Age-based Investing

Navigating the landscape of increased college costs

Although college tuition has soared in recent years and much ado has been made about whether a higher education is worth the price tag, many American parents remain driven to send their kids to college.

The trouble is, families are generally flummoxed about how much they should save for college, how best to go about that and how to navigate the complex world of financial aid. Many of those who are squirreling away money for college are flying blind, setting arbitrary and often lofty goals based largely on their own perceptions of the costs of higher education.

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To be sure, college isn't cheap, but experts say many parents overestimate the costs. Most students attend public colleges and universities, rather than the elite schools whose $50,000-per-year price tags make headlines, said Sandy Baum, a senior fellow at the Urban Institute and a research professor of education policy at the George Washington University.

The average tuition and fees—excluding room and board, and books and supplies—at public, four-year colleges is $8,893 for in-state students and $22,203 for out-of-state students during the 2013-2014 academic year, according to the College Board, a nonprofit association of more than 6,000 educational institutions. The average tuition and fees for public, two-year colleges is $3,264. For private, four-year colleges, it is $30,094.

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"It is not that college is cheap, but it is not as expensive as most people think," said Baum, adding that college-bound students shouldn't rule out schools they might want to attend simply because of high sticker prices.

"Frequently, those schools with the highest prices have the most generous financial aid packages and could end up being cheaper" than institutions with lower sticker prices, she said.

Financial aid for all

In fact, most families don't pay sticker price, said Myra Smith, the College Board's executive director of financial aid services. While tuition rates have risen faster than the cost of living in recent years, many students receive some type of need- and/or merit-based financial aid. Financial aid comes in the form of grants, student loans and work-study programs.

"The numbers tell the story that a significant portion of the population today gets financial aid of one sort or another," said John Heywood, a principal at the Vanguard Group and head of the mutual fund giant's Education Savings Group.

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When deciding how much aid to award, colleges and universities place a major emphasis on the so-called "Expected Family Contribution (EFC)" toward educational expenses, relative to the cost of attendance for a particular year.

The EFC is based on a variety of factors, including parental income, family size and assets, and is generally calculated using a federal government formula and/or one developed by the College Board. One of the key differences between the federal and College Board formulas is that the latter takes home equity into account in assessing a family's ability to contribute to educational expenses.

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Some experts suggest that parents of college-bound kids calculate their EFC for sample schools early on and set savings goals accordingly, as opposed to the common practice of using the inflation-adjusted cost of tuition over time as a benchmark.

"In most cases, the former is 50 to 75 percent less," said Todd Fothergill, founder and managing director of higher education consultancy Strategies for College.

Parents can determine their expected contribution for sample schools using any number of online, net price calculators, including one found on the College Board's website.

Colleges generally award the most generous aid packages to the students they most want to attract. So it behooves college-bound students to apply to a number of schools, including several where they fall into the top quartile of the applicant pool, experts say.

"The biggest assumption that most parents and students make is that the financial-aid process is cookie-cutter, but colleges make interpretations based on where the student falls in the applicant pool," Fothergill said. "The desirability of the student will impact the amount of money they end up paying."

Structuring savings

Another critical component of planning for college is determining how to structure college savings. Money held in accounts owned by parents, including 529 plans, is generally given less weight by schools when it comes to determining the EFC than assets in accounts owned by children, such as Uniform Gift to Minors Act accounts and student trusts. (A 529 plan is a tax-advantaged savings account set up by a state or college to help a donor set aside funds for the future educational expenses of a beneficiary.)

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What's more, many financial planners advise parents to prioritize retirement over college savings, making the maximum allowable contributions to employer-sponsored 401(k) plans or individual retirement accounts before allocating money to higher education. They note that assets held in retirement accounts or cash-value whole life insurance policies owned by parents won't impact financial aid decisions at many schools because the federal formula for financial aid eligibility aid doesn't take these into account.

No one ever saves enough for retirement. The old adage that you can borrow for college, but not for retirement, is very true.
Catherine Valega
owner of Green Bridge Wealth Management

"No one ever saves enough for retirement," said Catherine Valega, certified financial planner and owner of Green Bridge Wealth Management. "The old adage that you can borrow for college, but not for retirement, is very true."

It is never too soon for parents to begin saving for college or to cultivate an understanding of the admissions and financial-aid worlds, experts say. Michelle McFadden, an architectural historian by training and mother of four, began doing just that when her oldest son was in middle school.

To get a clearer picture of their financial obligation, McFadden and her husband, Chuck Hoffert, who live with their children in East Montpelier, Vt., calculated their EFC and found it somewhat higher than they had anticipated. They also made sure existing college-savings accounts were in their, rather than their kids', names.

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To set their children apart in the eyes of admissions officials, the couple has encouraged them to participate in extracurricular activities that reflect their individual passions, to take the most rigorous academic classes possible and to apply to a geographically diverse group of colleges and universities.

McFadden and her husband are off to a good start in the college game. Their oldest son secured enough financial aid to make it feasible for him to attend Northwestern University, where he is now a sophomore studying engineering. Next year, the couple expects to have two kids in college.

"Knowing well in advance how money needs to be allocated and helping your student do his or her best go a long way toward achieving success," McFadden said.

Misconceptions around costs common

Despite the plethora of information available online about tuition costs and other subjects weighing heavily on the minds of college-bound students and their families, there are still a great many misconceptions swirling around the issues of saving for college and securing financial aid.

One of the most common misconceptions is that putting money into a 529 plan or some other type of college-savings vehicle undermines a student's chances of securing financial aid, Heywood said.

In determining eligibility for financial aid, schools tend to give the same weight to assets in parent-owned 529 plans that they do to assets held in other types of parental accounts, Heywood said. In fact, experts say current income is generally a much bigger factor in determining financial aid awards than parental assets.

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"One thing I wish parents would understand is that the formula used to assess ability to pay for educational expenses is based almost entirely on income," said Myra Smith, executive director of financial aid services at the College Board.

Many parents make the mistake of assuming their children will get academic or athletic scholarships, and thus feel they don't need to save for college, Smith said. Often, scholarships don't cover the full cost of college, and the assumption that children will qualify for scholarships can be a dangerous one.

"While there are a lot of scholarships out there, they very seldom pay the whole bill, plus the student has to be eligible," Smith said. "Whether it is a football or academic scholarship, parents need to know the eligibility criteria."

The financial aid world is very complex. And just because a school calculates your expected family contribution does not mean you can actually afford it.
Catherine Valega
certified financial planner and owner of Green Bridge Wealth Management

When evaluating a financial aid package, students and their parents should pay close attention to how much they are getting in grant money versus loans and whether a financial aid offer changes from year to year, experts say. Students and parents also need to consider whether the level of financial aid in a given package will keep pace with higher tuition prices.

What's more, some advisors caution that one size does not fit all in the college-savings arena. "There are many savings strategies to consider, even before the oft-advised 529 plan," Valega said.

She urges clients to contribute as much as they can to retirement savings accounts before allocating money to educational-savings plans. She noted that many public schools don't consider assets held in parental retirement accounts when calculating how much families are expected to contribute to educational expenses. And under certain circumstances, parents can withdraw funds from retirement accounts to pay for qualified educational expenses without incurring a penalty, although they will likely be liable for income taxes on the distributions, Valega said.

"You want to be savvy about how your savings are structured," she said, adding, "The financial aid world is very complex. And just because a school calculates your expected family contribution does not mean you can actually afford it."