[Editor's Note: Today's post is from an article I wrote for ACEP NOW. I've written about the plan for how my kids will pay for their college, but in this article, I introduce the concept of The Four Pillars (a nod to Bernstein) of Paying for (your kids') College.]
By virtue of their high income, a physician's family situation is likely to differ significantly from that of the average student's family. Average students and parents will fill out a Free Application for Federal Student Aid (FAFSA) or the similar College Scholarship Service (CSS) application and discover a difference between the parents’ Expected Financial Contribution (EFC) and the cost of attendance at their chosen school. That is not the case for the typical children of physicians.
College Financial Aid Isn't Likely for High Income Families
What this means is that your children will not receive any need-based grants or scholarships, nor will they be able to take out federal and state student loans, at least as undergraduates, unless they are able to be considered independent from you (marriage, military service, or children). The exception to this is with a Direct Unsubsidized Loan ranging from $5,500 to $12,500 and available to students regardless of financial need.
Children of high-income professionals may still want to fill out the FAFSA just in case, especially if there are multiple children attending expensive schools at the same time, but don’t expect much. In addition, some schools require the FAFSA to be filled out in order to receive merit-based scholarships.
Financial-aid planning is the process whereby some middle-class families may benefit from making the difference between the EFC and the college’s cost of attendance as large as possible. This requires an understanding of what counts on the FAFSA (or CSS) and what doesn’t. Then you transfer your assets from those categories that count (taxable investing accounts, savings accounts, 529s) to assets that do not (paying off debt, retirement accounts, life insurance).
The theory is that this will allow students to get need-based grants and scholarships as well as to be eligible for loans. Most physicians will not benefit much from this process due to their high income. They will be much better off spending their time, effort, and money increasing their savings to help pay for college.
There are four pillars to successfully paying for children’s college education. Every situation is different, and it is likely that one or two of these pillars will be more important in your scenario than the others, but the larger the contribution from each of them, the easier the task will be.
The Four Pillars of Paying for Your Children's College
#1 School Selection
Far too many parents together with their children choose a school without paying attention to the value received for the price paid. The cost of tuition and fees varies dramatically from one college to another, not to mention the cost of living in the city the school is located in and the price of travel between your home and that city. There is also some variation in the quality of education and peers at each school. But paying no attention whatsoever to the price tag is a huge mistake. High-school seniors have chosen their college for reasons as silly as, “I thought the houses in the town were pretty,” or “The dorm rooms seemed nice,” or “My friend is going there.” In reality, if cost isn’t one of the top three considerations in choosing a school, a mistake is likely to be made.
This approach argues for attending a state university in your home state most of the time. Exceptions can be made for inexpensive private colleges and, perhaps for a very bright child with particular career goals, one of the premier national private universities, assuming it can be afforded.
An even less expensive option can be attending a community college for the first two years prior to transferring to a state university to get the final degree, but there is usually a significant drop in educational quality that comes with that approach, which will make a difference for some students depending on their educational and career plans.
#2 The Child's Contribution
This includes merit-based scholarships for athletics, academics, musical ability, or anything else. It also includes the child’s savings, part-time work during the school year, and full-time work in the summers. Many students have learned their spare time as high-school seniors is better spent applying for hundreds of scholarships than working for $8 an hour scooping ice cream. However, an 18-year-old is an adult and could be expected to work for pay. College is a busy time, but it is rarely so busy that students cannot work part-time while attending. An education may be appreciated more when part of it is paid for by the student.
#3 College Savings
Hopefully, most physicians will be able to save something for their children’s college in between the time they pay off their own student loans and the time children enroll. The federal and many state governments have offered to help via tax breaks.
The two main types of savings accounts used are:
ESAs are hampered by a low contribution limit ($2,000 per year) and no state tax break. Contribution limits to 529s are much higher and vary from one plan to another. To stay under the Federal Gift Tax exclusion, you'll want to contribute no more than $15,000 per year for each spouse. 529s have another useful option where you can even “front-load” up to five years’ worth of contributions.
529 Savings Plans vs Prepaid Tuition Plans
Each state offers a 529, but some are better than others. While most 529s are “savings” plans, which can be used at any school in any state, others are “prepaid tuition” plans. With prepaid tuition plans, if you do not attend a school in that state, you may not be able to transfer the full value of the 529 to an out-of-state school. For this reason, tread very carefully when choosing a prepaid tuition type 529 plan.
State Tax Deduction
To make matters more complicated, some states offer a state tax deduction or credit for using their plan, some states offer a deduction or credit for using any plan, and other states offer no deduction or credit at all. When choosing a plan, first see if your state offers a tax break and, if so, whether it requires you to use your state’s 529. If so, use that plan first. If not, or if you have already maximized the state tax break, then choose one of the top plans in the country with good investment options such as those of Utah, Nevada, New York, or Ohio.
The largest benefit of an ESA or 529 plan is that the money, once contributed, grows in the account and is withdrawn from the account tax-free, as long as it is spent on legitimate education. If the money ends up not being needed, the beneficiary can be changed to another family member, including yourself. Unneeded money can also be withdrawn penalty-free, although not tax-free, if the child gets enough scholarships to pay for school.
The earlier you start saving for college, the more of the heavy lifting the portfolio can do, thanks to compound interest, and the less you will need to save.
#4 Your Current Earnings
The final pillar is your current earnings. This is the main reason the FAFSA or CSS calculates your EFC to be such a high number. Typical physicians will discover that their EFC is something like one-third of their annual income plus 6 percent of their non-retirement investments. It is true that for most physician families, a significant portion of the college expense can be simply cash-flowed.
Unfortunately, one of the main benefits of cash flowing at least some of the cost of college is that tax credits and deductions are phased out for many high-income professionals. The American Opportunity Tax Credit ($2,500 per year) starts phasing out at an adjustable gross income of $90,000 ($180,000 for married filing jointly). The Lifetime Learning Credit is a 20% tax credit on the first $10,000 of eligible tuition and related expenses ($2,000 maximum). The LLC phases out between $58,000 and $68,000 ($116,000 and $136,000 MFJ).
Should High Income Families Use Student Loans to Pay for College
Notice that there is no pillar called debt. There is little reason for any student to have student loans when finishing a bachelor’s degree, especially the child of a physician. Certainly, there is no reason for the physician to take on additional debt such as Parent PLUS Loans or a home-equity line of credit to pay for school. If the cost cannot be covered with savings, the earnings of the child, and the earnings of the parent, consider choosing a less expensive school.
If you put it all together, college education for the children of a physician should not be a terrible financial stress. Consider a school with tuition and fees of $21,000 per year and a cost of living of another $15,000 per year, for a total cost of attendance of $36,000 per year. The child should be able to make $5,000 in the summer and another $4,500 during the school year with relative ease. Perhaps there is also $2,000 in scholarship money. If the parents also saved up $50,000 prior to enrollment, an additional $12,500 per year can be spent. That leaves just $12,000 per year, or $1,000 per month, to cash flow. That should be easily doable on a physician income.
What do you think? How will you pay for your kid's college? Which pillar do you think will be the most significant? Did your children qualify for any need-based aid? Why or why not? Comment below!