By Dr. Jim Dahle, WCI Founder
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
This means that your children will not receive any need-based grants or scholarships, and they can't take out federal and state student loans, at least as undergraduates, unless they can be considered independent from you (marriage, military service, or children). The exception to this is with a Direct Unsubsidized Loan ranging from $5,500-$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 they have 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 to receive merit-based scholarships.
Financial aid planning is the process where 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 and 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 a child’s college education. Every situation is different, and one or two of these pillars will likely be more important in your scenario than the others, but the larger the contribution from each of them, the easier the task will be.
More information here:
How Much Should You Sacrifice to Pay for Your Child’s Medical School Education?
The 4 Pillars of Paying for Your Children's College
#1 School Selection
Far too many parents and 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—plus the cost of living in the city where the school is located 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, a mistake will likely be made if cost isn’t one of the top three considerations in choosing a school.
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 before 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 rather than working for $12 an hour scooping ice cream. However, an 18-year-old is an adult, and they 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 save something for their children’s college between the time they pay off their own student loans and the time their children enroll. The federal and many state governments have offered to help via tax breaks.
The two main types of savings accounts used are:
Contribution Limits
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 they vary from one plan to another. To stay under the federal gift tax exclusion, you'll want to contribute no more than $18,000 per year [2024] 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.
Tax-Free Growth
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% of their non-retirement investments. It is true that, for most physician families, a significant portion of the college expense can simply be 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 $80,000-$90,000 ($160,000-$180,000 MFJ).
More information here:
How to Use Real Estate to Pay for College
Do Parents Assume Too Much Educational Responsibility?
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 with 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, a 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's goal should be to make $5,000 in the summer and another $4,500 during the school year. Perhaps there is also $2,000 in scholarship money. If the parents also saved up $50,000 before 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's 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?
[This updated post was originally published in 2017.]
Prolonged time to degrees is not a thing at the elite private universities. One of the things those tuition bills cover is having enough slots in required courses for people to graduate in 4 years. The HYP’s have very high 4 year rates. Those who don’t miss because of health or family reasons.
The long times due to packed required courses is a problem at the flagship state schools. At those places with limited financial aid, it is common for students to have to take time out to work. Leaving school altogether or taking reduced course loads to create time to do a lot of work.
Not all colleges, particularly the elites, give credit for AP courses. They say that their intro courses are more rigorous and contain more material than the AP syllabi. So even a 5 does not mean someone is ready for the next course. They use them, along with their own tests and faculty evaluations, to decide whether someone is really ready for the next course. Even if they do know a lot beyond the AP contents and are ready to move on, they don’t get credit.
So this is no longer a path to shaving off time. Caltech, for example considers BC Calculus to be a basic high school course. If you have done that and got a 5, then you are ready to take intro math.
We spaced our kids out to make sure we would have the money to pay for education and we put away savings for it.
When the time came, we cash flowed.
I’ve became more aware of this problem recently at my alma mater, a private but large school. It doesn’t do any good to have low costs if you can’t get the classes you need.
I think Caltech is likely in the minority on the AP Calculus issue.
Could be that Caltech is in the minority in considering BC calc as the standard high school preparation. Much of this discussion has focussed on kids going to top colleges, financial aid at those places, availability of required courses for majors and ability to shorten time to degree below 4 years. So I have been using those sorts of schools.
Harvard does not grant credit for any AP course.
MIT requires passing their own placement exam for intro calculus. If you get a 5 on BC calc AND pass the exam, you can get credit for the course.
Depending on your intended major, you may need a stronger background in theory and proof based math than a perfect knowledge of the BC calc syllabus would provide. A student could be in trouble when confronted with an expectation that they know everything the others in a class learned in their first year courses.
You said you could take unused 529 funds out penalty free if you didn’t need them and just pay tax on it. That’s not what I’ve read. There is a 10% penalty on the earned portion as well. Am I missing something there?
No, you’re right EXCEPT in the event of a scholarship and other exceptions to the penalty.
Exceptions to the penalty
In some cases, the 10% penalty on non-qualified distribution is waived, but the earnings portion of the distribution is still subject to ordinary income tax. These exceptions include:
When the 529 plan beneficiary dies or becomes disabled
When the beneficiary receives a tax-free scholarship
When the beneficiary receives educational assistance through a qualifying employer program
When the beneficiary attends a U.S. Military Academy
The qualified education expenses were used to justify another federal education tax benefit, such as the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit
https://www.savingforcollege.com/article/can-i-withdraw-contributions-from-a-529-plan-without-penalty
At what point is it recommended just to take a job that will cause your kid to get cheap tuition? Like if you’re an employee of my alma mater, it’s 50% off tuition. With that, you don’t even have to be there a year nor at the same campus. My friend works for a famous private school and after 10 years they pay for the equivalent of that private school’s tuition at that private school or any other school.
Do the math (a few years out in case of qualifying periods). If drop in pay is less than savings on college, that’s the answer. However make sure it transfers if kid wishes to go elsewhere or is unable to get admitted where you work. Best option: have nonworking or lower paid spouse get the qualifying job.
NB my college just subtracted my dad’s employer contribution (their tuition- would have been free if I went there) from my financial aid, no decrease in cost to us (but had we been too wealthy for financial aid would have saved us some money).
Depends on how much you make at the job and all the other factors that go into choosing one job over another. But it’s certainly worth including in a comparison between jobs. It was a big deal for some of my med school classmates whose spouses worked as nurses in the university hospital.
But I’ve got a neighbor who is a doc at the university hospital whose kids qualify for 50% off tuition. Not one of them has yet gone to that university. 3/3 to another one so far.
You mentioned federal gift taxes …
“ To stay under the federal gift tax exclusion, you’ll want to contribute no more than $18,000 per year [2024] for each spouse.”
This $18,000 threshold presumably refers to the (2024) annual gift tax exclusion.
But why does any amount qualify for the annual exclusion? I thought that only “present interest gifts” (also called “completed gifts”) qualify for the annual exclusion. And, I thought that in order to be considered a present interest gift, the recipient must have an immediate and unrestricted right to use the gift. But, clearly the beneficiary of a 529 does not have control of a 529 contribution at any time, much less an immediate right to control it. Not only can the current beneficiary not use the gift at the time of the contribution, the donor can change the beneficiary (subject to a few restrictions) to someone else altogether.
For gift tax purposes, I think of a 529 like a trust. When a grantor makes a contribution to a trust, the contribution isn’t considered a present interest gift unless the trust provides the beneficiary with the right to immediately take a distribution in the same amount. (A Crummey trust circumvents this requirement; see: https://www.investopedia.com/terms/c/crummey-trust.asp )
Why do 529 contributions qualify for an annual gift tax exclusion?
I agree 529 law is really weird and I don’t think anyone thought it through very clearly. It counts as a gift and yet you could take it and spend it on yourself because you still own it.
I don’t think I have an answer to the “why”, only that they do.
Jim what do you think about this 529 plan where you get “prepaid tuition at today tuition rates” rather than relying on the ups and downs of the stock market? https://www.collegewell.com/private-college-529-plan/
Unfortunately my state Colorado doesn’t give you any tax deduction for that 529 plan.
I think I prefer the simplicity of a regular 529 plan, but you can use a prepaid tuition plan if you think the rate of college cost inflation is likely to be similar to or higher than the returns of your investments in the plan.
I think your information on the Colorado 529 is mistaken though.
https://www.whitecoatinvestor.com/best-529-plans-reviews-ratings-and-rankings/
I believe the entire contribution is deductible.
Colorado’s 529 tax deduction allows individuals, estates, and trusts to deduct the amount of their 529 account contributions from their taxable income. The deduction is capped at $22,700 per taxpayer, per beneficiary for single filers, or $34,000 per tax filing, per beneficiary for joint tax return filers for the 2024 tax year.
https://tax.colorado.gov/sites/tax/files/documents/ITT_529_Contributions_Subtraction_Jan_2024.pdf
Qualifying taxpayers can claim a subtraction on their
Colorado income tax returns for qualifying contributions
made to a qualified state tuition program administered by
CollegeInvest, subject to certain limitations. The account
holder must add to their federal taxable income for the
taxable year of the distribution, any distributions, refunds,
or withdrawals taken for a non-qualifying purpose.
Thanks a ton for the great article on paying for college! Your breakdown of the four pillars and tips on 529 plans were super helpful.
I have a quick question about funding a 529 plan. Given the risk of overfunding, what’s a smart target to aim for? Should we plan for the cost of a state school or a private school? Any advice on finding the right balance would be awesome.
Thanks again for all the helpful info!
First, that risk is not particularly noteworthy for many people. For example, I almost surely now have four overfunded 529 accounts given my childrens’ current educational plans. I don’t care because my plan is to simply change the beneficiaries to their kids.
But I think this post is what you’re looking for:
https://www.whitecoatinvestor.com/how-much-to-save-for-college/
This is good information and I wish I had it before my kids were school age. I do think that pillar one should be tempered based on the child. One of my sons was very determined to get into a top tier school in California and did well in school. He did not have a particular vocational goal at the time but felt it would suit him better whatever he decided upon. (He came to this conclusion without any significant input from me). He managed to get in on early admission and we sent him there. We were prepared for the expense (but not happy about it!).
Bottom line, my gut feeling is, it would have been wrong to tell this kid to scale back his choices based on the cost.
Maybe we were just spoiling him. But If I had to do it again, I probably would not change. Although the latest cost per year ($92k) might give me some serious pause!!
By the way the state schools at the time were moderately cheaper overall ($33 k total vs 47k) with room and board.
I’m not sure what you’re arguing. Are you arguing that a kid should be sent to a school that the family can’t afford if they really want to go there? Seems like a weak argument.
In your case, it sounds like you COULD afford to send your child to this school, so I think it’s fine to send him there, even if there were less expensive options. If you couldn’t afford to send your kid there, then I would aruge that it would not have been wrong to tell the child to scale it back.
I agree with your last line. But in reading #1, it seems to be saying that cost of choices should be considered regardless of being able to afford them.
I re-read the whole line and I see your point.
Having just watched our 2nd/last child walk through their graduation at a private college in the Northeast (i.e. expensive), I do believe that having the student take out some loans is a reasonable option, and loans should not always be avoided. In our daughter’s case, it was a college that had a unique program that matched her interests, and she was always happy at school. She truly found her people. And given that she graduated high school May, 2020, and Covid dominated her college experience for two years, that was priceless.
My wife and I saved a lot, including a good amount for college, albeit not enough for the full 4 year ride, even after shifting unused 529 funds from our first child’s account (they went to a state school and didn’t fully deplete that account). My wife and I both came from upper middle class homes. Our private college and graduate school educations were supported by our parents/grandparents, but we also took out reasonable GSLs, as our investment in ourselves. That was our model, and it seemed appropriate to continue that. This is not a universal background; state/public college and avoiding loans might be the right option for some. I respect that WCI advocates against debt, including student debt, but some student loans, at a reasonable amount, might be appropriate, particularly if it allows the student to become involved in clubs, sports, activities that have value and meaning to them, in lieu of working during school or the summer.
So how does it help your child to start life out in debt exactly? So they don’t have to get a job during the summer and go to a really expensive school with “her people”? Seems a weak argument to me but it’s your/her money and your/her life so you get to make your own choices and deal with the consequences. I don’t think it is smart to borrow for an undergraduate education when it is so easy to avoid.
When I learned that President Biden instituted a loan forgiveness program despite the SCOTUS’ ruling, I cried. Why? Because my Dad, a GP, paid for 84 years of education for his five kids including a MD degree, a JD degree, and two MBA’s, all from top private universities and the Ivy League. Dad believed that a fine education was the greatest gift he could give his kids. We worked during summer vacation. There were no fancy cars or vacations. College savings programs did not exist at that time. At one point, three of us were in undergrad and grad school at the same time. In honor of his values, we opened UGM accounts for our two kids during the month they were born and contributed monthly. Luckily, we had no medical school loans to pay back, because forty years ago, tuition was $2,500 per semester.
Did you cry out of joy or because you’ve seen some people sacrifice for what others got for free?