Graduation season is upon us. If you have a student going away to college in the fall, you've hopefully received your award letters highlighting the financial aid and scholarships your student was awarded. You should have a general idea of the first-year cost by now (excluding, perhaps, extra costs that we all forget about like airfare back home, trips to visit your student, spending money, and so on).
You've done a great job saving for college, now it's time to pay the bills. Even though it might seem simple enough, there are some things you need to be aware of.
American Opportunity Tax Credit (AOTC)
The AOTC is a credit you get on your tax return for paying education expenses. This counts toward the first four years of college. The details are that you get 100% credit on the first $2,000 on qualified expenses and a 25% credit on the next $2,000. What that means to you is that you get a $2,500 credit on your first $4,000 of expenses.
That sounds wonderful, but the caveat is that you have to use non-tax-advantaged money to get the credit. In simple terms, you can't use 529 money AND get the AOTC. One common mistake is that people will pay for the first year or two with their 529 accounts and figure out the rest later. The problem is that by doing so they leave $2,500 or $5,000 on the table.
There are income limits with this. If you are single and have an modified adjusted gross income (MAGI) of more than $80,000, or married with a MAGI of more than $160,000, then this credit starts to phase out.
Federal Direct Student Loans
Federal Direct loans, which used to be called Stafford loans, are what many consider "good" student loan debt. These come in both subsidized and unsubsidized varieties; both are considered good debt. These loans don't have to be paid back until your student is done with school. With subsidized loans, the interest is covered by the government until you graduate. With unsubsidized, interest is due while in school. The most you can take out in four years is $27,000 ($19,000 of which can be subsidized).
Unfortunately, you can't take all that out in one year. There are yearly limits and it is use-it-or-lose-it. That means, in the example I used above, if you pay for the first year or two with 529 money, then your student doesn't have access to the first year or two of loans. The yearly limits are $5,500 in the first year, $6,500 in the second year, and $7,500 in each of the last two years (for subsidized loans those amounts are $3,500, $4,500, and $5,500).
Many people ignore the use of cash flow to fund college. If your student is going away for college (vs. living at home), then your monthly costs go down. One of the biggest expenses that goes down is food. You no longer have that mouth to feed. By some estimates it can cost $200 per month to feed your teenager, although the exact number will vary based on your child, where you live, and so on. Since that is a monthly expense that you are used to paying and it goes away, you can apply that to college and still maintain the rest of your budget.
Similarly, if you are currently contributing to a 529 plan, there is a good chance you will not be contributing to that student's plan anymore once they start college (although, if your state gives you a tax break like Minnesota now does, it may still make sense to contribute to the 529 plan, but not invest those dollars). Those dollars can be applied directly to the college as well.
Remember, what sounds like a small dollar amount, say, $200 per month, really adds up when you account for 12 months in a year over four years. $200 per month gets you $9,600 toward the college bill.
If your parents are going to help cover the costs of college, you need to be aware of how this will alter any future financial aid you may qualify for. The reasons are a little complex, but suffice it to say that it's usually best to have grandparents pay for the fourth year since you will not be filling out the FAFSA again.
When You May Not Care
There are some situations where none of this applies to you. If you've saved up significant amounts of money in 529 plans and are likely to have money left over, then you don't have to worry about these techniques. If your income is sufficiently high, then you don't have to worry about missing out on the AOTC since you won't qualify for it anyway. If your goal is to have your student graduate not take out student loan debt, then gaining access to Federal Direct Loans shouldn't worry you.
For most of us, though, stepping in college funds properly will save us big bucks and prevent us from robbing our retirements.
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