Jul 8, 2023

Paying for College: Make a Four-Year Plan (at least!)

Since my oldest is heading off to college next month, I've been deep in the weeds of figuring out how we're going to pay for it. And one thing I've come to understand is how important it is to plan not just for this first year, but for every year that he's in college. On his college's parent Facebook page, I've been seeing posts from parents who are confused, so I thought a post about this topic would be timely.

Here are some things to think about when planning out how you'll pay for college:

- What is the actual cost of attendance?

Every college will list an estimated cost of attendance (COA) on its website, but now that your child has selected a school, you'll want to figure out what your actual cost will be. That estimated COA should be accurate as to tuition and room and board, but the estimate will probably be off for costs like transportation. If you live far away, you can expect to pay more; if you live close by, your cost may be less. Other costs to evaluate include loan fees (I see a lot of schools including this in their estimate and they may not apply to you if you're not taking out loans); health insurance (many schools automatically bill for this but you can get a waiver if your child continues to be covered by your family policy); and lab fees (you may be paying a lot of these if your child takes a STEM-heavy course load).

It may be difficult to figure out the final, actual cost of attendance at this point of the summer, but just know that the estimated COA on the college's website is not the exact amount you'll be paying.

- How long will your child be in school, and what will the total cost be?

Sometimes students can't graduate in four years and need an extra year. Hopefully my son will graduate in four years, but he'll have the option of staying a fifth year to get a master's degree. Graduate school, possibly in the form of law school, is also an option he's considering. These are factors to consider when planning out payments. With graduate school on the horizon, there's no pressure to spend out the college savings accounts. A friend's son changed his major after two years, so he spent a fifth year in college to get his degree.

It's important to remember that each year, the COA will go up. It goes up more at some schools than others - my son's college's COA went up about 5% this past year, while the COA at a friend's son's college went up less than 3%. So when projecting the total cost, you'll need to factor in year-over-year increases.

- What are your sources of funding?

College savings accounts like 529s and even "regular" savings accounts are obvious funds to tap to pay for college. So is your current income, which I'll refer to as cash flow.

But other sources of funding include Roth IRAs (earnings can be withdrawn without penalty to pay for qualified education expenses), U.S. Savings Bonds (if you qualify, you don't have to pay taxes on the interest), home equity, and other loans. As one personal example, we re-financed our mortgage a couple of years ago to lower our monthly payment and free up cash we could put toward college instead.

Keep in mind that you should always consider the pros and cons of using various funds to pay for college, especially the long-term consequences, such as the risk of losing your house if you fail to make home equity loan payments.

- Are there benefits to paying out of pocket?

Even if you have the savings to pay for a full year or a full four years of college in a tax-advantaged account like a 529, there may be reasons to pay at least some of the expenses out of "regular" savings or cash flow (i.e., out of pocket). The most common reason is likely to be the American Opportunity Tax Credit (AOTC), as long you qualify. I'm finding that things get tricky here: for AOTC purposes, qualified expenses are tuition, fees, books, supplies, and necessary equipment. Expenses don't include room and board, which are qualified expenses for other purposes like 529 accounts. For the maximum AOTC credit, you'll need to pay $4,000 out of pocket.

- Which savings should you use first?

You'll want to think about which accounts you want to empty out first. If you have younger children, any accounts that can't be redirected to them should probably be used first in case you're lucky enough to have money left over. In our case, our children have custodial 529 accounts whose funds can only be used by them, so we'll use those up before we tap 529 accounts.

If you have a Coverdell education savings account, you might want to use that up first because those funds have to be distributed when the beneficiary turns 30, unless the funds are transferred to a qualifying family member. (There are no such age restrictions on 529 funds.) 

If you have a college savings account and a Roth IRA, you'll probably want to use the college savings before tapping into retirement funds.

- Should you take out loans?

When deciding whether to take out loans to pay for college, always keep your eye on the total amount borrowed. A student who takes out the maximum federal loan each year (discussed below) will graduate with $27,000 in debt - that's a $293 monthly payment for 10 years at the 5.5% current interest rate. A parent who borrows $20,000 per year will have $80,000 in debt at the end of four years - that's a monthly payment of $973 for 10 years at the current 8.05% PLUS loan rate. You'll want to make sure any monthly payment is manageable before committing to loans.

Moreover, you might be able to pay for the current year of college, but what about later years? If you're likely to need loans to pay for future years, it might make sense for your student to take out the federal loan available to your student this year, because the loan won't be available in the future. 

To make sense of this, you should know that every student who files the FAFSA is eligible to take out a federal Direct Loan. Depending on your financial aid eligibility, the loan may be partly subsidized (meaning the loan does not accrue interest while the student is in school). The loan amounts vary by year: 

  • First Year - $5,500
  • Second Year - $6,500
  • Third Year and Beyond - $7,500
If a student opts not to take the $5,500 loan their first year, they can only take out $6,500 the next year (not $5,500 + $6,500 = $12,000). These federal loans are almost always the lowest-interest loans available, so it probably makes sense to take out the federal loan in the first year at that low rate (even if you have to pay the interest on the full amount), rather than take out $5,500 at a significantly higher rate in a later year.

There are loans available to parents, such as the federal Direct PLUS loan, and private loans (which will have the highest interest rates, and if you go this route, you'll definitely want to shop around for the lowest rate). Some families take out home equity loans or utilize a home equity line of credit, especially during times of low interest rates; just remember that you're borrowing against your home when you do this.

Another thing to keep in mind before you borrow is that the money needs to be repaid even if your student does not graduate, so if you're uncertain that your student will stick with college, it could make a lot of sense to make sure the school is affordable without loans.

- Do you have younger children who will also be attending college?

This question is especially important if you'll have multiple children in college at the same time, because unless you're paying for college entirely out of savings, your cash flow will be impacted when you have to pay for more than one student. You might decide to pay more out of pocket now and save the money in the college savings accounts for the overlapping years. Or you might realize you need to take out loans.

In fact, this question ties in closely with the previous question about loans because as a parent, you're probably not going to want to take out $20,000 per year for one child and then add on another $20,000 loan per year for another child. While this is a question that would hopefully be addressed before your child commits to a college that requires you all to take out significant loans, if you find yourself heading down this path, it's a good idea for a full stop and re-evaluation of your family's financial circumstances. Your options include contacting the college's financial aid office to see if they provide additional information, ideas or funding; taking a second job; having your student(s) work while attending school; or even having your child attend a different, cheaper college.

- Should you sign up for the college's payment plan?

Every school should have a payment plan to help you cash-flow your way through the payments.  The plan will allow you to make monthly (or at least some form of installment) payments instead of paying the full cost at the beginning of the term, and you can decide how much you want to pay monthly. For example, you might pay $10,000 before the semester starts, and then use a payment plan for the remaining balance. These plans are particularly helpful if you plan to cash-flow payments, but even if you're using savings, you can keep earning interest/income. There's often (but not always) a fee involved, and the amount varies by plan. Information about payment plans should be readily available on the college's financial services page.


What works for one person doesn't necessarily work for another, but in my case, I started by creating a spreadsheet. I estimated the COA for future years at about a 7% increase per year, to be conservative. Then, for each year, I plugged in how much money we would use from each account to pay for college. Our kids have several different college savings accounts, so I figured out the order in which I wanted to use up the money, and estimated a very conservative growth amount for future years (since the investments are age-based, they are all conservatively invested, which protects the capital but minimizes growth). I also calculated how much we would be cash-flowing each term.

I'll be honest, it's a sobering exercise. But it gives me the peace of mind of knowing how we'll pay for four years of college, and especially, that we can do it. I don't have to worry that three years from now, I'll be pulling out my hair wondering where we'll find the money not just for my son's last year of college, but also his brother's second year.

I know this was a loooong post, but I hope it was helpful. If there's something you'd like me to discuss further, please let me know!

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