When developing a strategy to pay for college it is of the utmost importance that you understand the timeline of events for Financial Aid. Knowing when to apply, where to apply, and how to apply will make all the difference in the amount of aid that your student can be awarded.
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Determine the cost of college
The first step is to determine how much college will actually cost you in today’s dollars. You will need to take into consideration inflation and the cost of attendance on an annual basis. The national average to complete college is 5.9 years and each year the cost of attendance increases. This is one of most overlooked factors by parents and financial advisors when developing a strategy for college. There are many resources available to you and your children that can be used to help your child graduate in 4 years, one of which is the Discover Program. 90% of all students who use the Discover Program graduate in 4 years!
EFC is your Expected Family Contribution. This number is determined by several factors, including but not limited to, your income, your assets, the number of children in your household, the number of children currently enrolled in college, the age of the parents, and based on the methodology used, the equity in your home. EFC is calculated to determine the amount of Aid that you may be eligible to receive.
The basic formula to calculate financial need is: Cost of Attendance (COA)-EFC= Financial Need
General Funding Techniques
There are five common funding techniques used for college. Qualified State Tuition Programs (Section 529 Plans), Coverdell Education Savings Accounts, Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA), Cash Value Life Insurance, and U.S. Savings Bonds.
Section 529 Plans- are authorized under Internal Revenue Code Section 529 and are sponsored by the individual states. These programs allow parents, grandparents and non-relatives to contribute money to an account of which the child is the beneficiary. There are two types of plans; a prepaid tuition plan and a savings plan. Prepaid tuition plans guarantee that the investment will at least keep pace with increases in college tuition. Restrictions may apply regarding who may contribute to the prepaid plan and which schools are eligible. Savings plans are managed investment funds that can be more flexible. Income inside these plans is not currently taxable. Funds withdrawn to pay for qualified education expenses are also free from Federal income tax. Other, non-qualified withdrawals are subject to ordinary income tax and may be subject to an additional 10% penalty tax.
The child may attend almost any accredited college, university, or trade school regardless of location. These plans, having no income restrictions, are available to almost anyone. Unlike UGMAs and UTMAs (discussed below), the donor retains control over the funds. Tax-free rollovers from one plan to another are allowed for the benefit of the same beneficiary once per year. Because contributions are considered completed gifts, the plans may offer estate planning advantages. Some plans offer preferential state tax treatment.
Funds may be transferred, if necessary, to certain family members of the beneficiary without penalty. Taxable withdrawals may avoid the additional 10% penalty tax if they occur on account of death, disability or receipt of a scholarship. – Source College Board 2011
Coverdell Education Savings Accounts – Taxpayers may deposit up to $2,000 per year into a Coverdell Education Savings Account (ESA) for a child under age 18. Parents, grandparents, other family members, friends, and children themselves may contribute to the Coverdell ESA, provided that the total contributions during the Taxable year do not exceed the $2,000 limit. Amounts deposited into the account grow tax-free until distributed, and the child will not owe tax on any withdrawal from the account if the child’s qualified higher education expenses at an eligible educational institution for the year equal or exceed the amount of withdrawal. Eligible expenses also include elementary and secondary school (K-12) costs and the cost of computer equipment, internet services, and software. If the child does not need the money for post-secondary education, the account balance can be rolled over to the Coverdell ESA of certain family members who can use it for their education expenses. Amounts withdrawn from a Coverdell ESA that exceed the child’s qualified education expenses in a taxable year are generally subject to income tax and to an additional tax of 10%.- Source College Board 2011
Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) – A donor may make an outright gift to a custodial account for the benefit of a minor child. The parent or custodian may retain responsibility of management of the assets in the account subject to the terms of the act. The standard rules regarding gift tax exclusions apply, including the annual $13,000 limit. The donor may choose to contribute from a number of assets, such as stocks, bonds, mutual funds or real estate. The funds may be used for any purpose, including education. One possible problem with the UGMA and UTMA is that upon reaching a certain age, specified by each state’s laws, the child has full discretionary control over the accumulated assets and may choose to use such assets for purposes other than college funding. – Source College Board 2011
Cash Value Life Insurance – Parents, grandparents, or other family members may gift premiums, and the cash value build-up inside the policy is tax deferred during the accumulation period. When the time for college arrives, the needed cash may be withdrawn from the policy (generally on a tax-free basis up to the amount of the premiums paid), or the cash values can be borrowed from the policy. In most cases, loans or withdrawals will reduce the policy’s cash value and death benefit. If the policy is surrendered or lapses, taxes may be due. If the insured dies before the child goes to school, then the life insurance proceeds can be used to fund education expenses. – Source College Board 2011
U.S. Savings Bonds Interest earned by U.S. Series EE Savings Bonds is free from state income taxes. All or some of the interest may also be free from federal income taxes if the bonds are used for qualified higher education expenses. The exclusion from federal tax is subject to an income phase-out. The bonds must be registered in the parent’s name and redeemed in the same year as the eligible tuition and fees are paid. – Source College Board 2011
The next step in the process is to create your payment strategy. Using all the funding techniques described above, as well as the various types of financial aid that are potentially available, you can create a model that will show you if you have sufficient funds to pay for college or whether there is a shortfall.
After the aid is awarded it is time to review the individual aid packages from all the schools your student has applied to and determine whether or not aid has been under-awarded or mis-awarded. Using a side-by-side College Comparison (hyper link), you can view the actual out of pocket costs for each school and make a well informed decision.
Applying for Aid
After developing your strategy it is now time to apply for Aid. The FAFSA form is your key to Federal Financial Aid. FAFSA forms must be completed and may be submitted any time after January 1st of the student’s senior year of high school. At this point you may also apply for any grants or loans that the student may qualify for, as well as the CSS profile which may be required by certain universities.