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How to pay for college: Strategies & tips

At a glance:

One of the familiar images of the college graduate is the seemingly perpetual student loan that he or she never gets paid off.

Another is the graduate who must take a second job to pay down a huge loan balance. One of the goals of education planning is to make these scenarios less likely or, at the least, not as lengthy.

There are many factors to study when you plan for higher education. That is why advisors suggest starting your plans early. You need to evaluate the myriad investing plans and strategies to minimize taxes, and maximize college cash flow when the time is right.

Why college is still worth the cost

One bit of good news is that college still pays.

College is an investment for a lifetime. But does it create earning power?

"The resounding answer is yes. Research shows that people with college degrees have more job choices and earn more money," according to the College Board.

For most, college is still affordable

College can be more affordable than most people think.

According to the College Board, about half of full-time undergraduates attend a four-year college costing less than $12,000 per year for tuition and fees.

The average 2019–2020 cost of tuition and fees for public schools for in-state students is about $10,440 per year. For out-of-state students, it is about $26,820. Private schools average a little over $36,880 per year for tuition and fees.

Many of these higher-priced schools have grant aid available, making it easier to pay costs. Many who attend two-year colleges pay just a little over $4,000.

At the extreme end of low cost, a few colleges charge no tuition or offer all students full tuition coverage through scholarships.

(Graphic: David Foster)
(Graphic: David Foster)

There is a lot of financial aid available

Furthermore, more people are eligible for financial aid than realize it.

Many people who would easily qualify for need-based financial aid mistakenly believe that families with incomes over $35,000 are not eligible.

According to the College Board, there is currently more than $185 billion of financial aid being awarded. To qualify, a family must pass a needs test that considers not only family income and assets but also the total cost of education for all family members as well.

Families putting two or more family members through post-secondary education very often qualify for substantial financial aid despite "high" family income.

Although post-secondary education costs have risen dramatically, the cost of higher education is not out of reach for most families. There are several options available to make higher education possible.

Apply for financial aid. Choose a school that is within your family budget (including financial aid). Also, plan early.

Of course, there is a wealth of tax incentives available to help you save on college expenses. Savingforcollege.com lists several here.

Saving for college

You need not save money in a bank account for education.

There are special types of tax-advantaged accounts that you can use instead. Let's look at two of them here.

Coverdell education savings accounts

The Coverdell education savings account is a convenient way to start saving for a child's education.

Anyone may fund a Coverdell education savings account (formerly education IRA) for a child beneficiary, provided their modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return).

The maximum allowed contribution is $2,000 per year in aggregate, up until the beneficiary's 18th birthday, unless the beneficiary is a special-needs beneficiary.

The earnings remain tax-free when they are withdrawn and used for qualified educational expenses. All assets must be distributed within 30 days of the beneficiary's attaining age 30, unless the beneficiary is a special-needs beneficiary.

It is important to note that contributions to Coverdell accounts are not tax deductible.

IRS Publication 970 provides more information on Coverdells and other tax incentives for education.

Qualified state tuition plans (529 plans)

States have pre-paid tuition programs allowing families to save for a student's higher education.

These plans qualify for special tax treatment if the funds are used for qualified expenses at a post-secondary school that meets U.S. Department of Education standards for student aid eligibility or for certain K-12 tuition expenses or for certain K-12 tuition expenses.

These plans are generally referred to as 529 plans for the tax code section that describes how they are treated for tax purposes.

States offering such plans may also give favorable tax treatment for contributions. State tuition plans fall into two categories: pre-paid tuition plans and college savings plans.

How to buy pre-paid tuition plans

Pre-paid tuition plans allow participants to buy tomorrow's education at today's prices.

They may be purchased with a single lump sum or a series of payments. The state typically guarantees that the pre-payments will cover the future cost of education at the state college.

If the student chooses not to attend the state college, the state will often make available the amount of money equivalent to the cost of the state education at maturity.

Here's what you should know about paying for college. (Graphic: Hannah Smart/Cashay)
Here's what you should know about paying for college. (Graphic: Hannah Smart/Cashay)

Savings plans

State college savings plans have become more popular because of investment flexibility and the alluring possibility that, with investment skill and luck, proceeds may exceed the actual costs of education. These plans have some tax incentives, too.

While the contributions generally are not tax-deductible at the federal level, the earnings within the plans are tax-deferred until withdrawn. The earnings are federal income tax-free and, in most cases, state income tax-free if used for qualified educational expenses.

Loans for college

The federal government and colleges work together to provide many types of loans to graduate students. In order to get one, however, the school you attend must participate in these loan programs.

Here is a rundown of some common loans and loan types.

Stafford loans

Stafford loans are low-interest, need-based loans.

With an unsubsidized loan, interest on them begins to accrue immediately (meaning that you must pay that interest). With a subsidized loan, the interest is deferred (meaning that the government pays the interest as it accrues so that you don't have to).

Both types of loans have maximum limits on how much you can take out per year and over the course of your school career.

Perkins loans

Perkins loans are low-interest, need-based loans funded by the federal government and administered by educational institutions.

According to the US Department of Education, around 1,700 postsecondary schools participate in them.

One advantage of the Perkins loan is that you might qualify to get it discharged if you enter certain public-sector careers.

PLUS loans

PLUS loans have fixed interest rates, which are relatively high but which can be an advantage if interest rates rise higher.

However, you need a good credit history to qualify for one, and there is no grace period when it comes to repayment; that means you must start paying it back immediately after you graduate.

As with some other loans, you can get a PLUS forgiven if you enter certain qualifying public-sector or non-profit careers. There is no limit on how much you can borrow with a PLUS loan.

Private loans for college

Private lenders, such as businesses and financial institutions, offer loans for higher education.

But compared to federal loans, these private loans offer terms and interest rates that are likely not as favorable.

Loans from family and friends are also an option to consider. These may have more advantageous repayment terms and interest rates; but be sure to get the terms down in writing.

Do you own your home? You might qualify to borrow against the equity in it and use the proceeds for tuition.

Some advantages of a home equity loan are that the interest rate may be lower; however, as of 2018, the interest on home equity loans used in this manner is no longer tax deductible.

Grants, scholarships, and fellowships for school

Grants for college

Grants are awards of money that do not need to be paid back; they can be awarded in a variety of amounts.

Therefore, it is in your interest to apply for as many as possible. Schools offer them, and so do state and federal governments.

Private sources also offer some. Grants may be based upon need or merit. Among the most well-known of them is the Pell Grant. Grants are also awarded by foundations and associations that advance particular fields of study.

Grants in your field

Graduate fields that are in demand are the most likely to land free money for tuition. Trade associations and professional associations often have lists of scholarships and fellowships for students to apply for.

Private scholarships

Scholarships may be need-based, merit-based, or a combination of the two.

They may also be based on your chosen field or on certain specifics, such as your ancestry or where you live. Some scholarships cover your entire academic career, while others are limited to certain years or get capped at a certain amount.

For many of them, you must reapply each year or keep up a high grade level.

Fellowships

Fellowships are based on merit and in some cases need, and are often tied to a particular program. Like scholarships, there are sites online, such as http://www.ssrc.org/fellowships/, that list them.

Where to find them

The financial aid office and the department head of any given college have information on grants, scholarships, and fellowships. And there are many reputable sites online that list them. One example is www.fastweb.com.

Another popular and reputable source of information is the education issue of US News and World Report that comes out every year.

Haley Walters (C) marches with her class at the Pasadena City College graduation ceremony. (Photo: ROBYN BECK/AFP via Getty Images)
Haley Walters (C) marches with her class at the Pasadena City College graduation ceremony. (Photo: ROBYN BECK/AFP via Getty Images)

Repaying your student loans

Federal loans

If you have a federal loan, you have several options for paying it back.

  • The standard repayment plan. The standard plan is the plan offered by the lender. The payments will last for as long as 10 years. This plan is the fastest method because it is shortest, but that also means higher monthly payments to make. An advantage to it is that you will pay less interest.

  • The graduated repayment plan. Under a graduated plan, your payments start out low and increase every two years. The repayment period lasts up to 10 years. An advantage to this plan is that it recognizes that your income will likely be lower right after you graduate and then (hopefully, at least) increase as the years accumulate.

  • The extended repayment plan. This plan allows a loan term up to 25 years, depending on the size of the loan. Your loan balance must be at least $30,000 in order to participate in this plan. Those who want to pay smaller monthly payments may find this plan to their liking because it is drawn out. A downside is that you will pay more interest over the course of the payback period.

  • The pay-as-you-earn repayment plan. You must have a partial financial hardship. Your payments will change as your income changes. If you have not repaid your loan in full after you made the equivalent of 20 or 25 years of qualifying monthly payments, any outstanding balance on your loan will be forgiven, though you may have to pay income tax on any amount that is forgiven.

  • The income-based repayment plan. The income-based plan recognizes that some graduates go through periods of low income. This option lets you pay an amount based on your income, loan amount, and family size. It is refigured every year to reflect your income. If you pay on it faithfully for 20 or 25 years, you may qualify to have it cancelled.

  • Income-contingent repayment plan. This option is only for federal Direct Loans, which are made directly by the federal government. With it, your payments can't exceed a certain amount of your monthly discretionary income. Figuring your discretionary income involves subtracting an amount based on the poverty level from your gross income. If your payments are not sufficient to cover the interest portion, then any amount of interest not covered will be added to your loan principal. However, there are limits to this. The payment period is 25 years maximum. If you have not paid off your loan in this time, it will be canceled. But the IRS requires that you pay income tax on this canceled amount (in other words, the IRS will treat it as income).

  • Income-sensitive repayment plan. Your monthly payment is based on your yearly income. Payments will change as your income changes. Like other income-related plans, this one can be an advantage to those who are not earning much money in the early years after graduating.

You have the option of switching payment plans, usually once a year. But there are some regulations involved. And if you are in default, switching plans may not be allowed for you. More information can be found here.

School loans

If your loan (e.g., a Perkins loan) was issued to you by your school, there are repayment options for it. These options differ school by school, so consult yours about options.

Private loans

Repayment for private loans varies according to lender, but in general, you should expect fewer repayment options. Consult the lender to see what you qualify for.

Summary of how to pay for college

Planning for higher education has become more important now than ever.

The costs of higher education have skyrocketed, outpacing inflation. Yet the need for higher education has also become more important in order to succeed financially.

There are many ways to prepare financially for higher education. Preparation starts with a sound financial plan.

This should be followed by an investment strategy that minimizes taxes while maximizing cash flow during the educational years.

You should also explore the benefits and pitfalls of various education savings plans.

With planning and preparation, you can minimize the bite that paying for college may otherwise take out of your finances.

Practical ideas you can start with today

  • Start today to plan for your child's education by calculating how much you will need to save.

  • Become familiar with the many forms of financial aid and determine what sources your child and you might qualify for.

  • Estimate your ability to pay back your student loans.

  • Set up a tax-advantaged Coverdell education savings account for your child, if you are eligible.

  • Research qualified state tuition plans (529 plans) if your state offers them.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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