Whether you've just had your first child or you're parenting a teen, it’s never too late to make sure your college financial planning is on the right track. Check your current plans against our list of top 10 college planning mistakes and correct your course if necessary. Even if you only have a couple of years before you have to start writing tuition checks, you can make sure you're saving appropriately.
Failing To Minimize Your Expected Family Contribution (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 cost of attending college beyond your EFC.
While it makes no sense to try to 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% of the assets in accounts owned by the child, such as The Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts, are expected to be used annually toward college costs. However, a max of only 5.64% of the assets held in a parent’s name is 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).
Starting in July 2023, the FAFSA form will ask different questions because the EFC is replaced by the new Student Aid Index (SAI) for award years starting in 2023-24. Essentially, it's the same number but meant to reflect that not all families can be expected to pay the EFC.
Ignoring Your Time Horizon
Unlike retirement assets, which most people will slowly deplete over 20 to 40 years, you can expect to use up your college savings account over a much shorter window of two to four years. This means that, unlike with 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 you need the money, as you get closer to actually needing to withdraw funds, consider moving towards less-volatile assets. Age-based accounts in Section 529 plans automate this process, making them a great option for parents who have limited time or investment knowledge.
Bypassing 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.
The American Opportunity Tax Credit (formerly known as the Hope Scholarship) is open to individuals with adjusted gross incomes of $90,000 or less ($180,000 if married filing jointly) and provides up to $2,500 per student annually. The Lifetime Learning tax credit pays up to 20% of the first $10,000 in higher education costs.
Overlooking 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 using the right federal student loan programs can help parents and students finance a college education for as low as 2.25% annually. (During the pandemic, the U.S. Department of Education set a 0% interest rate and suspended payment requirements through at least Sept. 30, 2021.)
Whether or not you think you’ll ultimately borrow money through programs like the PLUS loans, it is still important to fill out a FAFSA form. This is the basic form used by most schools' financial aid offices to determine what you might be eligible for. The worst that can happen is they say no.
Underestimating 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% annually, college costs tend to increase 5%–6% 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 and 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.
Getting Too Fancy With Your Investments
Some families insist on non-traditional investments for their child’s education fund, such as planting timber to be harvested when it's time to go to college or trying to corner the market on a baseball player’s rookie card.
These may be fun and unique investments, but it's best if they're part of a broader, more diversified portfolio. Aside from the fact that most of these investments miss the tax-advantaged status other college accounts enjoy, they also can backfire as often as not.
With less than 20 years until you need your college funds, stick with the straight and narrow. Choose simple investments that get the job done, and avoid investments never meant for college planning.
Choosing 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 their long-term growth.
While it may not seem like it has a huge effect, an extra 2% in fees may decrease a portfolio’s ending value by up to 40% over 25 years. 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.
Using the Wrong 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 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 four to five 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. Familiarize yourself with the types of accounts used to save for college, such as 529 plans, Coverdell ESAs, Roth IRAs, UTMAs, UGMAs, and trusts.
Using Your Retirement Funds to Pay for College
The second most damaging 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 another 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 IRAs during the college years.
What makes this mistake so huge is the fact that most parents typically do this sometime between ages 40 and 60. That leaves a painfully short amount of time to make up the depleted funds before retirement kicks in. Many parents 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.
Procrastinating: The Worst College Planning Mistake
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 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, 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.