Saving for college. It’s something that those of us with kids worry about – how are we going to afford to pay for little Jane or Johnny to go to school? The financial press will often tell parents not to worry about this. Jane or Johnny can get loans, so if you don’t save, you’ll be fine! Just focus on your own retirement.
Well it doesn’t always work that way. If you have a high income, the government expects that you’re going to save for college. Little Jane or Johnny may get some loans, but with a high income your Expected Family Contribution (or EFC) is going to be high. When it’s high and you don’t have savings to cover the gap, you need to take out private loans, which require a cosigner. And when you co-sign a loan, guess who’s responsible if Jane or Johnny doesn’t pay? You.
As an example of a high income person who’s bought into this thought process, let me tell you a story about a conversation I had with a friend I’ll call “Susan” a few months back. We were talking over lunch about various topics. Susan told me about their 40k+ brand new car, and a few minutes later, was talking about how she wanted to protect their money from being spent on college. “We got an inheritance, and we’re going to have the mortgage paid off soon. I’m looking for ways to keep that money safe!” She obviously thought that they could find an investment that would keep their money safe and sound from colleges, so they could enjoy it instead.
I looked at her. First, I contemplated how someone couldn’t understand the conflict between “I just spent 40k on a new car” and “I don’t want to pay for college.” If college is an important goal, wouldn’t you have set that money aside instead? Second, this friend and her husband make somewhere approaching 200k a year. From what she just said, they would have an inheritance and a paid for house. The kids are still young, so there’s plenty of time to to save and let the magic of compound interest push the savings total up through time. And instead of celebrating that she has enough to pay for almost wherever her kids wanted to go, she was instead looking for ways to keep the college from getting their hands on their money.
“Um,” I said, “most aid offers are based on your income. Only about five percent of your savings are expected to go to college each year, and most schools don’t count retirement investments or your house.” I left out the explanation of the CSS profile and exceptions to this general rule, because I figured we were in very basic territory. “With a high income the only aid you’ll likely get is offers for loans.”
Her face fell. It seemed she was hoping to hear about a magic plan somewhere in which people who make 200k a year don’t need to pay anything for higher education. Some amazing investment where you can hide their money away and the colleges will fall over themselves to throw money at you while you continue to enjoy your money on vacations, home improvements, new cars, and whatever else. I guess the college is supposed to simply say “Oh, you make 200k but you didn’t save? You poor thing. Life is so hard for you. Here, have some grants and need-based scholarships. The child of the single mom making $40k a year doesn’t really need help anyway.”
This is exactly why goal setting and starting to save is important. If a home improvement, a new SUV, a second home, or a boat is important to you and your family – great! I don’t judge where you want to spend your money. All I ask is that you be honest with yourself. If those things are important, and college isn’t, then let your kids know that. And don’t be surprised when the college fails to make up for your prioritization.
How College Aid is Calculated – High Earners Pay Attention
A bit about how college aid is calculated – the Expected Family Contribution, or EFC, is based primarily on your income. Now you might be thinking of hiding some income by contributing to retirement accounts – sorry, it doesn’t work that way. The government essentially assumes you’ve done a good job saving so far and you can cut back on, or eliminate, retirement contributions while your kids are in college. Then they take 5% of your non-retirement, non-mortgage assets and assume you’ll use that for college every year. The bad part about that if you have multiple kids (I have 3) is that the 5% a year will really add up over time.For assets in your kids names like a UTMA or UGMA account, it’s assumed 20% of those would go to the college. After all, according to the government, the kids biggest priority should be paying for school. Over four years this takes about 80% of their savings. But your income counts much, much more in the calculation – up to 47%! If you’re curious about your own EFC go ahead and check out this calculator.
Does this mean there’s no legitimate way to keep assets from being used for college? Well, there are a few that will take them out of the FAFSA calculation. For example, using savings to bump up your retirement contributions or withdrawing from after-tax investments to help pay down your mortgage will move the assets into the “non-calculated” category. The same is true if you use after-tax money to pay off debt like credit cards or a car, or to make a big purchase. But if you go down that path, then you don’t have the money anymore to use for college – that’s why isn’t not counted. Unless you’re planning to re-mortgage your house (no!) or sell your car/boat/stuff to pay for college (you’ll be better off not buying it in the first place) or withdraw from retirement to pay for college (please don’t- a traditional account, might incur a penalty and will be taxed, plus both a traditional and a ROTH kinds of withdrawals get counted as income the next year).
What about your income? Well you can always retire early, legitimately dropping your income down. I did suggest this to my friend, since she’s talked before about retiring and trying to open her own business. As I mentioned her kids are young and she could plan to do this in 10 years or so when they head off to college. She asked how low her income would need to be to get substantial aid, and I said I wasn’t sure but likely less than $50k. For some reason she didn’t seem interested in that idea.
But if you’ve always wanted to start your own business, or you’re nearing retirement age, it can be an idea to look at. Now the trick is that a lower income really means that – you’re earning less and need to live off less, or live off savings. I think this would be a fantastic option for my friend. She could step out of the rat race with a paid off house and some investments, open a small business to earn income to live and use savings to pay for college. Sounds like a dream to me, and one very close to my own thoughts about my longer-term plan.
You see I have three kids – ages 13, 9, and 1. The oldest two will be done with college when I’m in my 40’s, while my later in life little guy will be going when I’m in my 50’s. With only 12 years left on the mortgage I’m aggressively paying down, I expect to be debt free-hopefully before the kids go off to college . My own college payment plan involves paying off the mortgage before my oldest goes to college so I will have additional cash flow to make the payments in addition to saving more for the younger kids. By the time my youngest hits college I hope to be retired from the 9-5 and instead doing consulting, working online, or something else where I have more flexibility.
The moral of this story? If you make $200k a year, the college financial aid train is not stopping at your station. You’ll need to make sure you have something set aside for college unless you like the idea of co-signing all those loans you’ll get offered from the nice private student loan companies.
Do you know any high income earners who are in denial about college? What are you planning to do to fund your kids college? Let me know in the comments.