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Ask any parent of a child who is college-age or older how quickly those early years seem to pass, and you'll realize why so many parents are caught flat-footed when it comes time to think about paying for college.
If you've got fewer than five years before that first tuition bill is due, you need to employ different college preparation strategies than parents whose children are still in diapers.
The following strategies reflect current tax laws, federal aid calculations and U.S. Department of Education rules. As college approaches, you'll want to check in with sites such as FinAid.org or SavingForCollege.com for the latest on how various accounts are treated for financial aid purposes.
Here are some basic rules of thumb:
Assume you'll get some financial aid -- just not enough. You can err two ways when it comes to financial aid: by assuming you won't get any and by assuming you'll get a lot. More than half the students attending college get at least some help, and you probably will, too, unless your household income is well over $100,000 a year. (Even then, you might qualify for aid at some of the pricier private colleges.)
If you're counting on a lot of aid, though, you probably will be unpleasantly surprised at how much colleges expect you to contribute on your own. The federal financial aid formula expects parents to chip in 5.6% of their investment assets and up to nearly half of their incomes over certain levels each year. (For an estimate of your "expected family contribution," check out the calculators at FinAid.org or WiredScholar.com.)
Don't give up on saving. Yes, you would have been better off had you started years ago, but every little bit helps. Even if your savings reduces your eventual aid package somewhat, the money you can put aside now typically will help reduce the amount of debt you or your student will take on later.
Don't mess with most tax-deferred accounts. Typically, the tax savings you'll reap in such a short period are pretty minimal and are more than offset by the restrictions these accounts impose, according to Kathy Kristof, author of "Taming the tuition tiger: Getting the money to graduate." There are a few exceptions. If you're already contributing to a 529 college savings plan or a Coverdell account, there's probably no need to stop. But otherwise, you probably should steer clear.
Don't save in your child's name -- and if you already have, consider spending down the account. Your student's assets will count much more heavily in financial aid calculations than yours will. (He's expected to contribute 20% of his assets each year toward his education, compared to your 5.6%. Some of your assets, such as home equity and retirement accounts, aren't counted at all.)
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Whose money is it, anyway?
Coverdells and 529s are typically considered the parents' asset. Accounts that are considered your student's assets include:- UTMAs, UGMAs, custodials: Whatever you call them, these accounts legally belong to the child, even if she isn't allowed access to the money until she's 18 or 21 (depending on your state). The good news is that this money can be spent in any way that benefits your child, as long as it doesn't replace money you're obligated to spend as a parent. So while you shouldn't use a custodial account to buy clothes or food, you can use it to buy your child a car, pay private-school tuition or upgrade her computer.
- Your child's savings. Obviously, any money your child puts aside on her own is fair game for financial aid calculations, but there are no restrictions on how the money can be disbursed.
The point here is to spend the money on stuff you would have paid for anyway. It doesn't make much sense to spend $1 in savings frivolously just to get another 35 cents in aid.
If your child still has money in one of these accounts when he heads off to school, use that cash first before tapping your own or taking on any loans. If there's $10,000 left in a custodial account, for example, and the school offers $2,000 in grants and $7,000 in loans to cover its $12,000 annual tuition, you'd be smart to pass on the loans and empty the custodial.
A problem with prepayment
By the way, there's one other type of account that could seriously erode your financial aid package, and that's:Prepaid tuition plans. This type of plan allows parents to offset the effect of inflation by locking in tuition rates years before the child actually attends school. Interestingly -- and unlike its cousin, the 529 college savings plan -- the prepaid tuition plan isn't included as an asset in the federal financial aid calculations. But once you use the plan to actually pay tuition at a school, the disbursement reduces your future financial aid dollar-for-dollar, said Mark Kantrowitz, publisher of FinAid.org.
Again, that's the opposite of a college savings plan. While college savings plans are counted in financial aid calculations as the parents' assets, disbursements from prepaid tuition accounts don't affect financial aid eligibility, according to Joseph Hurley, author of "The best way to save for college: A complete guide to 529 plans."
That could offer you a unique opportunity to save if the state that offers your prepaid tuition plan allows rollovers into its 529 college savings plan. If so, Kantrowitz recommends rolling over the account after you file your first FAFSA, the Free Application For Federal Student Aid. That way the money won't be counted as an asset the first year, and its disbursements won't be counted as aid-reducing resources in following years.
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How to get financial aidCNBC's Carmen Wong Ulrich looks at ways college students can fund their education, including the Free Application for Federal Student Aid.
Make smart money moves
There are several other ways to boost your shot at a decent financial aid package:Use savings to pay off credit card debt. You'll want to keep a few months' worth of expenses saved for emergencies, but excess cash or investments in a non-retirement account can be used to retire non-mortgage debt.
Don't realize capital gains. Selling stocks or cashing in options turns an asset into income, which can substantially increase the impact on your financial aid package.
Consider prepaying your mortgage. The federal aid calculation doesn't count your home equity at all. Private colleges sometimes do, but you can always take out a home equity line of credit to pay tuition -- and lower the amount of equity included in the next year's need calculations.
Continued: Divorce might be a viable option
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