By FPA member Amy Jo Lauber, CFP®
Last Updated: January 16, 2012
The message about the importance of higher education has not been lost for this generation of students. The problem is paying for it.
Educational costs increase at a rate more than twice that of inflation at about 6.5 percent per year and state budgetary problems raise concerns that cuts in state funding will cause tuition rates to increase at state universities.
Parents who are hoping to pay for even a portion of their child’s education must start early and invest regularly to have any hope of tackling this mountainous expense. Many couples struggle with saving for both their own retirement and their children’s college. A New York Times’ article, “Burden of College Loans on Graduates Grows,” states that 2010 graduates had an average of $24,000 in student loan debt.
While student loans are generally considered “good debt” (because education typically increases a person’s earning capacity and there may be tax deductions and credits available to offset some of the cost), large student loan debt has been shown to delay adulthood; keeping graduates at home with their parents longer and preventing them from buying homes and starting businesses and families. Most student loans cannot be discharged by bankruptcy and those individuals who default on their student loans may mar their credit for years to come, impairing their ability to obtain other loans and perhaps certain jobs.
Choosing the right degree program and school setting is crucial. Changing programs or transferring to another school could increase total expenses, due to additional coursework requirements. Here are some suggestions before freshman year begins.
- Obtain self-knowledge about skills, abilities, talents: Choosing a career in an area where one naturally excels will more likely lead to success. In addition, your passion for your stated career will show through in your application, increasing your probability of being accepted.
- Identify the best (most appropriate) school(s) for the course work you will need to have the career you desire.
- Identify your preferred school setting: Will a large institution make you feel lost or unconnected? Will a smaller institution offer all of the courses and activities you desire? Will living in a dorm help you develop friendships or would living at home and commuting provide the emotional support you may need?
- Develop your student profile: Grades and SAT scores are only part of your story; they may or not be your strength as a college applicant. Get involved in those activities you enjoy and that may enhance your skills in your future career. For example, if you plan to become a teacher, perhaps you can volunteer as a tutor at your local library.
- FAFSA (The Free Application for Federal Student Aid): Fill it out and fill it out early. Applications are accepted every January 1st. While you are still in high school, preferably no later than sophomore year, meet with a financial planner who specializes in college planning. Certain assets are not included in the application while others could prevent you from obtaining aid.
- Check for scholarships: All kinds of organizations offer scholarship programs. There are even advisers that can help you find and obtain scholarships based on your unique situation.
- Negotiate with the schools you wish to attend: Know what you can bring to the school and make the school aware of how committed you are to your chosen path (as evidenced by your student profile/application). Remember that your success will be a positive reflection on your alma mater; that’s good PR for the school.
Save: A Qualified Tuition Program (also called a Section 529 plan) can help you set aside money for college on a tax-preferred basis. The earnings within the plan are tax-deferred and distributions used for higher education come out income tax free. Many states offer these plans (although you may use the funds anywhere in the world) and may even offer state income tax deductions for contributions.
Once you are already in school, there are a few strategies that may help ease the financial bite. The Obama administration enacted and/or expanded some tax credits and deductions for education; such as the American Opportunity Credit (formerly called the “Hope Scholarship Credit”), the Lifetime Learning Credit, and the Tuition and Fees deduction. As a reminder, a tax deduction reduces your Adjusted Gross Income or AGI, which will reduce the amount of tax due. A tax credit is like a coupon off of your tax bill and is generally more favorable, but a qualified adviser should review each of the strategies to determine the most beneficial course of action for you.
- The American Opportunity Credit: Allows a 100 percent tax credit for the first $2,000 of college expenses and 25 percent on the next $2,000 for a maximum credit of $2,500 per student (40 percent of which is refundable, any balances can be carried forward for up to five years to offset future tax bills). This tax credit may be more beneficial for those families with several students attending college at the same time.
- The Lifetime Learning Credit: Offers a tax credit of 20 percent of your tuition and fees up to $10,000, for a maximum credit of $2,000 per income tax return.
- The Tuition and Fees Deduction: Allows taxpayers to reduce their AGI by up to $4,000 for qualified higher education expenses.
- The Savings Bonds interest exclusion: Allows interest earned on US Savings Bonds (series EE issues after 1989 and I Bonds) to be excluded from taxation if the bonds were used to pay for higher education expenses. The bonds must have been issued to someone who was at least age 24 years of age.
All of these are subject to certain AGI limitations that change from year to year. In 2012, taxpayers must have an AGI below $80,000 ($160,000 for married filing a joint return) to fully utilize the tax credits and deductions listed above.
There are coordination rules to consider when using the various strategies listed below (i.e. typically you may utilize only one strategy per education expense, per student, per year).Consult with a qualified tax professional and/or financial planner who can inform you on the coordination rules of these strategies
- Some employers provide tuition assistance programs to help their employees further their education and, therefore, make them more valuable to (and likely to remain with) the employer. This type of benefit is usually (but not always) income tax free. You may wish to negotiate such a benefit with your employer.
- Withdrawals from a qualified tuition program or 529 plans are income tax free, provided they are used for higher education. Such withdrawals may subsequently affect your ability to receive financial aid for the following year. Again, seek the advice of an expert.
Withdrawals from (traditional) Individual Retirement Accounts (IRAs) for higher education expenses are exempt from the premature (before age 59 ½) distribution penalty of 10 percent. However, any distribution is taxable. You may be able to withdraw contributions from a Roth IRA income tax and penalty free. If you have a 401(k) plan, you may be able to take a loan from the account. This is generally not recommended but may be necessary and appropriate.
Once you’ve graduated, you typically must start tackling the debt you’ve accumulated over the previous years. Here are some strategies for this phase of your life.
- Plan for the repayments by crafting a reasonable spending plan. Remember that overall debt (student loans, car loans, mortgages and credit cards) should not exceed 36 percent of your gross income.
- The Student Loan Interest Deduction of up to $2,500 is available to those taxpayers whose AGI is below $75,000 ($150,000 married filing joint return).
- The Federal Student Loan Repayment Program is used to recruit and retain employees to work for certain agencies. Eligible employees are provided with up to $10,000 per year up to a maximum of $60,000 if they work for a qualified agency for at least three years.
- Income Based Repayment Programs are available to those individuals whose income is 150 percent or less of the federal poverty level and are to pay for federal student loans. Repayments are limited to 10 percent of gross income and any remaining debt after 25 years is forgiven.
- Some loan forgiveness programs are excluded from taxable income and are available from a variety of sources such as:
- AmeriCorps: Twelve months of service provides $7,400 in stipends and $4,725 towards loan payments.
- Peace Corps: Two years of service allows you to defer payments on Stafford and Perkins loans and some forgiveness of Perkins loans.
- Volunteers In Service To America (VISTA): 1,700 hours of service provides up to $4,725 in loan forgiveness.
- The Army National Guard: Provides scholarships, tuition assistance and up to $10,000 in loan forgiveness for recruits.
- The National Defense Education Act: Provides 15-30 percent of Perkins’ loan forgiveness for full-time elementary and secondary school teachers in low income communities. The American Federation of Teachers also has programs available.
- Equal Justice Works: Forgives loans of law students if they serve the public interest or for a non-profit agency. The American Bar Association also offers programs.
- The US Department of Health & Human Services: Forgives certain loans for MDs and RNs if they work for a certain number of years in remote or economically depressed areas.
- Society Laboure: Provides loan forgiveness for those students pursuing religious life. (did you know that you cannot enter a religious order with debt?)
- The US National Institute of Health: Forgives up to $35,000 per year of student loans for those individuals conducting clinical medical research.
- The US Department of Agriculture: Forgives up to $25,000 per year for three years for veterinary doctors who work in vet shortage areas.
- The American Physical Therapy Association and The American Occupational Therapy Association: Both offer loan forgiveness to qualified physical and occupational therapists, respectively. Also, some hospitals may provide loan forgiveness to recruit PTs and OTs.
- Public Service Loan Forgiveness Program: Forgives remaining debt after 10 years of eligible service (full time in public service, government, 501(c)(3) organizations).
These strategies won’t remove the financial burden of higher education, but will hopefully reduce it.
FPA member Amy Jo Lauber, CFP®, is President of Lauber Financial Planning in West Seneca, NY.