[Editor's Note: This guest post is from Brad Bobb CFP® of Bobb Financial, a fee-only financial planner that specializes in working with medical professionals and federal employees. This article is about saving on the COST of college rather than the best ways to SAVE for college. We have no financial repationship.]
Paying for college can easily be one of the biggest expenses that parents will incur during their lifetimes. Although it is likely to cost a significant amount of money, it isn't much different from other major purchases that you will make in your lifetime; knowledge and preparation can help you save a significant amount of money.
Most people know that they should save and invest money to pay for future college costs, but not everyone starts saving as early as they should. It's also rare for a family to have enough in a 529 plan to fund 100% of college. It’s not a good idea to have all of your college costs come from a 529 plan, due to penalties for taking money out of a 529 plan if you have too much in the 529. That being said, this discussion is about saving on the cost of college versus saving for college.
[Editor's Note: While I agree that not all your college costs should come from a 529, I wouldn't spend too much time worrying about putting too much in there given the multitude of options available (penalty-free scholarship withdrawals, changing beneficiaries or just paying the penalty/taxes) in the rare cases where it happens.]
How to Save on the COST of College for the High-Income Earner
1. Financial Aid (Don't Assume You Won't Qualify)
The first thing you want to do it determine if you will qualify for financial aid. There is a lot of misconception regarding financial aid, just because you have a good job and an income of $100,000 or better doesn’t mean you won’t qualify for aid. It’s possible to receive financial aid with an annual income of $200,000 or even $250,000. Based on income alone, a family of five with an income of $225,000 would have an Expected Family Contribution (EFC) of $52,782. If college costs $70,000 and your EFC is $52,782 then you have a demonstrated financial need of $17,218.
It is also important to understand that a family’s EFC is a per household number. An EFC is the minimum amount a family is expected to pay for college whether one or five kids are in school.
However, if you have been a loyal follower of WCI and have a high income, you likely won’t qualify for financial aid by the time your kids are going to college. You can check your EFC with this tool.
[It's good not to assume, but don't be surprised when you don't qualify-ed]
2. School Selection is Key!
Far too often I have seen higher income earners send their kids to an elite, very expensive college. The reason for doing so is normally because their kid wants to. I would really like to drive a Lamborghini but unless you are financially independent, I don’t know that it makes sense to do so, much the same as sending your kid to an elite school. If one of your goals is to attain financial independence and retire early, it pays to be selective in your college search.
College can cost anywhere from $20,000 a year up to $70,000 a year. A $70,000 a year education doesn't necessarily translate to higher income or a better job after graduation. There have been multiple studies on this subject, and some show that for a select few majors the school may matter. Other studies show that employers are more concerned with skills and applications of those skills versus where someone went to school.
Elite schools rarely give scholarships. From my experience, it is common for high-income families to have kids that are very good students. Good grades and good ACT/SAT test scores can equal sizable scholarships at many schools, however, 568 Presidents Group schools like Northwestern, Yale and Notre Dame don't offer academic scholarships.
A kid that gets into an elite school, can likely go to a mid-tier or lower level school at a significantly lower cost. Is it worth paying an extra $50,000 a year to go to an elite school? If you pay for one kid to go to Yale, are you going to tell your next kid they can’t go because it costs too much? This is yet another question to consider when your firstborn is school searching — can you afford to pay for two, three, or four elite educations?
Here is a real example of an engineering major that got accepted to MIT. The student also applied to Case Western Reserve, a very good school but it doesn’t have the same name recognition of MIT.
- Cost of Attendance at MIT = $63,250
- Cost of Attendance at Case Western Reserve = $59,634
MIT doesn’t offer merit scholarships, however, Case Western Reserve offered this student $20,000 a year in merit scholarships. The cost of Case Western Reserve is $23,616 a year cheaper than MIT, for a total of $94,464 cheaper over four years.
This scenario is not uncommon, most students that get into elite schools can get a significant amount of scholarships from mid-tier schools and significantly cut the cost of college.
3. Will You Pay for Grad School?
Another thought to ponder is paying for grad school. Most kids that I see go to elite schools end up going on to grad school. How much more will that cost? Do you plan to pay for your kid’s grad school? Med school? These are all things to consider before choosing a school.
4. ACT/SAT Prep Helps!
ACT and SAT scores can have a big impact on the amount of scholarship money kids receive. An ACT score one point higher can translate to thousands of dollars in scholarships.
The University of Alabama has a grid that shows exactly how much students will receive in scholarships for their ACT scores.
|ACT Score (+3.5 GPA)||Per Year Award||Four Year Award|
Going from a score of 28 to 29 equates to $9,000 more for four years! I suppose it’s possible, but I have yet to talk to a student who didn’t improve their score after going through an ACT prep class. Most companies that do ACT prep will tell you that the average increase is four points. It’s worth the investment, do it!
5. Know How Colleges Operate: You CAN Appeal Their Offer
Colleges are businesses, and many schools will not give you their best offer the first time. If your student has one school in mind, it is still a good idea to apply to multiple schools. If you apply to four similar schools, and the one your student wants to go to doesn’t come back with the best offer, then appeal the offer.
Applying to multiple schools helps to get the universities to compete with each other. If you have an offer that is $10,000 better than the rest, you can use that award letter to send an appeal back to the other schools. There is a chance that those schools will come back with a better offer. The good news is that if a school lowers its offer by $3000, that is actually $12,000 over four years!
6. Tax Planning
The 32% income bracket starts at $315,000 and the top tax bracket of 37% starts at $600,000 for married, filing jointly. Capital gains tax rates are 15%, and 20% if you are in the top tax bracket. If your income is above $200,000 ($250,000 married) you have to add another 3.8% to the capital gains rate. Most docs will be paying at least 18.8% on capital gains.
One way to save some tax dollars is to gift appreciated assets to your kids. If you do this early, your kid can sell assets annually up to $2,100 of gains and pay no income taxes. A parent in the top tax bracket would pay almost $500 of taxes on $2100 of gains, but a child wouldn’t pay any taxes. [Technically, the first $1,050 per year is tax-free and the 2nd $1,050 is taxed at the child's bracket, which is 0%.-ed]
Are You Self-Employed? Pay Your Kids an Income
Disclaimer: The example below is meant to provide an example of how tax planning can help lower costs. I am not a CPA, and one would be needed to implement some of these strategies. There are a number of variables that need to be considered such as FICA taxes, household income, child tax credits, and paying a fair wage.
Paying your child an income at an early age is a great way to save some tax dollars. It’s also a great way for kids to learn responsibility and work ethic.
Thanks to the new higher standard deduction, a self-employed person can pay their child up to $12,000 and the child doesn’t pay income taxes [or payroll taxes if the child is a minor, the business is not a corporation, and the only owners are their parents-ed.] If you are in the highest tax bracket this could potentially save you $4,440 per year. If you start paying your child a salary at the age of 11, and pay them through age 21, you can save over $40,000 in taxes. Even if you start late, you can still get significant savings by employing your kids.
Self-employed parents in the highest tax bracket may want to look at paying their student an even higher income. Paying your child a higher income can be advantageous in a number of ways:
- Lower tax rates on income for the student
- Lower capital gains rate
- Student can get the American Opportunity Tax Credit (up to $2,500 per year of college)
If a student can pass the support test (accomplished by paying for half of their support with income and sales of appreciated assets) then they can take advantage of the American Opportunity Tax Credit (AOTC).
Here is an example of how this strategy can play out.
The first table shows taxes that the parent would incur.
|Income tax on wages||$7,400|
|Long Term Capital Gains (sale of assets)||$25,000|
|Capital Gains Rate (20% + 3.8%)||23.8%|
|Taxes on unearned income||$5,950|
|Total tax on parent’s wages (earned income)|
|and sale of assets||$13,350|
The following table shows the taxes that an independent student would incur on the same wages and sale of assets.
|Tax rate (10% on up to $9,525 )||$800|
|Long Term Capital Gains (LTCG)||$25,000|
|Capital Gains Rate (0% assuming no Kiddie tax)||0|
|Tax on unearned income||$0|
|Gross Federal tax||$800|
|American Opportunity tax credit||($2,500)|
|Total tax||+$680 (up to 40% of the credit is refundable)|
In the first scenario, the parent paid $13,350 in taxes. If the parent chose to employ the student and gift appreciated assets as the second scenario illustrates, the tax savings is $14,030 a year. If this strategy can be implemented over four years of college, the parents can save almost $56,120 in taxes. No state taxes were used in the illustration, so if your state has a state income tax, the savings would be higher.
This strategy can work well for high-income families, but I would highly recommend working with your tax professional to implement.
More Ways to Hire Your Student: Section 127 and 132 Plans for the Self-Employed
There are a couple of IRS codes that allow business owners tax savings when paying for education.
Section 127 plans allow employers to provide employees with up to $5,250 a year in tuition assistance. The dollar amount is tax deductible for the employer and tax-free to the employee when used for tuition assistance.
Hiring your student would allow them to take advantage of the $5,250, which is pre-tax dollars, therefore it would cost a parent in the top tax bracket $8,333 (37% fed tax) in after-tax dollars. The business also gets to tax deduct the $5,250, which saves the business $1,942 if it is in the 35% tax bracket. It would ordinarily cost the family $8,333 to pay for $5,250 of college, but by using a Section 127 plan it would only cost $3,307.
It is important to note a couple elements of Section 127 plans:
- There must be a written plan in place
- The same benefit must be offered to all employees
- It is only available for employees age 21 and above
Section 127 plans are best used for small companies and can be used for a student’s last two years of school (assuming the student is age 21) and grad school.
Section 132 is called the Working Condition Fringe Benefit. Section 132 plans don’t have to be offered to all employees, and there are no dollar limitations. A requirement for a Section 132 plan is that the education must be job-related. If your student’s education is job-related, a Section 132 plan could be an ideal fit.
This is a ton of information to process, but very important if you want to save on the cost of college. While I have a pretty good understanding of the tax law, I am not a tax professional. I do believe it is important that people know every angle that can be used to save on cost when paying for college. A tax professional would be needed to implement some of the strategies mentioned in this article.
What is your experience? What have you done to save on the cost of college? Which of these strategies do you think would save you the most?