Saving for College Takes Dedication and Careful Planning

Physician's Money Digest, September 2006, Volume 13, Issue 9


The only things that are certain in life are death andtaxes. But in recent years, a third item could easily beadded to that list—rising college tuition costs. Accordingto Alisa LeSueur, certified college planning specialist, thecost of attendance at elite schools is now topping $50,000a year and climbing, making it increasingly difficult to"just write the check to pay for tuition, fees, room, board,computer, transportation, and other expenses." As aresult, people are borrowing more frequently and in largequantities to help fund a college education. According to, by the end of 2005 the percentage of collegegraduates with loans had more than doubled overthe past 10 years—58% for those from public institutionsand 62% from private schools.

"The student debt load is having both financial andsocial ramifications," says Deborah Fox, founder of FoxCollege Planning. "Today many 30-year-olds are facedwith financial burdens from their student loans that arecausing them to have to put the pursuit of their dreamson hold. Students have been postponing a home purchase,marriage, or having children. Some have beenunable to pursue certain jobs they are interested in dueto the inadequate level of pay that would not cover theirmonthly bills." Planning is critical, because financing acollege education, not unlike financing a retirement,takes years of careful preparation.

Tuition Trends

Kathy Ruby, director of financial aid at St. OlahCollege in Northfield, Minn, says that the key trends infinancing a college education often mirror those in therest of the economy. "Middle and upper income familiesare saving less and are living paycheck to paycheck,so when the time for college arrives, they are not preparedto absorb any of those costs," Ruby explains."Yet a college education is more important than ever intoday's global economy. In response to this, colleges andlenders have developed many financing options for familiesto utilize in lieu of paying for college out of savingsand current income."

One such method is paying now for a college educationthat might not take place for quite a few years andlocking in tuition rates. According to Fox, there arebasically two ways to accomplish this. The first is a flatratetuition plan offered by individual schools. With anupfront prepayment the college will guarantee the tuitionrate for all 4 years. "I can only think of one familyI know of that has used this option," Fox says. "Theirchild is attending Baylor, which offers this type of plan.If I remember correctly, less than 5% of Baylor's studentstake advantage of this offer."

If a family is confident their student will remain at aparticular college for all 4 years, a prepaid tuition planmay add up to significant savings. The family will needto consider whether prepaying would likely result in abetter return on their money than investing it.

The second way a family can lock in tuition rates isthrough the 529 tuition plan, a consortium of approximately250 colleges that guarantee at least a 0.5% discountoff today's tuition price. This plan has the potentialto save a family quite a bit of money. However, if thechild doesn't end up being accepted to any of the collegesthat participate or chooses to go elsewhere, thefamily may actually lose money (maximum loss of2%) upon withdrawing funds or earn a 2% return atbest. "I'm not really a fan of this plan because I believea family can structure an investment portfolio that hasthe potential to outperform the college inflation costover the long term," Fox says.

Robert Weinerman, former manager of financialaid for MIT, echoes those thoughts. He points out thatpeople who have considered prepayment plans haveusually chosen not to pay for college in this manner."Few people have enough cash on hand to make thepayment without financing the purchase," Weinermansays. "And it is very difficult to figure out a way tofinance the payment with a loan and still come outahead over the time you'll need to repay the loan."

529 Plans Still Popular

For quite a few years now 529 savings plans havebeen considered one of the better options for savingfor a college education. Earnings are able to be withdrawntax-free when used for approved collegeexpenses, such as tuition or room and board, and thehope is that legislation will soon be introduced toextend this benefit beyond the sunset clause thatoccurs at the end of 2010. These plans are also financialaid friendly. Money kept in these accounts is treatedmore favorably as a parental asset, not a studentasset, which is more heavily counted against the family.In fact, soon custodial funds in a student's name canbe moved into a 529 plan and will no longer be countedas an asset of the student. However, for higherincome families this is irrelevant since they won't qualifyfor need-based financial aid unless they have morethan one child attending college at the same time athigh-priced private schools.

There are, however, some drawbacks to 529 plans.One of which is that if the student drops out or doesn'tattend college, their parents may be stuck with extrafunds they can only withdraw by paying taxes and a10% penalty. Fox's biggest concern is that some familiesare overfunding their 529 plans by putting all theireggs in one basket. "Because these plans allow 5 yearsof completed gifts to be made upfront in 1 year, someparents and grandparents have put large sums ofmoney into these plans, which may create a problemfor them down the road," Fox cautions. "What veryfew people understand is that it is possible that the 529plan withdrawals, or at least a portion of them, may betaxable, and not because of the sunset provision or notspending the funds on higher education expenses.What parents don't realize is there is a calculation thatneeds to be done in the year a 529 withdrawal is madeto determine which portion will be able to be withdrawntax-free." The solution, Fox says, is carefulplanning for the order of funding and timing of paymentsboth before and during college years.

Don't Overlook Financial Aid

How to Pay

for College

Gen Tanabe, coauthor of Sallie Mae's (Supercollege LLC; 2005), says that one ofthe biggest mistakes that high-income families make isassuming that they earn too much money to receivefinancial aid or scholarships. Every family, Tanabesays, is eligible for some form of financial aid."Families assume that scholarships only go to the mostdestitute families," Tanabe says. "The majority ofscholarships are based on merit, which includes academicachievement, public service, talents, futurecareer or major plans, and more. You also don't haveto be the class valedictorian or star athlete to win ascholarship. Scholarships are based on every background,talent, or achievement, and if you spend thetime, you will find an award that you can win."

However, be aware that deadlines are important.Weinerman points out that there's no easier way todeny a student financial aid than to tell them they'vemissed a deadline. But other homework is importanttoo. "If the family wants scholarships, they need toreview admissions applications carefully to see whatkinds of scholarships are available at the schools, andstudents should write their admissions applicationsnot only to get into the college, but to win thosefunds," Weinerman says. "Even earlier, studentsshould be selecting schools to apply to based in part onthe kinds of merit scholarships they offer. I talk tomany parents who are frustrated that their childrendid not win any merit scholarships, only to discoverafter talking to them that the student only applied toschools that do not offer merit scholarships."

Ruby points out that an important distinction tokeep in mind is the difference between merit-basedfinancial aid and need-based financial aid. The formeris awarded without regard to income and is givenonly on the basis of merit in some area (eg, academics,music, service, or athletics). Need-based financialaid is based on an individual or family's calculatedneed for the funds, using a federal or institutional formula.In some institutions, merit-based aid has beengrowing rapidly. When researching an institution, it'simportant to understand the types of financial aidthat are awarded and how they are awarded. You canlearn this by reading admission and financial aid Websites, and questioning admission and financial aidcounselors if the Web site is unclear.

"We encourage all families to apply for need-basedfinancial aid at least once," Ruby says. "Athigh-cost private colleges, families are sometimes surprisedwhen they qualify. They assume they won'tqualify because their income is too high. However, ascosts go up, so does the income required to qualifyfor need-based financial aid, and there are other factorstaken into account as well, such as householdsize and the number of people in the householdenrolled in college. A family should never disqualifyitself from any form of financial aid. If you don'tapply, you definitely won't get any money."

Other Considerations

For some families, home equity loans can be the bestform of financing available. However, this dependsupon the housing market, interest rates, and equityavailable. It is an individual choice for each family."When we get to the point of talking about parentfinancing, we often compare home equity to the easilyapproved Parent Loan for Undergraduate Students(PLUS), which has a fixed 8.5% rate, low upfront fees,and a federal guarantee that forgives the loan if the parentor the student dies or becomes permanently disabled," Ruby says. "For some families in certain incomecategories, the interest on the PLUS loan is taxdeductible, which makes it even more comparable to ahome equity loan."

Other student loan considerations are Coverdelland Stafford loans. According to Weinerman, Coverdell'shave never been popular. They have always beensmall accounts due to the small amount of money theycan accept annually (ie, $2000 per child per year) andthe fact that people whose adjusted gross incomesexceed $220,000 cannot fund them. More popularhave been Uniform Transfer to Minor Accounts.These have been facing stiff competition from 529plans, but for many high-income families they are avery viable way to save for college that fewer peopleare considering these days.

Stafford Loans have been very popular since theyare pure student loans. Students can borrow withouttheir parents cosigning, and the parents are not onthe hook if the student fails to make the payments.Recent changes to the Stafford Loan make themsomewhat less attractive than they used to be, butWeinerman still thinks they will continue to be a popularway for parents to involve their children in thefinancing of their own education.

The key thing to remember, Ruby says, is that payingfor college should be a partnership between thestudent, the parent, the federal and state governments,and the educational institution. "Begin conversationsabout finances in middle and high school—discussbudgeting, summer earnings, and savings expectations,as well as the perils of credit cards," Ruby suggests."Encourage your student to explore privatescholarship options, as well as carefully research eachinstitution to which they're applying. And finally,don't be afraid of the financial aid office. It is filledwith professionals whose job it is to guide you throughthe process and to offer you advice about possibleresources."