(and 3 Ways Uncle Sam can Help—No Matter How Much You Make)
It’s that time of year—the potential of receiving a college acceptance letter makes checking the mail a little more exciting than usual.
The cost of college has jumped four times as fast as the rate of inflation over the last ten years. The numbers facing students (and their parents) are staggering:
- Average student loan debt: $30,062
- Average length of time it takes to pay off student loans: 18.5 years
- Average monthly student loan payment: $393
- Average interest rate on student loans: 5.8%
I could go on, but you get the picture: College is expensive and can leave graduates suffering under a huge financial burden well into their professional lives.
It’s bad enough that the cost of higher education creates such a burden for students, but families can also suffer. Parents who foot the bill for their children’s education can find themselves unwittingly making tradeoffs with severe consequences for their own retirement.
So how can you help your child get through college without sacrificing your retirement?
Know Your EFC (Expected Family Contribution)
Every college in the country factors in your EFC when determining how much financial aid your student will receive.
Your EFC is calculated using the student and parents’ income data from two years prior and current asset data based on your Free Application for Federal Student Aid or FAFSA.
The impact of your assets and income on your EFC breaks down as follows:
|Parental Assets||Asset Allowance (~$10,000)||5.64%|
|Parental Income||Taxes and Living Allowance (~$30,000)||22% to 47%|
|Student Income||Taxes and Living Allowance (~$6,500)||50%|
If your income is high and you live in a more expensive part of the country like California, you should expect your contribution as parents to be closer to 47%.
Five Ways to Make College More Affordable
There are plenty of ways to make the prospect of paying for higher education easier to stomach, starting with one that may seem too obvious to state, but it’s important to keep in mind:
1. Pick a School That Costs Less
It is critical that you choose a school that’s affordable. That doesn’t necessarily mean your student has to attend the community college down the road, but the difference between the cost of attending a public in-state college and a private one can be exponential.
Collegedata.com is a great place to compare schools when deciding which one makes the most sense to attend.
2. Shop for Schools that Are More Generous with Financial Aid
The most important thing to understand about college costs is that the listed cost is often not the amount you will actually have to pay.
For the 2020-21 academic year, cost of attendance at Stanford was $73,424. The average need-based aid given to freshman was $56,500, leaving students and parents with an average cost of just under $17,000 for the year.
3. Shop for Schools that Offer Merit-Based Aid
Every school has their own merit aid program comprised of scholarship, grants, and other financial assistance that does not need to be repaid. Search collegedata.com to get an idea of how much merit aid a school typically offers.
In addition to a school’s merit aid, make sure you explore every avenue for private scholarships. Numerous organizations offer private scholarships for a variety of reasons, whether it’s where you live, the industry you want to enter, or a combination of factors.
4. Qualify for More Need-Based Aid—Lower Your Income)
If your current salary disqualifies you from receiving need-based financial aid, there’s a chance you may be able to lower your EFC enough to qualify. Remember, the FAFSA evaluates EFC on your income two years before you apply, so this will need to be done during their sophomore year of high school.
Reducing income is not an easy thing to do for salaried employees, but it can be accomplished in several ways, including taking a sabbatical, deferring bonuses, paying more taxes, and getting rid of student assets.
5. If You Must Borrow, Do so Wisely
Sixty-nine percent of college students take out student loans, so if you need to do so, know that you’re not alone.
If you have access to subsidized federal loans, take those first. If you have a higher EFC, your access to subsidized loans will be severely limited as they are based on financial need. Unsubsidized loans are typically the best option for high-EFC families as they offer the lowest interest rates and most lenient payment terms. When considering how much to borrow, a good rule of thumb is to keep it to the average first-year salary in your student’s desired position.
Here are a few examples from the National Association of Colleges and Employers:
|Average Starting Salary by Discipline (2021)|
|Math & Sciences||$63,316|
|Agriculture & Natural Resources||$54,857|
Divide the first year’s salary by four to find how much you can borrow each year. After you do all the research, if the school still costs too much, it’s simply time to find a less expensive school.
If you’re struggling to figure out the best route, consider reaching out to a higher education consultant.
Tax Strategies for Families with High EFCs
The following tax strategies operate on the basic premise that kids will almost always have a lower tax rate than their parents.
1. Let Your Children Realize Capital Gains
Your capital gains taxes could have a tax rate as high as 23.8%. By giving those assets to your child before selling, your dependent would only pay 10% in taxes up to a certain limit.
The first $1,100 of unearned income is not taxed at all, and the next $1,100 is taxed at 10%. Anything after that is taxed at the parent’s tax rate (known as the “kiddie tax”), so limit the unearned income to $2,200.
Keep in mind, when you give assets to your children, it is considered a gift for income tax purposes. Gifts of more than $15,000 per year per person must go on your gift tax return.
Gifts also reduce the amount of lifetime estate tax exemption you have (currently $11 million), so if you think your estate might exceed that value when you die, be careful with gifts greater than $15,000.
2. Make Your Kids Non-Dependents
As you can see, the kiddie tax rate keeps the ceiling on unearned income pretty low. One way to raise the ceiling is to make your student independent for tax purposes. As an independent, their income will be taxed at lower rates—as low as 12% or less on $50,000 of income. All they have to do to achieve independence is pay for more than half of their own support—housing, car, food, etc.
Once your child is no longer a dependent, they are eligible for lower tax rates and tax credits for low-income individuals—most notably the American Opportunity Credit.
3. Business Owners: Hire Your Kids
Our last tax strategy is just for business owners. By hiring your kids and giving them a salary, you can reap multiple benefits:
- The wages reduce your business income and taxes. Your child will have to pay income taxes, but at a much lower tax rate.
- Your child can start contributing to retirement accounts.
- Your business can offer tuition reimbursement programs, turning school costs into a deductible business expense.
- If your child is no longer a dependent, they are eligible for education credits.
For this strategy to work, you’ll have to give your child a W2 and a real job with a reasonable salary. Have them fill out a time card that you keep on record.
College is expensive—there’s no escaping that fact. But by following these three steps, you can help lower the cost to your family—and to your retirement plan.
Do Your Research
Find schools that either fit in your price range, fully meet your need through gifts, or offer high amounts of merit-based aid.
Know Your Cost
Find your EFC and estimate how much the net cost will actually be, then choose a school that won’t force you to borrow excessively.
Save on Taxes
High EFC families can take advantage of tax strategies to generate extra cash to pay for school.
Want to talk about how you can make college more affordable? Send us an email anytime, or use the contact form on our website, and we’ll set up a time to talk.