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The Case Against Saving for College
Fighting the Financial Aid Formulas
Although the case for saving for college is a strong, well-documented one, some people believe the concept is overrated. This month we’ll present this argument.
Those who advocate saving point out that college costs continue to increase faster than inflation as the population of college-aged students grows. So you need to start saving when your children are young and continue saving until they enter college. A number of tax-advantaged savings vehicles are specifically designed for this purpose.
Not everybody agrees with this perspective, especially regarding the tax-advantaged plans. One of the biggest reasons is that these types of accounts often count against students in financial aid calculations, especially at elite private colleges.
Second, when you direct dollars into a college savings account, you’re passing up on investing for retirement, which for most baby boomers is a far more urgent goal. Third, you’re giving up flexibility you’d have by saving in a less restrictive type of account that would allow you to adapt more easily to changing circumstances.
“So many things can happen with kids that I typically don’t recommend Section 529 plans,” says Wayne Starr, a Certified Financial Planner with BKD Wealth Advisors in Kansas City, Mo. When children are young, “you don’t know if something like autism might show up or if a child will turn out to be a prodigy or has the potential to win academic or athletic scholarships,” he says. “What we do is talk to our clients about their financial goals, and if they have an educational goal for their child, we figure out what that is before we start making a decision on how that will be accomplished.”
What’s at Stake
Although college is expensive, graduates outearn peers who don’t have a college education by an estimated $1 million over a lifetime. College graduates tend to get better benefits from their employers, including health insurance and retirement plans. With the economy in flux and foreign competition leaching away manufacturing jobs that were formerly a viable alternative for those not going to college, a degree is more important than ever.
The average cost for tuition, room and board at a four-year public university was $12,786 for the 2006-2007 school year, a 5.6-percent increase from the year before, according to the College Board, a nonprofit education information and testing company. For a four-year private college, these costs totaled $30,367, a 5.7-percent increase over the previous year.
Assuming annual increases of 6 percent, the table below shows what costs — including tuition, room and board — will look like for various age groups for four years. You can calculate your own future estimated costs for
a child of any age or for a specific college by using the college calculator at the College Board’s website.
Age of Cost of In-State Cost of
Child Today Public University Private College
13 $ 75,174 $162,027
8 $ 100,600 $216,829
3 $ 134,625 $247,998
With the baby boom echo — children of baby boomers — headed to college during the next 10 years, college attendance is expected to spike. This means competition will increase for admission to all schools as well as for the pool of available financial aid.
The number of students attending college in 2004, the last year for which data was available, was 17.3 million, up from 14.3 million in 1995. Based on enrollment trends, attendance will increase to 19.9 million students by 2015, an increase of 15 percent in 11 years, according to estimates by the federal Department of Education.
The Reasons Against
Despite the rising costs and increasing competition, some argue against setting aside funds for college because it diverts funding from other financial goals. “There is no such thing as a retirement loan,” says Sally Herigstad, CPA, author of Help! I Can’t Pay My Bills (St. Martin’s Press, 2006). “You must balance the needs of the whole family. Adequate insurance, your retirement plan and buying a house are a few things that may take precedence over college savings.”
Tracy Spaeth, CFP, of Uncommon Wealth Management in Lubbock, Texas, agrees: “Retirement planning should take priority over saving for college. Most people have a hard time prioritizing both. Also, there are ways for a family to maximize their cash flow from investments that can help pay for college without putting assets in the child’s name.”
Because college is so expensive, few except the very wealthy are able to save enough to pay for their children’s schooling outright, notes Paul Wrubel, Ph.D., of TuitionCoach, a business specializing in college funding. “Few parents in the middle- and low-income brackets will save enough early on so that the savings can grow to make a big difference in paying for college,” he says. “Also, many college savings accounts lock you into rigid investment options, leaving your savings at the mercy of a mutual fund manager.”
If you must put money away in an account designed to promote saving for college, be careful how you do it. In most cases, colleges assess money held in the child’s name at a higher rate than assets held in a parent’s name. This means some types of custodial accounts will hurt a student more in the financial aid process than others.
“Uniform Gift to Minors Accounts — UGMAs — were the vehicle of choice for parents and grandparents wanting to save for a child’s college education 10 years ago,” says Bruce Harrington of Cogent Research in Boston. “So now there are a lot of people with teen-agers who have these accounts, and they are a negative in the financial aid process.”
Federal financial aid formulas — spe-cifically those in the Free Application for Federal Student Aid program — count UGMAs more heavily than other custodial accounts such as Section 529s. But aid formulas at private colleges may count both against the student. Prepaid college savings accounts that are available in about 14 states are also counted heavily against the student in financial aid calculations.
In the financial aid process, the federal government and colleges use various formulas to arrive at an ex-pected family contribution — known as the EFC — to a child’s college education. Various financial aid formulas account for family assets such as savings accounts, home equity and in-vestments in different ways to reach the EFC. A college’s particular aid package generally combines scholarships, grants, loans and work-study money. Studies show that most finan-cial aid packages are made up of loans rather than scholarships and grants that don’t have to be repaid.
For parents and grandparents who want to save something but who don’t have a lot of money to put aside, Coverdell Education Savings Accounts are an option. Capped at $2,000 per year, Coverdells can also be used for private school tuition and expenses for children in grades kindergarten through 12.
Coverdells, which can be set up at most brokerages and mutual fund companies, offer unparalleled invest-ment flexibility compared with other college savings vehicles. Since Cover-dells are likely to have lower balances than other types of college savings accounts, their impact on financial aid awards will probably be limited.
If you still want to save for college but don’t want to tie up your money in an account specifically earmarked for college, here are some alternatives:
Roth IRA: If your child has earned income, setting up a Roth IRA in the child’s name is one way to give your son or daughter a leg up on retirement savings while potentially earmarking some money for college. Most colleges don’t count retirement accounts in their financial aid calculations. And because you contribute to a Roth with after-tax rather than before-tax dollars, you aren’t penalized for using funds from a Roth to fund educational expenses.
Taxable Account in the Parent’s Name: Buying shares in a mutual fund account in your and your spouse’s name is a way to retain control and flexibility over your money. You can also set up a brokerage account and buy stocks and bonds.
College Savings in the Parent’s Name: If there’s a chance you or your spouse might go back to school in the future, set up a college savings account in your names. If you don’t end up going back to school, you can transfer that money to your children or grandchildren.
Stuart Siegel, president of College Tui-tion Solutions in Erie, Pa., recommends any approach that doesn’t place assets in a child’s name because of the potential to complicate the financial aid process down the road. “Section 529 savings accounts are an idealistic program that really end up benefiting the rich, especially those who want to avoid paying taxes,” he says. “And because the rules change all the time, there are so many trap doors for parents, so it’s best to put any money you have elsewhere and leave the kids out of it.”
If you want to earmark some savings for college but aren’t sure which course to follow, you might want to consult with a comprehensive CFP who is knowledgeable about college savings issues or who works with an expert in this area. The National Institute of Certified College Planners offers a certificate for financial planners; to find out whether there’s a certified adviser in your area, conduct a search at the institute’s website.