Whether your clients’ higher-education bills are a year or two away, or just arrived in the mail, you can calm even the most panicked family by informing them that there are more ways to meet the expense than just by writing a big, fat check.
Here are most of the methods clients can use to pay their kids’ education expenses, presented in the order of most to least optimal for the situations of most families.
1. Grants
Grants are generally awarded via the school’s financial aid office and usually require the family to complete the Free Application for Federal Student Aid, or FAFSA, available at fafsa.ed.gov.
2. Scholarships
High school students should contact their school’s guidance counselor for regional or specialized academic opportunities. The intended college or university’s financial aid office can also help, as can sites like Fastweb.com and MyScholly.com.
3. Direct Subsidized Federal Student Loans
Families who haven’t fully saved for college costs should get direct federal loans as soon as they can, while they can, for as much as they can. The rates are low, generally no credit check is required, and several repayment and eventual forgiveness plans may come in handy down the road. There are annual and lifetime limits on the amount of money that can be borrowed.
4. Direct Unsubsidized Federal Student Loans
The primary differences between subsidized and unsubsidized federal student loans are that the unsubsidized version is not need-based, and the interest begins accruing as soon as the money is borrowed.
5. 529 Accounts
Assets and distributions from 529 accounts held by parents generally don’t have a material impact on need-based financial aid. But distributions from a grandparent’s 529 can be counted as student income in the subsequent year. Therefore, if possible, don’t tap those funds until the student’s last year in school.
6. Money in the Student’s Name
The assets can count heavily in the Expected Family Contribution that determines need-based financial aid. Worse yet, once the student reaches adult age, she can spend the money however she wants (despite her parents’ protests).
7. Direct Parent Plus Loans
The interest rate is currently higher than what is charged for federal student loans, but there is only a minimal credit-approval process. And the loans can be obtained regardless of family need.
8. Private Education Loans
A credit check and approval will be required, and usually a parent will have to co-sign for a borrowing student. Fees and interest rates can be more expensive than the federal loans, and there is much less repayment flexibility if the borrower runs into trouble.
9. Home Equity Line of Credit
This is the lowest-cost way to get access to accumulated home equity, and only pay interest on the amount borrowed for the time being. But the interest rate can fluctuate, so it could become expensive if rates rise in the future.
10. Home Equity Loan
This is an immediate loan with a fixed rate and an established time period over which principal and interest payments must be made. It’s best for when families are relatively certain of how much they will need, and that amount is in the low to mid five figures.
11. Home Mortgage
Usually this is the costliest home-equity borrowing option, but it generally provides the most amount of money at the lowest fixed rate and the longest payback period (meaning the monthly payment may be more affordable). Cash-strapped families may want to borrow as much as possible, and bank any unneeded funds for future emergencies and uncovered education expenses.
12. Parent Earnings
Contributions made to parents’ retirement accounts while applying for need-based financial aid will still be included in the Expected Family Contribution. Therefore, it might be better for parents to instead use that portion of their earnings to pay for higher-education expenses, especially if they will then qualify for education tax credits.
13. Parent Savings and Investments
If liquidating investments for the client, be aware that large realized capital gains could reduce need-based financial aid awarded in the subsequent years.
14. Student Earnings
Above an annually established limit, student earnings can reduce need-based financial aid by as much as 50 cents for each $1 of wages that exceeds the limit. The kid may be better off working a little less and taking a few more credits.
15. Parent’s Roth IRAs
The contribution portion can be withdrawn at any time for any reason (including higher-education expenses) with no taxes or penalties. When the earnings portion of the Roth IRA is withdrawn prior to the owner's turning 59 ½, it can be taxed as income. But the 10 percent penalty will be avoided if the money is used for qualified higher-education expenses.
16. Loan from Parent’s 401(k)
If the parent’s employer plan allows it, no credit check is required, and the interest is paid back to the account owner. But if the parent leaves the job, the loan must be repaid or it becomes a distribution, and may trigger income taxes and penalties.
17. Credit Cards
High interest rates and potential damage to the cardholder’s credit score aren’t the only costs. Many schools tack on an additional fee of 2 to 3 percent for paying college costs with plastic.
18. Parent’s IRAs
IRA distributions used for college costs will be taxed as ordinary income, but using the money for qualified higher-education expenses could avoid the 10 percent “pre 59 ½ penalty” that may otherwise apply.
19. Distribution from Parents’ Old 401(k)s
If the parent is over 55 and has a plan from a previous employer, funds can be withdrawn for any reason with no 10 percent penalty. But the distributions will still be taxed as income.
20. Distribution from Parents’ Current 401(k)s
Otherwise, the only way to tap a 401(k) from the parent’s current employer is via the aforementioned loan (if available), or a “hardship” distribution (if available). Even if the hardship distribution is an option, it can only be used for tuition bills that are due in the next 12 months, and only after all of the other options are exhausted.