The Myth of the College Savings Penalty

As a continuation of the Fee-Only Financial Advisor blog sharing group, this month’s post comes to us from Ann Garcia, a Financial Advisor in Portland, OR.  She shares her thoughts on saving for college and some of the myths surrounding the idea that one can be penalized for college savings by receiving less financial aid.

One of the most persistent—and pernicious—myths about college planning is that parents who save are penalized in the financial aid process for doing so. Perhaps you’ve heard, or even said, this: “I’m better off not saving for my kids’ college because I’ll just end up getting less financial aid if I do.”

It’s a common misperception and like many such misperceptions, it starts from a kernel of truth: Both the FAFSA and the CSS PROFILE ask you to report your assets as of the date you file their respective forms. And under the “assets” heading you’ll need to report on the FAFSA almost everything other than your retirement savings and primary residence, and on the CSS PROFILE essentially your entire net worth. But while the information requests are transparent, it takes some digging to understand what the formulas do with that information once you’ve reported it.

How Aid Eligibility is Calculated

The FAFSA is almost entirely income-driven. The formula allocates modest allowances against income—roughly the federal poverty rate for a family your size plus adjustments for taxes and a few other nominal items—and then assesses the remainder on a progressive scale which quickly reaches 47%. Which is to say that above a very modest income level, an additional $1,000 of income increases your Expected Family Contribution (EFC) by $470.

Assets get a different treatment. Net of allowances—generally around $19,000 for married parents or $7,000 for single parents—assets are only assessed at 5.64%. That means an incremental $1,000 of assets only increases your EFC $56, and only if you already had another $18,000 in non-retirement assets.

The CSS PROFILE, on the other hand, looks more at total net worth, but again income is the largest component of the formula. (Unlike the FAFSA, the CSS PROFILE offers schools leeway on what data they collect and how they calculate different items, so there isn’t a specific formula to point to.) In general the CSS PROFILE gives a slightly larger asset protection allowance than the FAFSA, but it also counts additional assets such as home equity. And similarly, it assesses assets at a fairly low rate.

The FAFSA 4caster, while not necessarily the most accurate predictor of your EFC, will at least give you a very helpful sense of how much savings would “hurt” you in the aid formula. Just plug in your data, then increase your assets by $10,000. The CSS PROFILE does not have a comparable tool; however, if PROFILE schools are among those you are considering, you can do the same exercise with their Net Price Calculators (generally found on the school’s admissions and/or financial aid web pages).

Need-Based Financial Aid

The college savings penalty myth has a corollary myth: that having a low EFC ensures that you will get gift aid. In fact, there is no requirement that schools meet your need; the phrase “need-gapped” refers to the situation where the offered aid does not make up the difference between the student’s EFC and the cost of attendance. And even when an aid package meets 100% of need, it’s highly likely that loans and work study are part of that package. According to the College Board, over 1/3 of undergraduate financial aid came in the form of loans.

Here’s an example of the breakdown of total undergraduate aid dollars from an actual public university:

Graphic - College Planning - Ann Garcia - June 2017

While most of those who applied for need-based aid received it (90%), only 10% had their full need met and less than 2/3 of the total need was met. Plus, comparing the average need-based loan to the average need-based scholarship shows how a large portion of that need is being met. Of course, every school has its own policies; you can get research schools you are considering at the College Board’s website.

In this case, a family that chose to forego savings in order to get more financial aid would find that their efforts were not very productive: They may or may not have received any aid at all, and even if they did it would not likely have met their full need, and even if they did they would still have loans.

Expected Family Contribution

A further consideration in choosing whether or not to save is this: Can you even afford your EFC? A family of four with income of $150,000 and minimal savings will have an EFC somewhere around $17,000. That means that the family is expected to spend the first $17,000 of college costs before aid kicks in. In contrast, if that same family had saved enough to have $5,000 annually for each student (let’s make it simple by saying they have $40,000 in assets when filling out their first FAFSA), their EFC would go up by about $1,400 the first year, but they would still come out ahead by $3,600 because of their savings. And as they spend down those assets, their EFC would go down as well.

Most families cannot come up with their EFC without some form of savings or borrowing. In effect, the formula is telling you that you need to save, because a family of four with $150,000 of income is unlikely to be able to hand over $17,000 out of pocket each year—but that family did have 18 years to come up with some savings. And if their aid package already includes loans, that leaves less borrowing options available.

The Subjective Side

Here is what an Occidental College financial aid officer had to say about families with high incomes and no savings: “I see so many well-to-do families appeal because of a job loss, and then you ask about assets and they have none. How can you have no assets when you’ve been making six figures for more than a decade?” Colleges expect that families have 18 years to prepare for college, and so they expect families to have some savings. Aid awards can have a subjective component to them—although EFC is determined and federal dollars must be allocated by formula, the college has some leeway in allocating institutional dollars in lieu of loans—so families should be aware of how a lack of savings might be perceived.

While it’s true that savings count in the aid formulas and can increase a family’s EFC, not saving for college will generally leave a family in far worse shape than does saving.

About the Author:

Ann Garcia, CFP®, is a fee-only fiduciary advisor and owner of Independent Progressive Advisors in Portland, OR. She also blogs about college planning as The College Financial Lady.

Unconventional Advice for College Students and their Parents

As a continuation of the Fee-Only Financial Advisor blog sharing group, this month’s post comes to us from Michael Garry, a Financial Advisor in Newtown, PA. He has some unconventional advice for college students and their parents.

Millions of high school students are getting notified of their college acceptances and will soon decide what to do next. Meanwhile, any story in the media about college always references the ever-escalating amounts of student loan debt. Those stories are almost always accompanied by news of the college majors that pay the most and conversely those that pay the least. If you want a life of misery, pick your college major by whatever pays the most when you are a high school senior.

Nothing could be more shortsighted than picking your major based on the earnings for it in one year out of time. You might work for 50 years after graduation. How likely is it that the major you pick based on one year’s earnings will still pay relatively well for a half of a century?

The field might not exist then. Many of the highest paying entry-level jobs now didn’t exist even ten years ago. Things change. Pick something you love and find a way to make money from it. With the rise of the Internet it is easier than ever to become an expert in your field and to make money from it as an entrepreneur.

There are people in every field doing that right now as you are reading this. You just need to plan for college like you would a business and you need to be creative. If you go to college for four years, taking courses with no plan, and then start sending out your resume in the spring of your senior year, then yes, you will struggle. You need to consider each course as an investment in time and money, and try to figure out how it will help you before you sign up for it. (Yes, I know there will be some courses you just have to take. You still want to figure out how to get the most out of them. Maybe it’s the content; maybe it’s the connections with the professor or other students. There will be something.)

If you aren’t sure yet what to major in, take all of your required courses first and see what you like. I was an undecided business major for almost two years. Then I became hooked on Finance and went with it.

In my MBA program I stuck with Finance because it was familiar. In law school I figured I might break from business and finance, but guess what? I found out that it really was what I liked so I took courses in finance, tax, and estate planning. I worked for a couple of years as a lawyer and I hated every second of it.

Fifteen years ago I made a break and started working as a financial planner. The courses that I took in tax and finance didn’t help me much as a lawyer back then, but have come in handy ever since. Now I get paid very well to do a job I love where I get to help people every day. What could be better than that?

Don’t be afraid to take out student loans just because you will have debt. It’s hard to go to college now without loans or semi-affluent parents who are generous. Debt is not evil. It’s very useful sometimes.

Just like your choice of a major, have a plan for how you will pay for college. You can’t just go in and hope for the best. Don’t be afraid to go to community college and state school. Take a little longer if you need to. The average student loan debt is about what a new car costs. Which one will provide you more value in the future? It’s education, by a mile.

Michael J. Garry, CFP(R), JD/MBA, is the owner of Yardley Wealth Management, LLC, and an independent Financial Advisor who provides Fee-Only financial planning services and investment management in Newtown, PA, and the author of Independent Financial Planning: Your Ultimate Guide to Finding and Choosing the Right Financial Planner

Developing a Strategy for Handling Student Loan Debt

Our Blog Post today is brought to you by fellow fee-only financial advisor, Gregory A. Johnston of Johnston Investment Counsel. His article discusses how to go about Developing a Strategy for Handling Student Loan Debt.  Gregory A. Johnston, CFA®, CFP®, CPWA®, QPFC, AIF® has over 25 years of investment and comprehensive finanical planning experience. He started Johnston Investment Counsel in 1997 as an independent, fee-only investment management and comprehensive planning firm located in Peoria, Illinois. His clients include individuals, retirement plans, and endowments / foundations.  Enjoy the article.

The amount of student loan debt is a significant issue in the U.S. The cumulative amount of debt is over $1.2 trillion and continues to grow. The burden of student loan payments force many recent graduates to move back home with mom and dad for several years or otherwise impedes traditional household formation activities (buy homes / cars or otherwise reduces financial flexibility).

Many have even wondered if going to college is even worth it. And, perhaps, for the first time in our history, this is a valid question one should consider. There appears to be a shortage of many trade jobs (plumbers, electricians, carpenters) who can make a good living.

There are things one can do before even going to college that can significantly reduce the total cost. The first is to realistically assess what the long-term income prospects are for their chosen degree and field.

If future prospects are financially modest, but are very personally rewarding, that does not imply do not go to college. In this scenario, as well as many others, one should spend considerable effort on trying to reduce the overall cost of college. The key, if future income is modest, is to not go into significant debt to earn your college degree. The cold hard fact is that not all college degrees are valued equally by the “real world”.

Some ways one might consider reducing the total cost of college include:

  • Going to the local junior college and living at home.
  • Cast a wide net in terms of selecting a college. While difficult, do not fall in love with a given school in that you are willing to pay any price. For many, where they go to college is an emotional decision, but the schools treat it as a financial decision. For every dollar they give you in an aid package, that is a dollar that cannot be used for someone else. Be as flexible as possible and play one institution off another.
  • Get good grades. Colleges are interested in getting good rankings which will help them attract good students (and future donors to their endowments). So if you have good grades, they may be willing to provide a better financial aid package. If you have average grades, there is no incentive for the college to invest heavily in you (in terms of financial aid).

So those are some thoughts on reducing the cost before your first day of going to “State U”.

Suffice it to say there are a variety of public and private alternatives for student loans. Because of the flexibility of some repayment options, one may have a preference for federally funded loans (more on this in a moment).

It is very important to read the terms and conditions of the loan so that you understand what you are signing up for. Unless you are totally disabled, student loan debt should be considered not dischargeable in bankruptcy. This simply means borrow what you plan on paying back because you will be paying it back – even if your future wages are garnished.

Loans typically do not require repayment while the student is in college, but the interest accrues and compounds from day one. If you choose, you could pay the interest cost on the loan while the student is still in school. Doing this will reduce the total cost of the loan.

Once the student has graduated, they need to decide how to pay the student loan back. There are a variety of repayment plans. While the following list is not all-inclusive, it provides a range of alternatives:

  • The standard repayment is 10 years. You would make 120 equal payments to discharge the debt. This would more than likely be the highest monthly cost but could be the lowest total loan cost.
  • Repaye. This is generally 10% of your discretionary income.
  • Paye. Generally 10% of discretionary income but never more than the standard 10-year payment plan.
  • Income Based Repayment. 10% of discretionary income for new borrowers after July 1, 2014.

Background information on different repayment plans is available at the Federal Student Aid Office website (

With the income based repayment, your student loan payment increases as your income increases. The income based repayment plans (Repay, Paye and Income Based Repayment) have a repayment period of between 20 and 25 years. The attractive feature of these income based repayment plans is that at the end of the repayment period any outstanding student loan balance is forgiven.

One possible “gotcha” is that any amount forgiven is considered taxable income in the year the loan is forgiven. So if $25,000 of a loan is forgiven, the taxpayer would add $25,000 to their income for that year. It could be a very nasty surprise, but as long as it is known, it can be planned for.

One other factor that should be considered is that adjusted gross income (or a modification of adjusted gross income) is used to determine the amount of loan repayment. If there is a couple that is considering marriage and there is a low and a high-wage individual, it is quite likely that their payment will increase as a result of the high-wage person.

It is important to realize that these programs are for federal loans only. If one consolidates all their loans with a single private company, they will only have the repayment options offered by that private company and, more than likely, no loan forgiveness options.

Another alternative is something known as Public Service Loan Forgiveness (PSLF). This program is usually available to individuals who work for the government or a qualified non-profit. Certain occupations are also targeted such as teachers and medical professionals who agree to work in underserved areas.

In addition to working for a “qualifying firm”, you must make 120 payments before the remainder of the loan will be forgiven. One may want to choose the smallest monthly payment as the remaining balance will be forgiven tax free (unlike the other income based replacement programs).

Today, the financial implications for those going to college are extremely high. There are ways to reduce the overall cost of college, but one needs to plan appropriately and realize that tradeoffs and choices may have to be made.

529 College Savings Plans

Many of my clients have children, grandchildren or other loved ones who plan to attend college in the future. However, it is becoming more challenging each year to plan for the cost of college as the costs are increasing at more than double the rate of inflation. This has been a consistent increase over the last 38 years. To put this cost increase in perspective, below is a chart comparing the rates of inflation over the last 38 years (since 1978) for college tuition & fees, medical care, new cars, and the overall consumer price index (CPI):

College Tuition Inflation - 12-1-2016

Chart courtesy of

Here are some current average “all in” college costs (tuition, fees, room and board) in today’s dollars:

• Public University – In-State – $20,100/year
• Public University – Out-of-State – $35,400/year
• Private University – $45,400/year
• Harvard, Stanford, Yale or similar = approximately $54,500/year

I can understand why many students have turned to student loans to partially or fully pay for college. In fact, today two-thirds of students graduating from American colleges/universities are finishing school with some level of debt. I have read that the average borrower is $29,400 in the red. Also, total student loan debt outstanding recently crossed the $1.2 trillion mark!

The good news is that if you have the means to save for a loved one that wants to attend college, there is an excellent savings vehicle for this purpose called the 529 College Savings Plan.

What is a 529 plan?

A 529 college savings plan is a tax deferred savings plan sponsored by a state to allow families to save funds for future college costs. They share some characteristics similar to IRAs and Roth IRAs. There are two types of 529 plans: prepaid tuition plans and savings plans. Prepaid plans are plans that allow you to prepay tuition at a particular college in advance at today’s prices. The most common type of plan is the 529 savings plan and that will be the focus of this article.

What are the main benefits of 529 savings plan?

One of the greatest benefits of this type of plan is that all contributions and earnings grow tax deferred like an IRA. And as long as the funds are used for qualified education expenses, all distributions from the plan are tax-free like a Roth IRA.

What are qualified educations expenses?

Qualified education expenses include tuition, fees, books, supplies, and equipment (computers) required for study at any accredited college, university or vocational school in the United States and some international schools. This can also include room and board.

How much can I contribute to one of these plans?

Most plans will allow you to make total contributions of up to $200,000 to $300,000 over the life of the plan. Since these contributions are considered gifts to your child, grandchild or other loved one, you will want to ensure any annual gifts stay below the annual gift tax exemption amount of $14,000. For those interested in making a larger lump sum gift, 529 plans specifically allow a gift exemption of 5 years’ worth of annual gifts to be made in one year or $70,000 (5 x $14,000).
These contributions are permanent gifts for estate tax purposes. Thus, for those with large estates, this is another way to gift family assets down the line but still maintain control of the gift if you are also the owner of the 529 plan.

Who is the owner of the 529 plan?

There is always one adult owner and one beneficiary (future college student) per 529 plan. Any adult can be the owner of the account. This is typically a parent or grandparent, but could include any adult family member or friend.

What if I save for college but my child receives a scholarship?

529 plans allow you to change the beneficiary of the account. Thus, if you have another child that needs more financial assistance you could make a change to designate them as the new beneficiary. Or, if the child may pursue a graduate degree, they could use the funds for later educational funding.

What happens if we use the funds for something other than a qualifying college expense?

Contributions and earnings are distributed on a pro-rated basis. You will have to pay taxes on any of the earnings distributed and also pay a 10% withdrawal penalty on the distributed earnings. There is no penalty or taxes on the distribution of original contributions.

You mentioned these are state run plans. Does that mean I need to invest in my home state’s 529 plan and must my child go to college in this same state?

Another great benefit of 529 plans is that you can invest in any state 529 plan and your child can go to any school anywhere in the United States, or certain schools outside the U.S. For example, you may live in Arizona, but you could decide to contribute to a 529 plan in California and your child may decide to go to school in Colorado.

If almost every state has a 529 plan, which one should I choose?

Out of all of the state 529 plans, there are a handful which are consistently ranked near the top each year for being well run plans, with excellent investment choices and reasonable fees. The one I highly recommend is the 529 plan run by the state of Nevada and administered by Vanguard. I personally use this plan for my two kids.

Morningstar recently ranked the best and worst 529 Plans for 2016. You can read the article here:  Morningstar has consistently given Vanguard’s 529 plan a top rating every year. Also, as the 529 plan has grown in assets, Vanguard continues to reduce the expense costs of the investment choices. There are other great choices for 529 plans as discussed in the above article if you prefer a different investment custodian.

Another great website resource to research and learn about saving for college and 529 College Savings Plans is at

Are there any additional tax benefits besides tax deferred growth and tax-free distributions?

Many states allow you to take a deduction against your state income tax return for any contributions made to a 529 plan each year. In Arizona, they recently increased this deduction to $2,000 for an individual and $4,000 if married and filing taxes jointly. Arizona is also very flexible in that you can make a contribution to any 529 plan in any state and still use the Arizona deduction against your state income taxes.

Below is a link to a chart of all current state tax deductions available by each state. You will want to review this with your financial advisor to help you determine which 529 Plan may be the best option considering your state of residence.

What are my contributions invested in within the 529 plan?

Most plans have a mix of mutual funds and age-based funds to invest in. Your financial advisor can help you determine the best asset allocation for each child. Note, 529 plans typically limit investment exchanges to twice per year.