be considered. These are federal loans available to parents of dependent undergraduate students, as well as graduate or professional students.
One of the key benefits of federal loans is repayment flexibility (source StudentAid.gov). You could potentially have income-based repayment plans or even loan forgiveness down the road. However, these provisions are subject to change, especially in light of the PROSPER Act (source U.S. News).
Finally, private loans can be explored. But the terms you get can vary greatly based on the institutions you use.
3. Alternative debt solutions: There are a few debt solutions that have starting rates closer to inflation, but can increase over time as interest rates rise. Their benefits include more flexible payback options, so you can maintain more liquidity and options in your cash flow planning.
Given that your home might be one of the largest assets on your balance sheet, you could consider using some of that equity as part of your college funding plan through a home equity line of credit (HELOC) (source Investopedia). Rates for HELOCs can vary, but typically aren’t much higher than the federal direct loans mentioned above. With HELOCs, there’s more payment flexibility during the initial draw period (usually 10 years from origination). During that time, you can pay interest only. After the initial draw period ends, amortizing payments would begin, or re-financing might be an option.
For those who can build up significant after-tax investments, securities-backed lines of credit (SBLs) (source SEC.gov) might be an appealing solution. SBLs have very flexible payback options, including interest-only for an indefinite period. Care should be taken not to overdraw on this line of credit though, as it may be subject to a collateral call should the markets decline precipitously.
Funding college can be a challenge on a number of fronts. One or more of the solutions described above may need to be a key part of your strategy. Your advisor can help you evaluate these options and build a holistic college funding plan that integrates with the rest of your financial goals.
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