Higher education is expensive—frighteningly expensive. For most parents, providing for their children’s college education is second only to retirement as their largest investment goal. But even with diligent saving, the first tuition bill may be a shock to your clients, so you may want to keep a jar of smelling salts on your desk just in case.
How can you help your clients face this fear head-on? It’s all about creating a solid plan. With a proper plan in hand, you and your clients will be better prepared to tackle college tuition bills in an organized and financially sound way. Sallie Mae recently published research titled “How America Pays for College 2016,” that reported families are paying less out of pocket for college as they take advantage of scholarships and grants. The report noted that scholarships and grants funded 34 percent of college costs in the 2015-2016 school year, up from 30 percent the prior school year.
Vanguard’s new research, Tackling the tuition bill, provides a practical framework to help you develop a plan with your clients. In this post, I’ll explore the factors that affect financial aid eligibility. (In Part 2 of this series, I’ll provide tips on how to help your clients maximize federal tax perks while also considering how to spend tax-efficiently from assets earmarked for college.)
As you know, household assets and income affect financial aid eligibility, but these sources are not treated equally, based on whether they come from the student or the parents. The graphic below summarizes the key points—income matters more than assets, and student income matters more than parental income.
So what does this mean? Obviously, individual circumstances will vary, but here’s a savvy strategy to pitch to your clients:
- Spend the student’s assets first.Because student assets affect aid eligibility more than parental assets (oddly enough, 529s owned by dependent children are considered parental assets), it can make sense to spend student assets before spending from a 529 plan. Such an approach gives 529 savings more time to compound tax-free. And by spending the more heavily penalized assets early, students increase their aid eligibility in later years, when inflation may boost tuition costs.
- Tell the grandparents to hold off.Gifts from grandparents and others are considered student income, which has the greatest impact on your student’s financial aid eligibility. As a result, consider tapping those grandparent-owned 529s in the later years of college, when they will no longer be reported or considered in financial aid evaluations.
- Don’t drain the 529 right away.Parent-owned assets, including 529 plan accounts, have more limited impact on aid eligibility. Unless a client plans to pay for the entire degree with 529 savings, it can make sense to spend from this account strategically over the course of a student’s college career. The account can benefit from continued tax-free growth. A client may also be able to time 529 withdrawals to create opportunities for additional aid or benefits.
I realize there’s a lot for you and your clients to think about; but with a bit of knowledge of the rules and some planning, the tuition bills can be tamed. Look for part 2 of this series, in which I’ll share some tax-savvy tips for tackling tuition.
Maria Bruno, CFP®
Senior Investment Analyst
Vanguard Investment Strategy Group
Editor’s note: This post originally appeared on the Vanguard Advisor Blog. The author also gives a special thanks to her colleagues Jonathan Kahler and Jenna McNamee for their research contributions.