Something Personal Episode 11: Paying For College, Start To Finish
With education expenses outpacing inflation for years, most Americans know that paying for college (or private K-12 schooling, or graduate school) isn’t always simple. Between 529s, FAFSAs, private student loans and more, it’s easy to feel overwhelmed. But just like pursuing any other financial goal, the keys to effective education saving are careful planning and fully understanding your options. For parents, grandparents, or adults considering going back to school themselves, this episode breaks down the basics of how to save, how to reduce the “sticker price” for your school of choice and — if you need to — how to navigate taking out student loans. Senior client service manager Thomas Walsh walks listeners through everything they need to know. He also suggests some strategies for maximizing your educational dollar. Thomas and host Amy Laburda cover how to choose when loans make sense, the benefits of work-study programs, FAFSA basics and more.
About the Guest
Thomas Walsh, CFP®, joined Palisades Hudson in 2011 as a client service associate and became a client service manager in 2015. He serves clients through his involvement in all areas of the practice and is a member of the firm's Entertainment and Sports Team. He contributed to the firm's book Looking Ahead: Life, Family, Wealth and Business After 55; his chapter on education funding is the inspiration for this episode. For Thomas's full biography, click here.
Episode Transcript (click arrow to expand)
Welcome to “Something Personal.” Today is an episode that's truly for listeners in all stages of life. If you're planning to go to college, if you've gone to college, or if you have kids or grandkids who will probably go to college one day, education funding has some sort of impact on your everyday life. Heaven help you if any of those plans include grad school. Just kidding. Don't call heaven; we're here to help. My guest today is Thomas Walsh, a senior client service manager at Palisades Hudson Financial Group.
Thanks for joining me, Thomas.
Thanks for having me on the show, Amy.
So Thomas, in our firm's book, Looking Ahead, you wrote the chapter on education funding. Now, that chapter is really aimed at people who either had kids late in life or are looking to contribute to their grandchildren's education. But since this show has a broader audience than the book, does your advice apply similarly to younger parents who are thinking about funding their children's education?
Thomas Walsh 01:01
It certainly does, Amy. The subject of our conversation is focused around the student, or future student, and planning for their education. So it doesn't really matter whether you're a new parent early in life or a grandparent hoping to contribute toward a grandchild's college education. Tuition prices are rapidly increasing, and if current trends continue as they are, today's infants could face college costs more than triple the current rates.
how should people prepare themselves for this major expense?
So you want to start saving as early as possible, and you want to minimize the amount that is covered by student loans. You also want to keep in mind that the sticker price is rarely what you're going to end up paying at the school. This past year, about 72% of college students received some type of grant or scholarship, and many schools offer merit scholarships regardless of your need.
All right, so say you're a grandparent,
tying into the audience of Looking Ahead. Say you have the means to just fully cover your grandchild's education — lucky them. Should you just write your grandchild a check?
Well, no, and I suspect you know why, Amy.
We have talked on the show before about this, but if anyone hasn't listened to that episode or is just joining us, the reason you shouldn't give your grandchild the tuition money directly is because that could trigger the federal gift tax, right?
And the way you can avoid that is by paying the tuition bill directly. That would be exempt from the gift tax. But if your payment doesn't cover the entire tuition, you want to keep in mind that it could impact your grandchild's eligibility for their need-based financial aid.
All right. For students not lucky enough to have someone entirely foot the bill for them, let's get back to savings, which is probably the more common method a lot of people use. In our book and elsewhere, you and some of our colleagues have talked about
the merits of saving for a big expense like college starting as soon as possible. What are some of the ways that parents, students, grandparents, whoever can get started with saving for education expenses?
Sure. So the most straightforward and probably well-known way is through a Section 529 plan. There are actually two kinds. There are Section 529 prepaid tuition plans and Section 529 college savings plans. A prepaid tuition plan
lets you essentially lock in today's cost of tuition. Some prepaid plans cover tuition only, while others also cover things like books and housing expenses. Once you pay down the plan, the plan is then obligated to pay for the student's tuition, no matter how expensive it is by the time the student actually does go to college. The rules for these types of plans can vary
based on the states offering them, and they often only cover certain groups of schools, or even just in-state schools. And, in general, these plans are mainly aimed at paying for public institutions rather than private ones. And you're not necessarily tied to a plan that's in your home state, but there may be additional tax breaks for residents. Just like health insurance, there are additional costs for going out of network. So it might tie the beneficiary of the plan
to a group of particular schools when there's a chance they grow up and find themselves to be a better fit elsewhere. And one additional risk is that some states are already struggling to fund their obligations for fulfilling these prepaid plans and given the rising rates of tuition across the country.
Sure. It's funny, you mentioned tying beneficiaries to a particular school or location. It makes me think of me and my sister. I think fairly classic two ends of the scale.
I was down to the wire on decision day for college. I had two colleges I'd both gotten into. I liked them both. It was truly uncertain until I made that final decision. Whereas my younger sister knew in middle school where she wanted to go. She had found a college. She was excited about it. And she went straight through: applied to that school, got in, went to that school for four years. So I think, you know, it's hard to predict when you have
a kid or even a future kid if you're planning for someone who doesn't exist yet, knowing what kind of kid they're going to be as far as certainty, uncertainty. And I think the prepaid plans are a little bit risky just for even that level, as well as the funding that you mentioned.
That's a great example for prepaid plans and sort of some of the drawbacks to them, and how you can lock yourself into ending up at a certain school. And that just isn't always the case, as was with you and your sister.
There is another kind of plan though, you know, that has a lot of the same benefits, and it's the 529 savings plan. This avoids a lot of the downsides of the prepaid plan. You're not locked into any tuition price, and they're basically savings plans that are tax-exempt and also they have a minimal impact on the student's financial aid eligibility. The
owner of the 529 savings plan, or really anyone for that matter, will make contributions into an investment account, which grows the money, with the goal being to have enough for the beneficiary's tuition by the time he or she is ready for college.
So what if you open a 529 plan for someone who ends up choosing not to go to college?
So the account owner can change the beneficiary in that case, as long as it's another member of the original beneficiary's family.
Amy Laburda 06:34
OK. What about educational expenses before college, or after college, if you go on to grad school? Can 529 plans be used for those?
As of 2017, yes. The Tax Cuts and Jobs Act expanded educational expenses to cover K-12 education. So you can withdraw up to $10,000 per year from a 529 plan to cover that. Though your savings will have had less time to grow if you choose to go that route
and not use those funds for college education. And also though, as of 2019, funds from a 529 plan can be used to repay student loans up to $10,000. And as of 2022, unused 529 plan funds can actually be rolled over into a Roth IRA for the beneficiary. And to do that, each beneficiary is allowed to roll over a maximum of $35,000 from a 529 plan into a Roth IRA.
And the rollover is still subject to the annual contribution limits to a Roth IRA account.
So a 529 savings plan definitely sounds more flexible than the prepaid tuition plan, but do the savings plans have downsides?
Sure. Any kind of investment really carries with it some degree of risk, but they also have the potential to earn greater rates of return and have more flexibility than the prepaid 529 plan.
Most 529 savings plans offer different asset allocation strategies based on the age of the beneficiary to try to help mitigate this risk. The investment strategies typically start off aggressive and are a little more risky, and then become more conservative as the beneficiary nears college age. Some other drawbacks are that some plans are less efficient than others, and some states charge excessively high management fees for their state 529 plans.
Amy Laburda 08:28
All right, so not every 529 savings plan is the same. If you have a client who's looking for one of these plans, how do you advise them to pick? Do they have to look in the states where they're living, or can they cast a wider net?
They can cast a wider net, and you don't necessarily have to use your state's plan. Generally you do if you want to receive any type of state tax benefit for contributions. But as far as choosing a plan,
the college savings plan network is a great resource that lets you compare all of the different plans and lets you see the different advantages or benefits and costs for each of the plans. Most states actually offer more than one 529 plan, so there is a lot to look at. But I also — I give my clients a few places to start. We often recommend Utah's My 529 plan, or Connecticut's Higher Education Trust,
Nevada's Vanguard 529 College Savings Plan, and, for New York residents, we often recommend New York's College Choice Tuition Savings Program.
All right, so do people have other options for saving, outside of 529s?
There are other options, although 529 plans tend to be the best option for saving. Other savings vehicles would include the Coverdell Education Savings Account,
also referred to as an ESA, and that allows you to save up to $2,000 per year on behalf of a qualified beneficiary. The funds will grow tax-free and can be used for educational expenses, including for elementary and secondary school. So if your goal is to maximize funding for K-12 education, it can make sense actually to use both an ESA and a 529 plan simultaneously to fund education. However, one drawback to ESAs is that the account owner
cannot recover or transfer the funds should the beneficiary decide not to attend college. Another savings option is to open a custodial account for the student, and that would be like a UGMA or a UTMA. And with these accounts, any adult can set up a custodial account for a child that is under the age of 18. The assets in the custodial account will belong to the minor, but they are controlled by the custodian
until the child reaches adulthood. So unlike 529s or ESAs, there is no contribution limit on custodial accounts, although gift taxes can still apply. So one benefit to using a custodial account, compared to a 529 plan, is that you have access to a wide range of investment options in the custodial account. Whereas a 529, you may be more limited to a set list of investments or investment allocations. And
while some of the income earned in custodial accounts are shielded from taxes and some is taxed at the lower child tax bracket, they are not as tax-advantaged as 529 plans. Annual taxes will still be due on the income earned in a custodial account, or if there's any realized capital gains. One drawback to custodial accounts is that the child gains complete control of the account assets when they reach adulthood.
Amy Laburda 11:43
All right. So let's shift from talking about saving for kids who are still pretty young or on a longer timeline just generally, and talk about kids or other learners who are going to college in the next year or two. So we're past the point of long-term savings plans. What can people who are getting ready to go to school in the immediate future do to try to keep things more affordable?
So most listeners are likely familiar with this. But when students apply to college, they and their families are going to
fill out a Free Application for Federal Student Aid, or the FAFSA form. And this is used for two things. First, it's to apply for federal grants. And it's also used for schools to figure out exactly how much need-based financial aid the student is entitled to. And as a side note, there have been some changes to the FAFSA form recently. And this is something that you definitely want to consider in your overall financial planning. The
largest factor in determining need-based aid is going to be the student's own assets. And if the, so if the student has a UTMA or a UGMA custodial account, this actually counts as a student asset. But if the parents had opened a 529 or an ESA account for the student, it's counted as a parental asset, which has a lesser impact on the overall calculation. And even further, if the grandparents own the account,
it doesn't count at all as toward the calculation, since it's neither a parental nor the student's asset. We get into this a lot in a lot more detail in the book, but there are some more strategies for minimizing the assets that are counted toward both the student and parent contributions on the FAFSA form. One other tip for parents is that they should max out their own retirement account contributions, because those assets also won't be included in the calculation.
Good to know. So
what kind of help can you get once you've filled out your FAFSA?
So the biggest federal grant is the Pell Grant, and the current max award there is $7,395, though most students get less than this amount. There are other federal grants that go to students in specific circumstances, such as those that have exceptional financial need, those that plan to become teachers, and those who are
children of parents who died while serving in Iraq or Afghanistan.
OK, so we're chipping away at the expenses a little bit. That's the federal government side. What about the school side?
Sure. So then we get into scholarships. Need-based scholarships are also often referred to as grants, while merit-based scholarships are generally referred to as just scholarships. Either way, it's money that the school is knocking off of their sticker price for you as the student.
Like I said before, schools will determine how much need-based money to give based on your FAFSA. Well, merit scholarships are awarded to high academic achievers, but this also covers sports scholarships, arts scholarships, things like that. A lot of high-ranking private schools will offer merit-based scholarships to students with little financial need, because they want to attract high-caliber students to the school and boost their selectivity ratings. As you get into the
most elite schools like the Ivy League, this is less commonly done. Most of those schools don't offer merit-based scholarships at all. Basically, at that point, every student is deserving of a merit scholarship, so they only give out the need-based ones.
And I sort of skipped over this, but between federal grants and scholarships from schools, there are also sometimes state grants and scholarships out there that students can apply to, right?
That's right. Some of those only apply to students going to school in-state.
They may still apply to in-state private schools though, in addition to public.
All right. Let's keep knocking money off this sticker price. What else can students do, beyond the FAFSA and applying to these particular scholarships?
So there are lots of independent scholarships. They're offered by community organizations, religious groups, or even private companies. These tend to be small, but they can really add up. It takes a lot of time and energy to apply for them,
and one pitfall to watch out for is that some schools, including some top-tier ones like Cornell or Dartmouth, they will adjust the amount of aid they award to the student based on these extra scholarships that they receive. So before you spend all that time and energy applying for a scholarship, make sure you're doing it to save yourself money, rather than saving the school money. These third-party scholarships could also potentially decrease federal aid and need-based award eligibility, depending on the amount
of the scholarship awarded. So that's just something else to look out for there.
Speaking from personal experience, I can also bring up that some schools include work-study in their packages. That was part of my personal college experience. I ended up working probably 12 or 15 hours a week in the campus library. And my college factored that into my financial aid package. Personally, I thought it was nice to sort of have a first job on a lower pressure level before getting out into the real world.
But is that something that students can generally look for when they're receiving financial aid packages from schools?
It certainly is. And that's a great way to fill in some of the gaps for funding your education if you're there. And a big advantage to work-study jobs is that the income is actually exempt from the student contribution portion on that FAFSA form. So it keeps the student's aid eligibility higher than it otherwise would have been, should the student work the same job
outside of a work-study program.
So we've covered grants, we've covered scholarships, we've covered work-study. I think we've probably chipped away as much as we can expect to. So if there's still a gap between savings and what you need to pay after these adjustments, I guess we've reached everyone's favorite topic: student loans.
Yes, let's get into student loans. So the first thing to know about student loans is that if you eventually file for bankruptcy,
your student loans may not be discharged. Courts are reluctant to do this, and they only do it when they decide that paying back the loans would impose significant hardship on the student. They'll also look at if you've made a good-faith effort to try to repay the loans in the first place.
All that sounds about right for student loans, but let's back up first. Can you tell us a little bit about the different types of student loans you may encounter?
Sure. There are federal student loans,
and within these are various subtypes. There are direct subsidized loans, which used to be called Stafford loans, and some people still call them that. These are need-based, and they don't start accruing interests until the student is actually done with school. And then there are direct nonsubsidized loans, which are not need-based, but begin accruing interest right away when you take them out. Then there are direct parent loans, which are for parents of undergraduates, or for graduate
or professional students. And then there are direct consolidated loans, which allow students to combine their federal loans into just one loan.
Listeners probably know that student loans have been in the news a lot lately. What's been going on with them recently?
Well, Amy, I'm sure you've seen there have been a lot of different headlines on this. It's been in the news. This podcast is being recorded in October. So the loan payments did just resume
after a three-year break due to the pandemic. And just recently, President Biden did announce his plans for a second attempt to secure forgiveness for at least some federal student loan borrowers. His initial plan for broad forgiveness using the HEROES Act was rejected by the Supreme Court. So Biden has since directed the Education Department to look for other routes toward providing this forgiveness. And as of this recording, the details are still not publicly available,
so we don't know yet exactly who's going to be eligible or how much debt may be forgiven. There could be some significant developments coming in the future, but the rules are slated to be finalized sometime in 2024.
All this news is about government student loans, but those aren't the only student loans out there. So let's take a minute to talk a little bit about private student loans, if that's OK.
generally speaking, students should exhaust all of their options, including federal loans, before turning to private student loans. These tend to have the highest interest rates, and often you can't see the full terms until you've already applied. If you are considering private student loans, you're going to want to compare the lenders carefully. You'll want to look at the interest rate on the loan and make sure to ask about the APR, which will give you a better idea of the actual expenses
around the loan. And then you'll want to think about whether your future earnings in your selected field are really worth the terms of the loans that you're looking at. If there is a program that gets you to the same place at a less expensive institution, from a purely financial perspective, that might be the way to go.
To back up just a second for our listeners who may not know or may just need a refresher. What is APR and how is that different from the interest rate?
Thomas Walsh 21:10
Good question. So the interest rate is typically the stated rate that you see for the loan. The APR is what's known as the “annual percentage rate.” And that one bakes into the interest rate. It adds in the effect of different expenses, like the loan origination fees or annual administration fees. It will essentially increase — it will typically be higher than the stated interest rate,
because it builds [in] some of those extra fees that come with the loan. It builds it into the interest rate. So you're actually getting the real rate of interest that you're paying.
So it lets you compare a little bit more apples to apples between lenders, too.
So when you're comparing these kind of loans, sort of stepping back and looking at the big picture, if you're a student who could maybe go to an elite institution, an Ivy or something with similar
brand recognition, for lack of a better term, but that would require you to take out student loans, versus you could go to an in-state school or somewhere a little less prestigious but graduate without the debt. If you had a client considering that, or a client's child considering that, what would you advise?
Well, it really depends on how much you plan to borrow and what you expect to do after graduating. If you pursue a degree in say engineering or business,
you may be able to repay your loans within a reasonable amount of time. But if your heart lies in a field like journalism, or if you anticipate graduate school, the prestige of an elite university is likely not worth the stress of starting a career or financing another degree with tens or even hundreds of thousands of dollars of debt. And, you know, since flagship state universities can be regarded as highly as many private schools are,
those are sometimes the best bets for academically gifted students who want to position themselves for success.
Good advice. And I think advice that current students are probably taking even more seriously after seeing what happened to the students who preceded them. So Thomas, was there anything else you wanted listeners to know about funding education that we haven't already covered?
I think I would just say that at a high level, the way that you should prioritize
funding your college education, it really boils down to the level of financial aid that you expect to receive. If the student is unlikely to qualify for most forms of need-based financial aid, then the best option is to pursue merit scholarships first, and then maybe turn to any saved funds you have in a Section 529 plan, ESA or custodial account. And if additional funds are needed after that,
you should look into work-study programs, and only turn to student loans as a final, last resort. For students who will qualify for need-based financial aid, I recommend turning to federal grants and need-based scholarships first, as the best choice for education funding.
Excellent. Well, thanks so much for coming on the show today, Thomas. It was a pleasure talking to you.
Of course. Thanks for having me, Amy.
Amy Laburda 24:28
“Something Personal” is a production of Palisades Hudson Financial Group, a financial planning and investment firm headquartered in South Florida. Our other offices are in Atlanta; Austin; the Portland, Oregon metropolitan area; and the New York City metro area. “Something Personal” is hosted by me, Amy Laburda. Our producers are Ali Elkin and Joseph Ranghelli. Joseph Ranghelli is also our director, editor, and mixer. Our firm has written two books:
Looking Ahead: Life, Family, Wealth, and Business After 55 and The High Achiever’s Guide to Wealth, which offers advice for younger professionals, entrepreneurs, athletes and performers. Both books are available on Amazon, in paperback and as e-books.