Saving for college is undoubtedly important, but there are right and wrong ways to do it. Be wary of these six common and costly mistakes that families make:
- Saving for college in your child’s name
- Paying for college with the help of a grandparent or non-custodial parent
- Using retirement funds to pay for college
- Not using the financial aid appeals process
- Not applying to enough colleges
- Not starting early enough
1. Saving for college in your child’s name
The form that you fill out in order to apply for financial aid — the Free Application for Federal Student Aid (FAFSA) — assesses the income and assets of both parents and students in order to determine the student’s need-based financial aid eligibility. Since savings accounts are assets, the money you save will somewhat decrease your child’s financial aid eligibility.
But that doesn’t mean you shouldn’t save — it just means you should save smartly. The FAFSA assesses parent and student assets differently, and it weights student assets more heavily: Student assets are assessed at 20% or 25%, depending on the college, meaning every $1,000 saved in their name reduces their financial aid eligibility by $200-$250. Parent assets, on the other hand, are assessed at 5.64%, meaning financial aid eligibility is only reduced by about $56.40 for every $1,000 saved.
Solution: In order to minimize the extent to which your savings reduces you child’s financial aid package, save in accounts that are in the parent’s name instead of in the child’s name. (Note: 529 plans are considered parent-owned assets.)
2. Paying for college with the help of a grandparent or non-custodial parent
If a grandparent or another non-custodial parent wants to help pay your child’s tuition bill, that’s great. However, don’t allow them to pay the school directly. If they do, the money will be considered student untaxed income on the FAFSA and will be assessed at 50%. In other words, if a grandparent write the college a check for $10,000, it will reduce the student’s need-based financial aid eligibility by $5,000. (Note: Since the FAFSA does a two-year look-back on income, it will affect the student’s financial aid package in two years).
Solution: If a grandparent or non-custodial parent offers to help pay for college, the best approach would be to have them give the money to the parent and have the parent pay the tuition bill.
3. Using retirement funds to pay for college
Taking money out of your retirement savings accounts in order to pay for college is a bad idea for many reasons. First of all, it’s not wise to jeopardize your own retirement savings in order to help your child pay for college.
Secondly, although the government waives the 10% penalty that’s normally assessed on early retirement fund withdrawals if you use the money for education expenses, you’ll still be penalized by the college. Money you withdraw from an IRA or 401(k) will be considered parent income on the FAFSA, and it’s assessed by colleges at 47%. So if you withdraw $10,000 from a retirement account, your child’s need-based financial aid eligibility will be reduced by $4,700 — almost half!
Solution: Keep your retirement savings in your retirement accounts.
4. Not using the appeals process
Many students and families don’t know that you can appeal your financial aid award. There are two main reasons to do this:
- Your financial situation has changed since you filled out the FAFSA. The Free Application for Federal Student Aid (FAFSA) uses two-year-old tax information (for instance, 2018 tax information for the 2020-21 academic year), so it’s entirely possible that things have changed since then — especially now, amid the coronavirus pandemic.
- You want to request more merit-based financial aid. Of course, everyone wants more merit-based aid. But you’re most likely to be successful if you’re a competitive applicant in the top 20% of the college’s incoming freshman class.
Contact the college’s financial aid office in order to initiate the appeals process. Different schools have different processes, but be prepared to write a letter and/or document the changes in your financial situation.
» Need help with your financial aid appeal letter? We can help.
5. Not applying to enough colleges
If a student is accepted at multiple colleges, they can use the financial aid award letters from those colleges as leverage when negotiating the financial aid package from their top-choice school. But if a student doesn’t apply to enough schools, they lose some of that leverage.
Solution: Students should apply to several schools — five to eight schools is the College Board’s recommendation. Students will be more likely to be offered merit-based aid from schools at which they’d be in the top 20% of the incoming freshman class.
6. Not starting early enough
Regular savings over time can have a significant impact on your ability to pay for college. A contribution of $200/month for 10 years at a 5% compounded annual return, for example, would grow in excess of $31,000. In 15 years, that savings would grow to approximately $54,000. The earlier parents start making regular deposits into a 529 College Savings Plan, the more time the money has to grow. Distributions for payment of higher education expenses are exempt from income (including the profits from growth and dividends).
Solution: Start saving for college regularly as early as possible.