One of my jobs as a bankruptcy attorney is to counsel people on how to handle student loans. The first line of defense is to borrow as little as possible. Plan ahead, and you can get more financial aid for your child, and less student loan debt.
For many years, the conventional wisdom for saving for college has been: Open a 529 plan for your child, and let the money grow tax free. You get a deduction if you use your state’s plan, of your state income tax. Besides, it is good to save, early and often, for your child’s college. With costs rising astronomically in the past 10 years, with no end in sight, savings alone doesn’t usually give families enough money to pay for the full amount of college. Most college students end up leaving a 4- year college with debt, in the form of student loans. The average college student ends up graduating with $35,000.00 in student loans, according to the Wall Street Journal.
That figure doesn’t take into account the fact that more and more, parents are taking on loans for whatever the student cannot borrow. Your child, who is your dependent, can only take $5,500.00 per year in Federal Loans. See the rules here. With in-state tuition, plus room and board, in Illinois running $23,000.00 to 30,000.00 per year, that won’t come close to paying for undergraduate college. How do people make up the difference? You can borrow the rest, through private loans, whose interest rates are much higher than the Federal Loans, and through parent-plus loans. And, the private loans have very few options for repayment, unlike the Federal Loans. These loans have been putting a huge burden on parents.
How can you prevent huge student debt? Through careful planning, before your child ever applies to college. For years, the student would apply to colleges during their senior year in High School, and, only after the application process is nearly complete, in January, and February, the student and their family submit a FASFA (Free Application for Student Financial Aid). The FASFA is the ACT of financial aid. Your family’s score on the FASFA will determine how much financial aid you’ll get.
In 2016, the FASFA will be due in October of the Student’s senior year, much closer to the time of application. Why does this matter? Because, every school determines the student’s financial need based on this form. Then, once you submit the form to the schools, your Expected Family Contribution (EFC) is determined. Then, and only then, can you figure out how much aid you might get from the Federal government, or from the school itself. If you have a low EFC, then grants and subsidized loans should help with the rest of the cost.
How is the mysterious EFC determined? It is a mix of formulas and allowances based on your most recent tax return, your family size, how many children you have in college at once, and how old you and your spouse are. But, it is not solely based on your income. And, don’t say to yourself, it doesn’t pay to do anything, because we won’t get aid. If you plan right, you can get help, and with fewer loans.
Some things that you should know are: Your family will be allowed to have some money available, but after that allowance, a percentage is expected to be used for college. Those 529 college savings accounts count toward that allowance. The amount you have which is above that allowance counts as a percentage to be contributed. Generally, the value of your house, and small family business doesn’t hurt you, and credit card debt or other debts don’t help.
If the money is in your child’s name, it reduces your aid more. All money saved in your child’s name, or in Custodial accounts, is expected to be contributed towards college (20% per year). So if you decided to set up a custodial account for the child, that money will cut into the amount of aid your child will get.
Why are these things so important? Because, with proper planning, you can maximize your student aid. By student aid, I’m talking about grants and other governmental help, not loans. This planning should take place years before your child applies to college. Talk to an accountant or financial planner about your best options. And, each year, the rules change!
This planning can help you avoid crushing debt in the future. Some resources to look at: Paying for College Without Going Broke.
In the Chicago area, I recommend that you consult with CPA Gerald Knight, who speaks throughout the year. (), and, along with tax preparation, helps families with FASFA preparation.
Financial planning for college starts well before your child applies to school. This can help you for those expensive years down the road. Call us if you have questions.
Daniel J. Winter
Offices in Chicago, Gurnee, Oak Lawn, and Skokie, Illinois