Tara Unverzagt September 28, 2018 No Comments

Cost of College Can Be More Stressful Than a Final Exam!

College is supposed to be “the best four years of your life,” filled with long hours at the library, meeting lifelong friends, and creating experiences you’ll have for the rest of your life. Simultaneously, it has also become “the most expensive four years of your life,” and, for most people, making decisions about financing your education and the inevitable debt begins at the ripe old age of 18. As a high schooler, you’re faced with one of life’s biggest decisions at a time when you’re still developing. Trying to decide what you want to do for the rest of your life can often seem daunting, but, nonetheless, you must make a decision. Deciding which school to go to and what to major in will have countless impacts on you for years to come.

As a recent graduate of Case Western Reserve University in 2016, I have found there is no worse feeling than having debt lingering over my shoulder, especially at the age of 22. Having learned from my mistakes–and my successes–I hope that this article will help those of you who are preparing yourself or a loved one to go to college. If I could go back and speak to 18-year-old Stuart, I would share some thoughts that I’ll cover in a series of articles starting with this one.

The Different Types of Student Loans

Student loans come in many different shapes and sizes. Before choosing any of them, you need to understand the differences among all of the options that you could be presented. They break down into two categories: federal and private.

Federal loans are offered through the U.S. Department of Education as either Direct Subsidized, Direct Unsubsidized, and Parent PLUS. Subsidized loans come with slightly more favorable terms but are strictly provided to students who meet the requirements of being in “financial need.” The main benefit to Subsidized loans is that they are offered at a low-cost and fixed rate, with the interest being paid by the government while you are in school, hence the term “subsidized”.

Unsubsidized loans are available to everyone and also come low-cost and at a fixed rate.  The key difference, however, is that the government does not pay for the interest that accrues on the loans while you are in school, which means you are on the hook for a larger bill.

Parent PLUS loans are available to parents who are paying for their dependent children’s college costs. Because they come with higher interest rates, students and parents need to utilize subsidized and unsubsidized loans before considering taking out a Parent PLUS loan.

On the other hand, private loans are taken out from banks, certain states, the college or university, and other non-bank financial institutions. The rates and repayment terms vary by institution, personal credit scores, income level, debt-to-income ratio, etc., very similar to any other loan you would take out from a private institution. Due to the lower costs and repayment terms of Federal loans, a general rule of thumb is to explore those first and then pursue Private loans after you have shopped them, to ensure that you get the best possible rates and terms.

Best Practices for Loans

Understanding different types of loans is important but equally as important is knowing how to utilize them. Obviously, there are many different factors that will be in play, such as money or investments that can be used, eligibility for financial aid or scholarships/grants, and ability to work while in school, so each individual’s situation will be different. Your best option is to sit down with an expert and make your decision based on your personal situation, but I will lay out a general blueprint that you can follow when you are considering loans.

If you qualify for Subsidized loans, it is of utmost importance to make sure you utilize these first, followed by Unsubsidized loans. Following those, you can consider private loans up to the amount that is needed to cover the total costs of attendance.

Note that if you don’t use a Direct Loan one year, you are not allowed to go back and reclaim it for the current year–they are very much “use it or lose it”. A common mistake people make is failing to budget their resources for all four years and running out of resources the final years and, consequently, being cornered into taking more expensive loans.

If, for example, you have $20,000 saved and allocated for costs of attending, you’re better off allocating $5,000 per year to tuition from a 529 account in order to maximize the number of Direct Loans that you are eligible for. Below is a chart that shows how much in Direct Loans you are eligible to receive per year for an undergraduate student who is still a dependent of his or her parents.

 

$5,500 total, no more than $3,500 Subsidized $6,500 total, no more than $4,500 Subsidized $7,500 total, no more than $5,500 Subsidized $7,500 total, no more than $5,500 Subsidized
Year 1 Year 2 Year 3 Year 4

Considerations When Picking a College

There is absolutely nothing simple about college planning, and, unfortunately, understanding the types of loans is only one piece of the puzzle. Deciding which college to attend goes beyond just a school ranking, location, major, etc. For best college planning, you must analyze all of your and/or your child’s financial and academic information to determine eligibility for need-based and merit-based financial aid, which can then be referenced against a list of schools to maximize scholarships. In addition, it’s important to understand the differences among schools and how they award financial aid.

The sooner you start planning for the cost of college the better. For parents, spending time planning when your children are young, picking the right school when they are in high school, and planning how you will fund each year can reduce the amount you may need to borrow and the types of loans you have access to.

Tara Unverzagt February 19, 2016 No Comments

What’s up with 529 plans?

Let’s explore college planning for your children or grandchildren. There are so many great questions about the “best way” to get ready financially for college, but the answers are very complicated. There’s no way to cover this vast topic in one shot, so let’s look at one college saving method: the 529 plan.

If you haven’t heard of 529 plans, they are college saving accounts that are run by states. You can invest in the state where you are a resident or most any other state’s plan. Most people only look at their state, but if you are considering a 529 plan, it’s a good idea to look at what plan fits your needs best. That may be your state’s plan or another state’s plan.

I’ll use Illinois and California as examples of the differences between states. California has one 529 plan which is a savings plan. Illinois has four different plans which include saving plans and pre-paid tuition plans. I’ll just be addressing the Illinois Bright Start program here which is a savings plan similar to the California 529 plan.

What are the advantages of saving for college in a 529 plan?

  • On the state level, there are often tax advantages on contributions.
  1. California does not have a tax advantage for California residents.
  2. Illinois has a deduction of up to $20,000 of Illinois income for a married couple. Illinois businesses can also get a tax break for matching contributions. And there’s a tax break for rolling over another state’s program into Illinois.
  • On the federal level, 529 accounts are somewhat like a Roth IRAs. Contributions are after-tax dollars while the account’s earnings and growth are tax free.
  • The accounts are professionally managed. If you don’t have an investment advisor or you aren’t comfortable managing your own investments, 529 plans can help you with investment decisions.

Are there disadvantages to investing in a 529 account verses other investment accounts?

  • At the state level, some of the advantages mentioned above can come back to haunt you.
  1.  If you rollover your Illinois account to another state, it will be included in your Illinois income.
  2. Since California doesn’t allow deduction on contributions, there is no recapture if you move the funds to another state.
  • Most 529 plans have low fees, but each plan is unique. Illinois has the same plan via advisors and direct with the state. The Advisor version can have almost 1% higher fees than the direct plan. If your account has $100,000, that’s almost $1,000 per year going to fees!
  • Most plans are with a particular investment company (for example, TIAA-CREF or Fidelity) and you will be limited to the investment options they allow. This doesn’t always represent the best choices for you.
  • On the federal and state level, if you don’t take the funds out to pay for qualified expenses, you may pay taxes on the earning and a penalty. I’ll discuss this further later.

What if my child doesn’t go to college or goes to a cheaper college than we expected?

  • Non-qualified distributions (distributions not used for tuition or fees) will be taxable and have a 10% penalty on the earnings if withdrawn.
  • You can use the funds if your child wants to go to graduate school or take vocational/advance skills classes.
  • You can change the beneficiary and use it for someone else’s educational expenses. Haven’t you always wanted to go to culinary school?
  • You can save it for the next generation’s education.
  • There are exceptions that can eliminate the penalty (but you will still pay taxes on the earnings), including: the beneficiary dies or becomes disabled, goes to a US Military Academy, or receives a scholarship.

How does a 529 account affect federal financial aid?

  • A 529 account is counted as an asset of the parent. Federal financial aid considers 5.64% of parents’ assets and 30% of their income “available” to pay for college and 20% of a student’s assets and all their income over $6,260.
  • A grandparent can also start their own 529 account for a grandchild. That account is not included in financial aid reporting.
  • The catch with a grandparent’s account is that the distribution is included in the child’s income the following year.
  • If a grandparent plans to have a 529 account with one year of tuition and fees, your grandchild could save it for their senior year. The funds would never be counted as assets or income for financial aid.

What are the advantages of using a retirement account to pay for college instead of a 529 account?

  • A Roth IRA or Roth 401(k) makes a good college saving tool. You don’t pay taxes or penalty on Roth distributions for principal that has been in the plan at least 5 years.
  • Retirement accounts aren’t counted toward assets for financial aid.
  • If you distributed the taxable earnings from a Roth IRA or Roth 401(k) or from a traditional IRA or 401(k), the funds distributed won’t be penalized (they will be taxed though)

What are the disadvantages of using a retirement account to pay for college instead of a 529 account?

  • The limit for a Roth IRA or Roth 401(k) contribution is $5,500 ($6,500 if you’re over 50) in 2016 and phased out for higher incomes.
  • Each 529 plan has its own limits, but many will let you contribute $300,000 or more at one time.
  • Grandparents should remember you will have to pay gift tax for contributions over $14,000 ($28,000 for married couples) to each beneficiary or up to $70,000 each using a special 5 year exemption, but requires a Form 709, Estate & Gift Tax form, to be filed for each grandparent.
  • Distributions will count as income towards financial aid the next year.

Whether you should use a 529, a Roth IRA/401(k) or other saving plan depends on your needs and expectations. You also need to think about everyone’s tax situation, likelihood of wanting financial aid or need based scholarships, and flexibility. There’s not one right answer for everyone.