It’s back to school season, and that means it’s also the time of year for high school seniors to start agonizing over college applications.
Applying to college is an anxiety-filled rite of passage for high school seniors, but it’s often just as anxiety-inducing for parents who bang their heads on how to pay for it.
That’s because paying for college is, for many families, the biggest single expense they’ll have for their child. It’s also often the second biggest life expense a family will incur, right behind buying a home. Paying for college is like buying a Tesla Model Y and giving it away. Every year, for four years.
So this week, I chat with my friend Ann Garcia about how to pay for college. She just wrote a new book on this topic, which we discuss in detail, along with important new updates to the federal financial aid process (FAFSA) + key things to know about 529 plan rules.
- Why Ann decided to write this book now, what makes it different
- The mind-boggling cost of college today; forecasted cost in 15 years
- Why college costs so much now, what’s driven up the cost in recent decades
- Goals that colleges are trying to accomplish with their financial aid awards
- Things parents should do to prepare their child and finances for the cost of college from birth to high school
- Why it’s important for your child to do the official campus tour for colleges they’re interested in
- Recent key changes and updates to the FAFSA process
- Difference between 529 savings plans vs. pre-paid tuition plans vs. Private College 529
- Mechanics of 529s: roll-over-ability, qualified expenses, taxes & penalties for non-qualified expenses, how scholarships are handled, changing beneficiaries
Have you been through (or will soon go through) the college financial aid process? What’s been the most confusing or frustrating aspect? Let me know by leaving a comment.
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- Book: How to Pay for College: A complete financial plan for funding your child’s education
- Online course: The College Financial Plan Masterclass – 20% discount exclusively for HYW subscribers (use code: HYW20)
- 529 college savings plans: rules, tax benefits, & qualified expenses (HYW026)
- College financial aid tips and strategies, with Ann Garcia (HYW053)
- College student financial aid changes coming to the FAFSA application (HYW079)
- Schedule a private 1:1 consultation with me
- HYW private Facebook community
Read this episode as a post:
Andrew Chen 01:22
My guest today is my friend Ann Garcia.
Ann is a Portland-based Financial Advisor who specializes in college financial aid planning.
She advises parents on how to navigate college financial aid, and she writes frequently on this topic on her blog: TheCollegeFinancialLady.com.
She also has a new online video course out on college financial planning at: howtopayforcollege.com
And she’s offering a discount off her course exclusively to Hack Your Wealth podcast listeners, which I’ll talk about at the end of the interview, so stick around for that.
I’ve had Ann on the podcast a couple times in the past. And I invited her back today to talk about her newly published book: “How to Pay for College: a complete financial plan for funding your child’s education.”
We’ll also hear about the latest updates and changes to the financial aid process, including simplification to FAFSA that’ll fully roll out next calendar year. And key tips to keep in mind when applying for college financial aid.
With the new academic year starting up, I think this will be an insightful and informative episode, so stick around for a good conversation, and let’s dive in!
We’re here, obviously, to talk about your book. It was a great read.
This is definitely one of the better personal finance, just in general, let alone college financial planning books that I’ve read. I’m not being paid to say that, by the way.
Ann Garcia 07:16
Thank you for saying that.
Andrew Chen 07:21
The thing I like about it was it was very no-nonsense, no fluff, just straight to the point, and covered all the aspects that one would need to know from start to finish. I wanted to start by just understanding, why did you decide to write this book?
There’s lots of financial aid books and guides out there. Why this moment? What makes your book different?
Ann Garcia 07:41
A lot of it was just prompted by the pandemic. There we were, in spring of 2020, with a whole bunch of time on our hands, and it’s something that I had toyed with in the back of my head for a long time, having written a blog about college planning for going on 10 years. At that point, I thought, “Well, maybe I could organize this all into a book, and now would be a good time to do that.”
And just as I started thinking about it, I was listening to an industry podcast, it was about writing for your practice, and they were talking about doing a blog, and one of the hosts said, “The great thing about doing a blog is it’s really easy to turn it into a book.” And then he said, “And by the way, there aren’t very many books in our industry by women, so if you’re a woman who wants to write a book, I want to help you.”
One of those things was true. He did want to help me and was very helpful. The other one, that it’s easy to turn a blog into a book, is maybe less true.
It was a whole lot more work than I expected that it would be. But it was a fun project, and I’m glad it’s done.
Andrew Chen 08:59
To open, let’s set the stage for how important it is to get college financial planning right in the first place. For a parent sending their kid to college next year, this upcoming year, what is the cost of attendance range that they’re going to be staring down if they have to pay full sticker price for a four-year nonprofit university, spanning low to high, public to private? Basically, how expensive is college today?
Ann Garcia 09:26
The list price of college today is very high. Your public universities, your four-year flagship schools, are going to run $25,000-45,000 a year, full price.
Andrew Chen 09:44
Just tuition or all in?
Ann Garcia 09:45
That’s all in, usually, room and board. Obviously, there’s some room around those numbers. There are definitely some outliers on both ends.
Private colleges, many of them are $75,000-80,000 a year or more, list price. But I think one of the really important things that families need to understand is not very many people pay list price. And while tuition inflation for list prices has been quite high forever, averaging 5% or 6% per year, the actual net cost that families pay really hasn’t budged for the last decade.
So, while those list prices are going up, and while there are certainly plenty of people who are willing to pay those list prices, that doesn’t mean that your family has to pay that much. In fact, for last year, the average tuition discount rate across four-year colleges was about 54%, which means that for every $1000 of tuition that is being charged, $540 of it is not paid, so only $460 is actually coming out of anyone’s pockets.
So, those are really the numbers that families should be thinking about, far less than the $75,000-80,000, but “What is college actually going to cost my family?”
College is a lot like air travel. You and your seatmate on the airplane could be paying vastly different prices for the exact same service.
Andrew Chen 11:39
So, if you just follow the growth lines, for parents of young children or toddlers, who are going to be sending their kids to college in 15 years (which is about when I’d be sending my kid), on the current path, if it continues, what is the cost range they’re going to be facing? Again, full sticker price, four-year university, low to high, at the current rates.
Ann Garcia 12:04
If current trends continue, you’re looking at double the current rates. At 6% increase per year, in 15 years, you’re going to be more than double where you are right now. And part of me says that’s completely unsustainable, but I also look back to when my kids were your kids’ age, and I thought that the path we were on at that point was unsustainable as well.
The thing is if you look at any of the higher-end private colleges, anywhere between a quarter and a third of students there, their families are not even filing the FAFSA or the CSS Profile, so they walk in there expecting to pay full price.
So, while normal talk about “This is not sustainable, not acceptable, not something my family can do,” if you’re a college and you’re seeing lots and lots of people are willing to pay the cost, why wouldn’t you keep raising it?
Andrew Chen 13:09
Help us understand why college costs so much today. The sticker prices today are pretty breathtaking compared to what college cost when I was a college student, which I guess was a long time ago, but it doesn’t feel like a long time ago.
Ann Garcia 13:23
There’s so many factors that go into the cost of college. I think one of the big ones is just the increase in administrative and other service costs that are in colleges. There’s far more career counseling, and far more academic advising, and far more support services than when you and I went to college.
And if you think of it, in a way, it makes sense. The risk of failure at college is much higher than it was when I went, so colleges do have much greater incentives to make sure that students got through in four years and to provide all the support that goes along the way.
My husband went to the University of Michigan, and at his orientation, they said, “Look to the person at your left. Look to the person on your right. At least one of you isn’t going to be here at graduation.”
No college would ever say that anymore. They all want to tell you, “You’re all going to be walking across the stage four years from now.”
So, that’s a big piece of it. I think this year, colleges are experiencing all the same inflation pressures that are everywhere else in the economy, so there are going to be some raises just on that basis.
At the state level, while higher ed funding as a share of the budget has stayed relatively constant, the number of students going to college is much higher than it was 20, 30, 40, 50 years ago. And the end result of that is increased need for facilities, construction, increased hiring.
In many cases, like in the UC system, opening new colleges. In many states, that’s part of it as well. And all of those have costs that trickle down.
Not to mention, on the public side, you have the impact of pension costs at the state level impacting budgets. And unfortunately, students are footing the bill for their professors’ pensions.
Andrew Chen 15:55
It makes financial aid all the more important, and knowing about it, and knowing how to get it. And I think it’s pretty natural for parents to think about financial aid from the vantage point of being the recipient. You want to reduce your expected family contribution, your student aid index, as much as possible, so that you can get as much financial aid as possible and not have to take out a bunch of expensive loans or give up your retirement.
But could you shed light on how colleges view financial aid? What are the goals they’re trying to accomplish with the finite number of dollars that they can grant, or award as scholarships, or disperse as loans? Help us understand their mindset.
Ann Garcia 16:35
I think it’s really helpful to look at things from the perspective of the colleges. We let the Stanfords and Harvards of the world drive far too much of the college narrative, and in fact, most colleges operate very differently than do Ivy League schools. Most colleges are actually actively trying to attract and enroll students.
So, when we have this vision in our head of college being this super exclusive experience, and we’d be lucky to get in, and we’ll do whatever it takes to go there if our kids get in, that’s really not how the college landscape works.
Colleges use the dollars they have available to them to attract the students that they want to have in their community. Putting together a college class is a lot like putting together a football team, or an orchestra, or any other multifunctional entity.
You can’t have all punters on a football team. You need a quarterback, wide receiver, linemen, and whatnot. You can’t have all piccolo players in your orchestra.
Colleges use their financial aid budgets to bring in the students that they want, and they use them very differently. Different schools have different wants.
One thing that a lot of people aren’t maybe as aware of is, for example, smaller private colleges love to be able to say that they have students from all 50 states. So, if you are a student from, say, North Dakota, it’s quite possible that you are the only student from your state applying to that college.
And they really want you to go, so chances are good that you will get that offer. And most students apply to colleges within about a 200-mile radius of their home, so looking beyond that is a great way to get more aid.
Other schools are trying to recruit a more diverse student body, and those schools will often focus on need-based financial aid as opposed to merit scholarships, to broaden the pool of students who can potentially attend there.
And then lots and lots of colleges want to become more exclusive, want to move up in the U.S. News and World Report college rankings, all of those things, so they tend to offer merit scholarships to students with good grades and good test scores.
So, lots of different ways that colleges use their budgets. But I think an important consideration when you start looking at the landscape of schools and deciding where you’re going to apply is: how is that school funded? Because that’s going to have a big impact on what dollars are available to you.
A school that’s largely funded by tuition has limited means to discount tuition. A school that’s largely funded by its endowment has a lot more options. And a school that gets state funding has a different set of options.
Andrew Chen 19:57
When I look at the U.S. News rankings, which probably have more authority over perceptions and decisions than they should, but nevertheless, they do…
Ann Garcia 20:07
There’s an actual conference that schools go to that’s all about the rankings, and how they work, and how to move up in the rankings.
Andrew Chen 20:18
It’s kind of sad, actually.
Ann Garcia 20:19
The tail is wagging the dog there.
Andrew Chen 20:22
Yeah, definitely. So, if you were to go down the rankings, roughly, at what numerical cutoff in the rankings would you say that the considerations that you just described actually really start to kick in?
If you’re Harvard College, you’re going to get all that stuff automatically that you described: you’re going to get great students from all states, etc. But as you move down, it’s going to be harder and harder.
I was curious, is there a heuristic that listeners can think about? Is it at 50, is it at 100, that the colleges really have to start to work harder to fill the class with a diverse collection of students, all 50 states, they want to use things like merit scholarships, all the things that you just described?
Ann Garcia 21:13
Yeah, I think it’s almost like a bell curve. You’ve got, on the one hand, the most selective schools out there: the Ivies, the Stanfords, the whatnot. None of those schools offer any merit scholarships because being fabulous is just table stakes to get in.
They don’t offer any merit scholarships, but they’re extraordinarily generous with need-based financial aid. And their approach is “We want everyone who we admit to enroll.”
So, their yield, which is the percent of admitted students who enroll, for most of those colleges, is 80% or higher, which means they don’t have to admit a whole lot of students, but they do have to make sure they all attend. So, those schools tend to be really generous.
But even within that top tier, there are some different levels. Like UChicago, for example, gives National Merit Scholarship and uses the FAFSA, not the CSS Profile, so their need-based awards are, in almost 100% of cases, going to be more generous than need-based awards from other schools of comparable academic profiles.
So, the top tier, very focused on need, with a few exceptions in there. The next tier of schools, maybe schools 10-25, in our experience of applying, and in looking at their websites and seeing what they offer, those were the least generous schools.
For reference (and I talk about this a lot in my book), my daughter applied to 10 different colleges. We didn’t bother applying to anywhere she wasn’t going to get any financial aid.
Her actual cost in the award offers she got ranged from $11,000-56,000 a year. So, big range of numbers in there. And we found the least generous ones were that next tier down from the little Ivies or the Ivy Plus schools.
Once you get below those schools where you have colleges that are accepting probably half of applicants or more, and who want to be top 25 schools, or top 50 schools, or top 100 schools in their categories, those are the ones where you start seeing much more generous scholarship offers.
Andrew Chen 24:20
So, is it fair to say roughly number 25 is where you start to see that inflection point happen for real?
Ann Garcia 24:29
Probably somewhere around there. It’s going to vary from year to year, because the rankings vary from year to year, for lots of reasons. Think Columbia.
Andrew Chen 24:41
That’s a little bit of a smaller number than I expected because they’re definitely good schools sub-25. They’re fantastic schools sub-25.
Ann Garcia 24:50
They’re fantastic schools. And just because U.S. News doesn’t put them in the top 25 doesn’t mean they’re not great schools. U.S. News has a specific set of criteria, and they’re not necessarily the criteria that are going to make this the best college experience for your child.
Andrew Chen 25:16
Why are the ones from roughly 10-25 the least generous? Because they’re good schools, I assume. When they admit students, they want them to enroll to improve their yield, and also so it’s less work for them.
And they’re desirable too. They’re fantastic schools, 10-25, yet why are they so ungenerous?
Ann Garcia 25:40
Because they can be, honestly, is the answer. One of the things I thought was so interesting with those schools, there’s Ivy League acceptance day. All the Ivy Leagues send out their acceptance letters or emails on the same day.
And then most of the schools in that next tier send out their acceptances the day after, on the assumption that you’re not going to make a decision about (and I won’t list any school names here) this school until you’ve heard from Yale or Stanford or wherever else. They know that all of those same kids who are applying to the Ivies are applying to their schools, and they’re going to get the ones who don’t get accepted to the Ivies, which is the majority of applicants there.
Andrew Chen 26:29
And is it also then a fair assumption to say most of those students will not matriculate lower than 25? So, the 10-25 range, they’ve captured the remaining students who don’t accept the Ivies?
Ann Garcia 26:46
A lot of them. It’s funny for us on the West Coast because we have great public universities here, and great students go to our great public universities, but that is not the case consistently across the country. I talk to so many families who just wouldn’t even consider sending their kids to a public university.
So, yeah, they are looking to hear from those other schools, and they will choose one of them.
Andrew Chen 27:18
In one of your early chapters in the book, you lay out a roadmap or timeline for key tasks and conversations that parents should do to prepare their child and their finances for the cost of college. And it progresses from the time kids are born to the time they’re submitting their applications.
Could you walk through some of the key highlights of the major tasks and conversations that parents should be doing at each of those major milestones of their child’s growth to be well-prepared for this? You don’t have to get into all the detail, but maybe just some of the highlights would be awesome.
Ann Garcia 27:55
I think one of the most important things to remember is the earlier you start to plan, the more choices your child will have. That’s not to say that it matters what preschool you go to. It just matters that you are disciplined and intentional about your savings, and that you have a clear set of goals and values for your family.
I always recommend that as soon as you are pregnant, set up a 529 account. Why? Because you’ve got more time then that you will for the next 18 years, and because people are going to be giving you money.
So, get your 529 account set up as early as possible.
When kids are very young, it’s so helpful for the parents to have conversations among themselves about what their expectations are for college. Not just “We’re going to pay for college” or “We’re not going to pay for college…”
…but “Is college something that you see as an essential step in life? Do you have strong feelings about public or private colleges?”
Have those conversations among yourselves when your children are young, and get on the same page about where you see that and how you’re going to communicate that. That doesn’t mean that you have to agree on everything. It means you have to agree on how you’re going to communicate to your children in a respectful manner that incorporates both parents’ points of view.
As they get older, getting into elementary school, I always feel like that’s a great time to just incorporate college into your everyday conversations.
Maybe it’s talking about friends you made in college. Maybe it’s going to a college football game. Maybe it’s some fun fact you learned in a class you took in college.
Those are good conversations to have with young kids: just introducing the concept of college as something that you’d like to put on their radar screen.
I also think as your kids transition from daycare to school, it’s a great time to increase your contributions to your 529. In fact, I would recommend every year on your child’s birthday is a great time to increase your contribution to your 529.
Once kids hit middle school, I think it’s really valuable to start some actual college planning. One thing that families can do at that point is do the Student Aid Estimator on the Department of Education website. That will help you figure out if you’re likely to be a candidate for need-based aid or if you should be looking for merit aid.
It’s also a great time to look at what scholarships your in-state public schools offer, because you can make sure that you’re on the right academic trajectory, once you get to high school, to get there.
Once students are in high school, freshman year is a great time to really look at your budget and come up with a good sense of what you can pay for, both from savings and from cash flow.
And of course, that will change over the years, but having that as a starting point, that lets you know, “Do we need to do more? Are we okay with what we’ve got?” And you’ll have a sense of what academic trajectory your kids are on.
That’s also a great time to start talking about college costs with your student. I think those conversations need to be goal-based, which means not “You can only go to a public school because that’s all the money we have…”
…but “We would like you to get through college with a minimum of student debt. We have saved enough where we know we can get you through a public school with no debt. You might be able to find some other options that work with our budget as well, and we will absolutely support you in that process.”
And again, look at your savings rate, look at your budget, and start building a spreadsheet of colleges that you’re interested in and tracking what they’re likely to cost someone like you. My book has a really detailed plan for all of this, so check that out. It walks you through all the checkpoints there.
Andrew Chen 32:23
In your book, you talk also about how important it is for students, as they’re approaching the application season, to do the official school tour, and also to respond to emails and other contact from schools they’re interested in, because that demonstrates interest, which is an input to both admissions and financial aid at many colleges.
After all, they want to admit students who are going to enroll because that allows them to increase their yield, decrease their admission rate, good for U.S. News ranking. Makes sense.
Do you have any insight on how colleges actually use the info? When you respond to outreach or tour the campus, do you get put on a watchlist or some kind for those admissions and financial aid review committees?
Ann Garcia 33:13
It’s different at every school. Honestly, that’s the challenge of college planning. Every school has their own set of processes and criteria and priorities and everything else.
But for schools that track demonstrated interest, which is a lot of them, they’re just looking for “Have you done something to interact with us?” And I think a lot of students are under the mistaken impression that because they’re getting an email from a college, that means they’re in the college’s database.
And it doesn’t mean that. It means that the college bought a list of people who had an ACT score above x number, or some other list that they’re on, and got it.
Colleges are more likely to admit students who they think are going to enroll, and they’re more likely to give good financial aid packages to students who are likely to enroll. So, by demonstrating interest, you do increase your chances of admission at a lot of schools.
I’d say that is not the case at a large public school, it’s not the case at many more exclusive private schools, but it costs you nothing. So, if a school is important to you, follow them on social media. Respond to their email.
There’s a reason why they’re offering something, and that’s because they want you to respond and get in their database. And yes, they’re going to continue marketing to you, but you’re not in their database until you’ve engaged with them.
And similarly, if you’re going to visit a college, don’t just walk around the campus by yourself. Do the official tour. You’re going to learn things on the official tour that you’re not going to learn just from walking around, but you’ll also be in their system as someone who’s interested in their college.
One of the few silver linings of the pandemic is schools have terrific tools to engage students without the student making a visit. There are great virtual tours on their websites.
You can reach out and say, “Hey, I’m interested in studying math at your college. Can I talk to someone in the math department?” And chances are good that you will talk to someone in the math department.
If it’s a school that’s across the country, you can ask them to put you in touch with students from your area. So, there are lots and lots of easy ways to engage with the college, so you are doing yourself a disservice in the admissions and the aid processes if you don’t do that.
Andrew Chen 35:51
I understand you mentioned that some of the more selective schools, let’s say above rank 25, it probably doesn’t matter because they’re going to get good applicants anyway. They’re not going to have too much of a problem filling their classes.
You also mentioned large in-state public colleges. I think I heard you say it doesn’t matter so much there, and I was wondering why.
Ann Garcia 36:14
Colleges do admissions one of two ways. One is holistic admissions, when they look at the full package of the student. And the other is just numbers-based.
There’s a guy who writes a great college admissions blog who compared it to the Olympics. It’s like the difference between track and ice skating.
At those big public schools, by and large, you’re going to get admitted if your GPA is above a certain threshold, and if they require test scores, if your test scores are above a certain threshold. They might require you to submit your common app essay, but there’s a good chance that they won’t read it because they’re going to admit all the students who meet certain numeric criteria.
Other colleges that do holistic applications (look at the whole person), that’s where things like demonstrated interest can be more important. And you can look on the college data website, which is collegedata.com. It shows whether demonstrated interest is something that a college tracks.
But again, it costs you nothing to demonstrate interest, so why run the risk that it mattered to the college and you didn’t do it because you thought it didn’t?
Andrew Chen 37:33
That makes sense. I wanted to talk a little bit about FAFSA. Your book does a nice job explaining the FAFSA process, how it works, so for all those details, I’ll just point listeners to your book.
But could you talk a little bit about any important changes and updates to the FAFSA process, including the move towards simplification that are now starting to roll in, or are upcoming in the next one to two years that parents should be aware of?
Ann Garcia 38:02
A couple of years ago, a bill was passed as part of the pandemic relief bills that had a section called FAFSA simplification, and the goal was to make it less cumbersome to file the FAFSA. And I won’t go into a lot of editorial detail about how I would have simplified the FAFSA, which would have been different from this. But they’re four big areas of change in the FAFSA that are being phased in this fall and next fall.
The big one that’s going to impact a lot of people is, currently, your expected family contribution is based not only on your parents’ income and assets, student’s income and assets, and the size of your household, but also, it’s divided by the number of students in college from the family. And that is going away, so instead of it being expected family contribution for the whole family, it’s the student aid index, which is per student.
So, families who, in the FAFSA formula, were having a low EFC because of having multiple children in college, their EFC will change just due to the FAFSA not considering how many kids are in college anymore.
Another big change is, in the current FAFSA, there’s a question which is money paid on your behalf, and that basically is asking you, “Did anyone else contribute to your education?” The big source where this comes into play is when grandparents have set up 529s for the kids, and the kids take the money out. That turns into income to the student in that year.
That question is going away, so it’s basically a freebie for grandparents who are saving for college.
Another area of change is for divorced families. Under the current FAFSA rules, the parent with whom the student spends the most time is the custodial parent whose income and assets are reported on the FAFSA. With the changes, the parent who provides the most financial support to the student will be the one who fills it out.
This is very impactful for a student whose parents are divorced, maybe they live with a stay-at-home parent, and the other parent is a high earner and pays child support. Under the current rules, only the child support would be a factor in the student’s income. Under the new rules, the higher-earning parent’s income would be included.
And then there are some little adjustments to the formula: changes in the income protection allowance and a few other things.
Another big change that isn’t really part of how the formula is structured is the expected family contribution is being renamed to the student aid index. It’s an insignificant change, but I think it’s a good one.
Because the problem with expected family contribution is you might hear expected family contribution and think that’s what your family is going to be expected to contribute to college. In fact, it’s at the discretion of the college what they do with your expected family contribution. Do they meet your financial need: all of it, part of it, using grants, using loans?
So, I think it’s good that it’s being renamed. The new name is student aid index. The unfortunate thing is, honestly, if they’re going to do it as an index, it should just be a number.
Maybe it’s 1-10, maybe it’s 1-100, but it’s still a dollar number that looks an awful lot like the expected family contribution. So, those are big changes, but there are a few caveats to them.
Number one is the only place where this is absolutely the only formula that’s used is in the federal needs analysis methodology. That is eligibility for Pell Grants. It’s eligibility for work study.
It’s still up to the colleges what they do with all of this information. And many of them will still continue to offer what’s called a sibling discount, where you have multiple children in college, because of course, your income and your assets can’t be spent twice. They can only be spent one time.
The other thing is the CSS Profile, which many private colleges require you to fill out, does still ask for the grandparents’ 529s. The profile has always required you to report all 529s for which your child is the beneficiary, and that certainly hasn’t changed.
Now, it is entirely possible that one quirky outcome of this will be that it’s far cheaper for a lot of students to attend private schools than public schools, because public schools use the FAFSA whereas private schools use the profile, and private schools are the ones who can add their own questions.
For example, my daughter’s college uses the FAFSA, but then they also have some supplemental questions, and they’ve added a question about how many students are in college to their supplemental questions.
Andrew Chen 43:24
Does the CSS profile follow any of these simplification changes at all, or not?
Ann Garcia 43:30
No, they’re keeping the students in college, keeping reporting of other 529s. Most CSS Profile schools require both parents, in case of divorce, to report income and assets.
Not all do. There’s actually a list on the college board website of which ones do it. So, these are really just impacting the federal needs analysis methodology.
Andrew Chen 44:04
In your book, you talk at length about 529 plans. Could you talk a bit about the different types of 529s and, in particular, the difference between the regular state-run 529 plans versus prepaid tuition plans and the private college 529? What are each of these?
How do they differ? What are the tradeoffs? And who is each one best suited for?
Ann Garcia 44:27
Great question. There are two big buckets of 529 plans. There are 529 savings plans, and then there are prepaid tuition plans.
529 plans are the ones that you think of. They’re the plans that are run by states, where you sign up, you make a contribution, you choose an investment portfolio, and you experience the market returns that that investment portfolio generates. That’s a 529 savings plan, and that’s what most of us think of when we think of a college savings vehicle.
There’s another type of plan called a prepaid tuition plan. In a prepaid tuition plan, basically, you’re buying tomorrow’s tuition at today’s prices, so your returns are based on the actual inflation rate of one or more colleges.
There are several states that offer these plans. Typically, they only offer them to state residents.
Washington has one. I think Florida has one. Pennsylvania has one.
There are a few different ones, and each of them has their own formula for which inflation marker is used. For example, in Washington, the school with the highest tuition inflation is just the inflation rate that’s used every year.
Then there’s another prepaid tuition plan called the Private College 529. Private College 529 is just a consortium of a couple hundred private colleges, where if you use their plan, you get the actual tuition inflation at the college that you ultimately attend.
So, I think that prepaid tuition plans are great when you’re a resident of a state that offers one. They are a great addition to your savings plan.
Now, one of the things with prepaid tuition plans is the word “tuition.” There are a couple of exceptions, but in almost all cases, prepaid tuition plans can only be used for tuition, so you will need extra dollars for room and board.
And that’s where a savings plan is a good complement. When you get closer to college, those are a great addition.
There are a few considerations in deciding between a savings plan and a prepaid tuition plan. One is what prepaid tuition plans are you eligible for, and does your state offer one or not? The other is do they have any lock-up requirements?
Generally, with a prepaid tuition plan, they’re assuming that over the long term, they can earn higher investment returns than the rate of tuition inflation, but they will typically require you to keep your money in the plan for three years before you withdraw. So, oftentimes, start of high school is a really good time to start adding dollars to those plans.
The other big question is what colleges can you use these plans at? Now, most state plans allow you to use those dollars at any college, and typically, they will give you the in-state tuition inflation rate. Sometimes it’s modified down.
So, let’s say I’m a Washington resident and I’m in Washington’s GET prepaid tuition plan, and in-state tuition goes up 5% every year. So, my account balance is growing at 5% every year, and I can take that 5% growth and use it at any college that I choose to attend.
Andrew Chen 48:25
Even outside of Washington?
Ann Garcia 48:26
Even outside of Washington.
Andrew Chen 48:28
Even private universities?
Ann Garcia 48:31
Yeah. So, it’s a great late-stage vehicle when you’re eligible for it because you’re guaranteed a return on your dollars with no risk to your principal. The worst thing that can happen is tuition doesn’t go up.
Andrew Chen 48:56
So, let’s just run with the Washington example. Is it accurate to say that I’m a resident of Washington, I contribute to the prepaid tuition plan for Washington, I could actually spend the money at the same schools, and maybe even more schools than the Private College 529?
Because it sounds like the state-run prepaid tuition plan is valid to be used at any school. The private college one, you have to be part of the consortium. Is that correct?
Ann Garcia 49:20
That is correct. Most state plans let you use it at any school. They might nominally discount the tuition inflation rate if you go out of state, but by and large, you will get that investment return at any college you use it for.
Now, the private college plan is different. If you go to one of their member schools, then you get that school’s actual tuition inflation.
If you don’t, you get a much lower rate. I think it’s about 1.5%. In the current environment, for the past year, you would have done better on that than in a state plan, because most of the state plans have you in various investment vehicles, bond funds, short-term TIPS, and stuff like that, which still haven’t had a fabulous year.
The other thing with prepaid tuition plans is the tuition price typically resets once a year. So, unlike the market returns that you get in a 529 where you have a different account balance every single day, in a prepaid tuition plan, you buy a certain portion of a year’s tuition, and the value of that changes once a year.
So, a great strategy for anyone whose student is accepted to a Private College 529 college in the spring is to buy senior year’s tuition that year, because as long as you buy it before June 30th when tuition rates reset, you get senior year of high school’s tuition rate for senior year of college’s tuition.
For example, my daughter goes to one of the Private College 529 schools. After she was accepted, I put some money in the Private College 529, and we’ll be using it for senior year. And that’s been the best-performing piece of her 529 over her college years because it’s gotten that inflation rate, and we discounted back a year because we bought it at high school senior’s tuition rate, not college freshman.
So, that’s an important consideration with prepaid tuition plans: when do the rates reset? Because you want you get your dollars in before that. It gets you an additional year of inflation growth.
Andrew Chen 52:11
So, did I hear correctly that because there are lock-up requirements, in your case, you contributed senior year of high school knowing that portion can only be used senior year of college? Is that correct?
Ann Garcia 52:26
Yeah. I think we could have used some in spring of her junior year, but I put in money that we were intending to use for college senior year.
Andrew Chen 52:39
I think you mentioned a moment ago, when you were describing the differences between state-run prepaid versus private college, it sounded like maybe the state-run prepaid is always a better deal, because as long as you’re eligible for it, like you’re a resident of the state, let’s say, it can be used at any college.
But in the private college case, you only get the school’s tuition that you actually matriculated at, and then if you end up not going to one of those schools, I think you said you only get 1.5% return on what you put in. Is that correct?
Ann Garcia 53:19
Yeah, I think it’s 1.5% annually if you don’t go to one of their schools. You can check on their website. So, if anyone is interested, the Private College 529 website has that information.
But yeah, the state plans are much more broadly applicable. However, they’re typically only open to residents of those states. So, they’re a better deal for a smaller group of people.
Andrew Chen 53:51
And if you were eligible for both, is the only scenario in which the Private College 529 would be better would be a more narrow scenario where the state-run inflation number is exceeded by the private college that you actually attended, that was a member of the Private College 529, who actually raised their rates even more than the state rate, that you would have gotten?
Ann Garcia 54:22
Right. And typically, that’s going to be the case. But the thing that’s nice about the state-run plan is if you’re a resident of those states, you have a much longer runway to invest in that plan, knowing that it can be used at any college and will get that inflation rate.
Whereas the private college plan, because it’s got a limited pool of schools that it’s eligible for, you may know that your kid is going to go to one of those schools. You may have five kids and you know that one of them is going to go to one of those schools. But by and large, if you have access to a state-run prepaid plan, that’s going to be a better option for you.
Andrew Chen 55:02
So, it sounded like in both the prepaid and the Private College 529, you’re not investing in risk assets with your contributions? It’s more like a defined benefit pension plan?
Ann Garcia 55:12
Yeah, it’s almost like an insurance contract.
Andrew Chen 55:15
So, there’s no upside if the market performs better than tuition growth, but there’s also no downside if the market underperforms tuition growth. Is that right?
Ann Garcia 55:23
Correct. That’s why typically it makes the most sense. If you’re a resident of a state that offers that, you will probably get better investment returns in the savings plan in the early years, and you will probably get better returns in the prepaid plan in the later years.
Again, keeping in mind there are limitations on what the prepaid plan can be. Prepaid tuition plan, in most cases, can only be used for tuition, not for room and board or books.
Andrew Chen 55:55
Is there a time that you would advise parents thinking about the trajectory leading up to college attendance, where they should switch their contributions from savings to prepaid? Is there like t minus six years you might consider switching? Is that a thing?
Ann Garcia 56:19
I think it depends a lot on the family: on their savings rate, their risk profile, and so on and so forth, and then again, how much money they’re planning to pay out of pocket for college too.
For the most part, you can look at the investment returns (1-year, 3-year, 5-year, 10-year investment returns) for any of the portfolios in your 529 plan. So, a good exercise is, for those who are eligible for a prepaid plan, look up what the tuition inflation rate has been historically in that plan, and compare that to the investment returns in your savings plan for those close to college years.
To have many available for freshman year in college, you need to start transitioning it over freshman year of high school. And you can typically roll funds from savings to prepaid, as long as you do it within one of their signup windows. So, high school is usually a good time.
For a family that’s really risk-averse, though, who isn’t at all comfortable with what they’ve seen in 2022, for example, or just doesn’t like the volatility, prepaid plans are a great option because you will typically get at least 4-5% return every year without any ups and downs.
I do think, by and large, for younger ages, up to five, six, or seven years old, you will probably do better in the savings plan. After that is probably the time to start thinking about prepaid.
Andrew Chen 58:24
You mentioned the convertibility. I do want to circle back to that in a moment. But do you recommend that parents consider converting from savings to prepaid (assuming the state offers it, and they’re eligible) in order to, just in the last few years, in the run up for attendance, just take the risk off the table?
Ann Garcia 58:44
I think it can be a great strategy. Like you said, it takes risk off the table, and it guarantees return. With interest rates going up, it’s possible that the closer to college years of age-based portfolios will start having better returns.
But for the last few years, your money has been parked and not doing much in those close to college portfolios where it’s largely invested in bonds. So, reducing risk while guaranteeing yourself a return is usually a pretty good strategy when you’re close to spending the money.
Andrew Chen 59:32
We talked a little bit about the prepaid plans being offered by the state, and often will have residency or state domicile requirements to sign up. But who administers the private college 529? It’s not the state, I assume.
Ann Garcia 59:52
No, it’s not. It’s an organization called the Private College 529. They administer.
They have their own investment manager. They work with the colleges to get them to sign up for the plan. And they’re the ones who assume the investment risk.
Andrew Chen 1:00:10
Are all the top 25 private universities and colleges (by U.S. News anyway) members of the Private College 529?
Ann Garcia 1:00:20
No, there’s a subset of them. I want to say it’s a couple hundred colleges.
I’m looking at Massachusetts, for example, and Amherst, and Smith, and MIT, Wellesley, to name a few. Harvard is not.
Andrew Chen 1:00:47
We were talking a little bit about converting 529 from savings to prepaid a moment ago. It sounds like you can roll a 529 savings plan into a prepaid plan. Can you also roll it into a private college 529?
Ann Garcia 1:01:03
Andrew Chen 1:01:04
And if you have leftover money from your prepaid or private college 529, can you roll it back to a savings plan, should you so desire? Or is it only a one-way direction?
Ann Garcia 1:01:14
No, you can transfer them between account types the same way you can any other 529 funds. In fact, oftentimes, when people realize that they have too much in the prepaid tuition plan and they actually need money for room and board, they can roll it out to a savings plan and use it for room and board.
Andrew Chen 1:01:40
Let’s say your 529 ends up having a surplus, for whatever reason. Maybe your child doesn’t end up attending one of the participating colleges, in the case of the private college 529, or doesn’t attend a degree-granting or FAFSA eligible institution, whatever it is. In those cases, what are the taxes and penalties that apply when you withdraw the money, presumably for non-qualified expenses?
Ann Garcia 1:02:04
If you do a non-qualified withdrawal for any reason other than that your student got scholarships in excess of your 529 dollars, you pay taxes and a 10% penalty on the growth in the account.
So, let’s say, hypothetically, you put $10,000 into the account. It’s now worth $20,000. Half of every withdrawal is going to be considered growth and subject to tax and penalty.
The thing about the withdrawals is the tax and penalty are paid by the person who receives the withdrawal. So, if you have saved aggressively for your student’s college and they get enough scholarship dollars, or they choose a college where you’re not going to use all that money, you might come up with a plan to get that money out of their account little by little every year.
When you distribute it out to the student, it’s taxed at their rate, and the penalty applies at their rate. So, there are quite a few dollars you can get at 0% income tax and 10% penalty on growth.
There are lots of other options that you have with 529s. If you have a surplus because the student got scholarships, then the 10% penalty doesn’t apply. You just pay taxes on the growth.
Of course, you can use it for a different beneficiary. I heard of one parent who had extra money, and he found a college that had a PGA golf tour class, and he changed the account’s beneficiary to himself and used it to take golf lessons.
Andrew Chen 1:03:48
Ann Garcia 1:03:49
So, there are definitely some creative ways to do it. If you want to take enrichment classes at your local community college, you could make yourself the beneficiary of the plan. Or decide there might be a grandkid coming along at some point, and you’re going to save the money for them.
I’ve worked with a number of families who have had surpluses. Sometimes because the kid didn’t go to college. Sometimes because the kid got scholarships.
And there are lots and lots of good outcomes for those dollars. This isn’t like it all goes away if you don’t spend it on college.
One kid didn’t go to college and found a great job, needed a car, and was happy to pay a nominal tax bill to have a couple thousand dollars to buy a car so that he didn’t have a car payment.
Andrew Chen 1:04:39
And it sounds like, from the examples you’re giving, you can fully control the timing of distribution, so that you don’t have to take them all in a year, for example. Basically, there are no required minimum distribution type of provisions for these cases, right?
Ann Garcia 1:04:53
Correct. 529s are a great estate planning tool that way because you’re never required to take the money out, under current law. That could all change in the future if there ends up being millions of tax-deferred dollars that are not getting tapped out there.
But you can control the timing of the distribution. You can control who pays the tax on it. As you transition from your working life to your retired life, you may have some low tax years where you could take the money out, and it wouldn’t be a big deal.
You could almost treat it as a Roth IRA. Your kid may have opportunities for that. You could change the beneficiary to someone else who is in a low tax bracket.
So, there’s lots of things to do there. It’s not like “Oh, you’re 22. It’s all got to go.”
Andrew Chen 1:05:46
And you were touching upon, a moment ago, enrichment classes, so I was curious. Regardless of whatever type of 529 option you choose, whether it’s savings, prepaid, private college, or whatever, if you did have leftover funds, you don’t have another student to use it on, you want to use it on yourself as the parents for, say, enrichment classes, what are the restrictions in terms of where you can use it?
I understand, in the example you gave, you could use it in universities and colleges. But what other educational institutions can 529 money be used at?
Could I take a cooking class, or a sailing class, or get my private pilot’s license, or whatever? Because around that time, when your kid is turning 22, you might actually be nearing retirement.
Ann Garcia 1:06:30
You can use it at any college where you could take out a student loan. And there’s a list on the Department of Education’s website.
So, if you were to take a cooking class through community college, you could use it for that. You do have to change the beneficiary to be you. If you took a cooking class at a local cooking store, you could not use it for that.
Andrew Chen 1:07:01
How should parents think about the optimal amount of funds to contribute to a 529 plan?
I think about the unpredictability of college costs. You don’t know, when your child is young, whether they’re going to go in or out of state, public, or private, whether they’re going to earn zero scholarships or full ride. There’s a lot of unknowns.
And ideally, you don’t want to be overfunded either. So, maybe the right strategy is to contribute an amount you think you’re going to use, regardless of the unknowns, like a lower bound floor, and don’t exceed that, even though there’s a risk it might fall short of your actual funding needs, like if your child attends an expensive private college with no scholarships.
So, I’m just curious if you have a framework for how to think about this. Is there an optimal amount to contribute, given all the unknowns?
And for this purpose, let’s assume also that your 529 contributions are not coming at the expense of other key contributions, like tax-advantaged accounts, your 401(k), HSA, FSA, even a backdoor Roth, and even your rainy-day fund. So, all you’re trading off against by making these incremental contributions is personal savings.
And at the same time, let’s say you’re also not a zillionaire, you’re not flushed with wads of extra savings, so you could use that money to build up a bigger cushion, or just on consumption and enjoying life, and not locking it up in a restrictive 529. So, in that scenario, how might parents think about the optimal amount?
Ann Garcia 1:08:19
It’s a great question, and I think that’s one of the hardest things for parents to do, because as you said, there’s such a range of outcomes and prices. My recommendation is this:
Your child will have good choices at any price point that’s reasonable. Maybe not at zero, but your child would have good choices at any price point. So, save what you can.
Family finances are not linear. However, with that being said, even though they’re not linear, you still need to be disciplined and intentional with your savings. So, set up an automatic monthly contribution to your 529.
Even if it’s $10 a month, you’re still going to come out ahead for doing that. So, if you start a 529 today, come up with a number that’s comfortable for your family. If you’re able to contribute $100 a month, that’s going to be great.
Depending on your child’s age and your investment portfolio, you’re going to have a good amount of savings and good dollars available to you just with that. If it’s $20 a month, that’s going to amount to something too.
Kids who have any amount of college savings, even a nominal amount, enroll in college at higher rates and graduate from college at higher rates than do those who don’t. So, whatever number it is, do it.
And then what I like people to do is pick a time of the year when you’re going to look at what you’re doing and make an adjustment. Maybe it’s the month of your child’s birthday where you’re maybe thinking about how far they’ve come, getting from five to six to seven, or two to three to four, whatever the case may be.
But that’s also an opportunity to think about who you’d like them to become, and to set aside maybe some additional money so that you’re contributing a little bit more every year.
It is impossible to plan for the range of outcomes, so plan for the range of outcomes that works for your family. My family decided we were not going to spend $75,000 or $80,000 a year for college. We did save, and we were diligent in our savings, and we had a good amount of savings.
And we had really good conversations with our kids about what that savings translated to in terms of the college opportunities that were available to them, and they both made choices that they’re just blissfully happy about and that work for our family. And we didn’t choose schools that didn’t work for our family.
So, there are lots and lots of good choices out there. A lot of it is going to depend on your family values. There are families who place a really high value on taking a nice family vacation every year, and having that quality time to spend together.
That may come at the expense of college savings dollars. And that’s okay too, because that’s what’s important for your family. Those relationships are something that matters to you, and you should be investing in them.
If that’s you, that’s fine. But just make sure that you are clear in communicating with your children about what their college budget looks like, and that you are doing something. Because that whole thing of “save for retirement, not for college,” that’s how we got to $1.5 trillion in outstanding student loan debt.
You need to do both. Retirement is a bigger priority, but college has to be right there with it, because for most families, college is your second biggest expense after retirement.
Andrew Chen 1:12:17
What do you most want people to take away after reading your book?
Ann Garcia 1:12:21
The thing I would like people to remember is you have a lot of choices. Whatever your family’s financial circumstances, whatever your student’s preferences and priorities, you have a lot of choices. It just takes some work to find them.
In my book, I try to outline all the things that you can do to increase the range of choices available to you. Also, the sooner you start, the more choices you will have, both because your savings has more time to grow, and you have more time to do the research, to clarify your values, to talk with your kids, and all those things about it.
But your kid is going to be awesome because they’re an awesome kid. It’s not the college they go to that’s going to make them who they are. That’s going to make them a more educated version of who they are, but being themselves, and having some success and some failures, and learning some skills and resilience along the way are what’s going to make them who they are.
Andrew Chen 1:13:23
All right. I really enjoyed this conversation, as usual. Where can people find out more about you, your work, your services?
Ann Garcia 1:13:29
My book is “How to Pay for College.” It’s available from Amazon and bookstores everywhere. And my website is howtopayforcollege.com, where, in addition to the book there, I have my college financial plan masterclass that’s really tailored for families who are really getting started in looking at the nitty-gritty of how they’re going to come up with a college plan: researching colleges, coming up with a budget, finding scholarships, and all of that good stuff.
So, “How to Pay for College” is where to find me, whether it’s the book or the website.
Andrew Chen 1:14:03
And your class, we’re doing a 20% discount for podcast listeners. I’ll include details about that in the show notes page. Check that out there.
I hope you check out both Ann’s book and the course. And I look forward to sharing this with our audience.
Ann Garcia 1:14:19
Thank you so much for having me.
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