Today, I will address the huge return on investment available from the little-known college planning industry and also review the familiar tax breaks that help offset the cost of paying for college.
Back in 2012, my wife and I had one son in college (Missouri S & T) and another, two years away from attending Mizzou. Naturally, we were very interested in how to pay for college and how I could help my clients who were also in this stage of life. I joined a national college planning association and earned continuing professional education credits studying this field.
I remember from years ago the presenter sharing an incident about how he was able to obtain about $200,000 of financial aid for a student to attend Harvard. As I recall, he was able to reclassify much of the land the parents farmed as a business asset and valued it at a fire sale. Long story short, he applied his expertise and training to meet the letter of the law regarding financial reporting for college financial aid, which made his clients appear on paper has very needy. He also helped deserving students get into the college of their choice.
In a recent seminar, the speaker mentioned a couple with two daughters. The elder did not qualify for any student aid because the parents had set up a UGMA (Uniform Gift to Minors Act) at the advice of their CPA. Unfortunately, actions that may save a little bit in taxes often costs more than $100,000 in forfeited free financial aid. Let me repeat. The tax code and the rules regarding the computation of need for financial aid are enemies. What is good for one is usually bad for the other. The entire UGMA was counted as the student’s income reducing the potential award of financial aid.
Let me stop here and review the basic formula for financial aid. College Financial Need (CFN) = Cost of Attendance (COA, tuition, room, board, fees, travel, etc.) – Expected Family Contribution (EFC).
That makes sense. Need equals the cost of college less the portion paid by the family. As I recall, most private schools will come up with a combination of grants, loans and work study (job at college) that equals a student’s CFN. However, many public schools offer a financial aid package that falls short of the computed CFN and includes lots of loans that burden the future of a new college grad.
Let’s pick up the story of the younger daughter. Fortunately, the expertise of the college planner was sought in time to plan for the younger daughter’s college expenses. She chose to attend a private college where the COA was $47,000 per year. The family received $32,000 in grants for a 4-year total of $128,0000. Nearly three years of college for the younger daughter cost nothing.
Now let’s consider the tax advantages of college planning. That $128,000 that was given to the younger daughter as nontaxable financial aid, would have cost the parents about double that amount ($256,000, assuming a combined tax rate of 50%) since the parents earned well into six figures. Without considerations for college funding for children, most tax reduction plans implode! The savings related to college planning can run 150% to 200% of the awarded grants. Even at a 50% combined tax rate, a dollar of deduction only saves 50 cents in taxes. So, college planning could be four times more effective.
How does this work? There are about 20 key factors in the Need computation. By moving money out of an UGMA or 529 plan to a specially favored investment vehicle allows that money to avoid being counted. Basically, the formula assumes that 100% of the student’s income and assets will be used to pay for college. There are percentages that apply to the parent’s assets and income that depend on factors like how many children are in college now.
By anticipating the tax year on which the FAFSA formula will focus, it is available (just like with the tax code) to own assets and produce income in ways that are friendly to the computation of Need. Just like a taxpayer may choose to invest in a municipal bond offered by a Missouri municipality for the purpose of avoiding federal and MO income taxes, the finances of a family can be formed to optimized the grants offered in a financial aid package. As with taxes, there are lines you don’t want to cross. Consulting an expert is prudent.
Regarding commonly known education benefits, all of which have income thresholds that phaseout the benefit, you have probably heard of the American Opportunity Credit, the Lifetime Learning Credit, the Tuition deduction, and the Student Loan Interest Deduction. The American Opportunity Credit is the most robust. If offers a maximum credit (which is a dollar for dollar reduction in tax) of $2,500 of which a portion is refundable. It can only be taken for four years toward an undergraduate degree. The Lifetime Learning Credit is a 20% credit on the first $10,000 of tuition paid in any tax year. Student Loan Interest Deduction is maxed out at $2,500 per year. The Tuition deduction is capped at $4,000 per year and is often an alternative to the Lifetime Learning Credit
Like most things in life, it is better to plan where you are going (and get help if you need it) rather than wonder where you are now.
Aric Schreiner, CPA, PFS, is managing member of Columbia CPA Group, LLC
