01Raising Your Expected Family Contribution (EFC)
With as little media coverage as college planning receives relative to other types of financial planning, it’s no wonder that parents are making mistakes left and right. Sadly, with so little time between a child’s birth and the start of college, there’s typically very little time to recover from college planning mistakes.
Whether you’ve just had your first child or major college expenditures are just a few years away, it’s never too late to make sure you’re on the right track. It’d definitely be a wise investment of your time to check your current plans against my list of Top 10 College Planning Mistakes.
Raising Your EFC
The Expected Family Contribution (EFC) is the portion of your family’s income and assets that you’ll be expected to spend in any given year before financial aid kicks in. Essentially, financial aid will only cover the costs leftover above and beyond your EFC.
While it makes no sense to try and make less money to receive more financial aid, it does make sense to make sure your child’s savings accounts are titled properly. For example, 20 percent of the assets in accounts owned by the child (such as UGMA or UTMA accounts) are expected to be used annually toward college costs. However, only 5.64 percent of the assets held in a parent’s name are expected to be used. Even better, none of the assets owned by a grandparent are expected to be used for the child (since there is no place to designate this on the FAFSA form).
02Not Watching Your Time Horizon
Unlike retirement assets, which most people will slowly deplete over 20-40 years, you can expect to use up your college savings account over a 2-4 year window. This means, that unlike your retirement account, you don’t have the freedom to ride out a temporary hiccup in the investment markets.
While higher risk investments may be acceptable when you have a decade or more left until the money is needed, as you get closer to actually needing to withdraw funds, you should consider moving towards less volatile assets. The recent introduction of aged-based accounts in Section 529 plans has made this process automatic and is a great option for parents who have limited time or investment knowledge.
03Not Taking Your Educational Tax Breaks
Some of the most generous tax benefits available to middle-class America are meant for college planning. These benefits, which may either come in the form of a tax deduction or tax credit, can save you thousands of dollars for paying college tuition or funding your state’s Section 529 account.
Perhaps the biggest tax breaks that remain unused are the Hope Scholarship and the Lifetime Learning Credit, both of which can put $1,500–2,000 right back into your pocket at tax time. Sadly, many parents are completely unaware they can claim these benefits.
04Not Using Student Loans
Many parents view student loans as an embarrassing sign that they fail to earn enough money or didn’t do a good job saving what they had. While this occasionally may be the case, it is important to realize that college costs are spiraling faster than most Americans can keep up. Properly utilizing the right Federal student loan programs can help parents and students finance a college education for as low as 3.40 percent annually.
Whether or not you think you’ll ultimately borrow money through a program like the Stafford or PLUS loans, it is still important to fill out a FAFSA form. This is the basic form used by most schools’ financial aid office to determine what you might be eligible for. As the old saying goes, “the worst that could happen is that they say ‘no’!”
05Underestimating the Effects of Inflation
Until you understand how fast college costs are spiraling out of control, it is tough to do an adequate job of planning for college. While the broad “cost of living” has increased or “inflated” at a historical average of 2 percent annually, college costs tend to increase 5-6 percent every year. That means that college costs are rising three times as fast as life’s other costs, and likely three times as fast as your paycheck.
Understanding proper investment selection as well as using accounts that are meant to combat inflation, such as Prepaid Tuition plans, are crucial to making sure a college education stays within reasonable reach.
06Getting Too Fancy With Your Investments
I don’t know what it is about us (especially men) that we insist on going against the flow of things. But, for every 10 families I do college planning with, there’ll be one who insists on non-traditional investments for their child’s college account. Over the years, I’ve seen everything from people planting timber to be harvested when their child goes to college to someone trying to corner the market on a certain baseball player’s rookie card.
Don’t get me wrong. These may be fun and unique investments when part of a much larger investment portfolio, but they are not the place for your child’s education fund. Besides the fact that most of these investments lose the tax-advantaged status other college accounts enjoy, they also seem to backfire as often as not.
With less than twenty years until you’re going to need your college funds, stick with the straight and narrow. Choose simple investments that get the job done; avoid investments never meant for college planning.
07Choosing Investments With High Annual Expenses
Unfortunately, the cost and expenses of most mutual funds and Section 529 plans seem to require an advanced degree in math to understand. While it might be tempting to overlook this aspect of college planning, making sure your investments are cost-efficient is crucial to ensuring your long-term growth.
While it may not seem like it has a huge effect, an extra 2 percent in fees may decrease a portfolio’s ending value by up to 50 percent over a 20-year period. Excessive fees, even on a well-performing portfolio, can greatly increase the amount you’ll have to save to reach your unique college planning goals.
08Not Using the Right College Savings Accounts
You can earmark virtually any type of account, from a checking account at your bank to a Roth IRA, as a college account for your child. Unfortunately though, not all of these accounts are created equal. The exact same mutual fund bought in one type of account may be subject to greater taxation than if bought in another account. Likewise, one account may hurt your chances of financial aid 4-5 times more than another.
The first step in choosing the right college account is to get your vocabulary nailed down. You need to know what the different accounts are and their basic features.
To get you started, you should review our profiles of the half-dozen major college accounts. If you’re tight on time, jump ahead to my article on choosing the best college account for your family.
09Using Your Retirement Funds to Pay for College
The second most traumatic college planning mistake many parents make, is using their existing retirement funds to pay for college. In other words, many parents take distributions or loans from their company’s 401k or other retirement plan, usually to avoid taking out student loans. To add insult to injury, many parents also fail to continue saving into their 401ks or IRA’s during the college years.
What makes this mistake so huge is the fact that most parents typically do this somewhere between age 40 and 60. That leaves a painfully short amount of time to make up the depleted funds before retirement kicks in for mom and dad. For many parents, they don’t realize until it is too late, that borrowing against their retirement actually postpones it for 5-10 years!
If you find yourself on the fence with the decision to raid your retirement plan, just remember this tidbit of wisdom: You’ll always have an easier time getting a student loan than a retirement loan!
10The Worst College Planning Mistake: Procrastination
By far, the biggest college planning sin you can commit, is procrastination. From the day your child is born, you’ve got roughly 18 years until you’re going to need to come up with some major cash. Every year you wait to deal with that fact raises your out of pocket costs substantially.
The most important first step, one you should start on today, is calculating what your future cost will be. This in turn will allow you to calculate what you need to save each year to get to that goal.
Now don’t get me wrong. Just because a college savings calculator tells you that you need to save $250 per month doesn’t mean you have to do that or nothing. But, by knowing the number, you stay aware of how every dollar is spent. Even though you might only be able to save $100 per month, knowing your target number will help you to be wise with extra cash when you come across it.
Visit our step-by-step college savings calculator and find out what your target number is.