This is part 1 of our mini series around college savings and financial aid. As part of these we have a guest post from our Podcast guest, Jack Wang.

Families often ask about the best way to save for college, trying to figure decide if one type of account or investment is better than another. After all, there are a myriad of choices available.

Before deciding on where to put that money, families need to answer a few questions:

First, what does “saving for college” mean for the family?

If you’re married, try this little experiment. For both you and your spouse, each gets a piece of paper and a pen.

Write down your answer to this question: how much money or percentage of the cost per year are you willing to pay for college?

No cheating! Don’t let each other see! Keep this as a surprise.

Some families will answer that they are willing to pay $x per year. Or x% per year.

Okay, now compare answers.

If you’re like the thousands of families I’ve spoken with over the years, your answers didn’t match.

Paying for college is a deeply emotional and philosophical decision. A person’s answer could depend on where they went to college - if at all, who paid for it, and how the person viewed the experience. It’s not uncommon for one spouse to say that they will only pay 50% of a public college while the other spouse is willing to pay 100% of private.

This is an important exercise because it helps set the target. After all, it may be easy to just save something, but unless you know what target you’re aiming for, you’ll never hit it.

For those who indicated that they would pay 100% (pay for all of college), consider this - the most expensive colleges in the US now have sticker prices of over $80k/yr. Did you really mean that you want to pay that entire cost, times 4-6 years?

Second, how much to save?

The unfortunate part of saving and paying for college is that how much college will cost in the future is difficult to gauge. The sticker price, or cost of attendance which includes tuition, room & board, fees, books, travel and miscellaneous, for an in-state public school is around $30k/yr. For private schools, it ranges between low $40k to over $80k.

That’s not what most families pay. According to US News and World Reports, the average price ranges from a low of $10,338 for an in-state public to $22,698 for an out-of-state public to $38,185 for a private college. This data is for the 21/22 academic year.

And these figures paint a completely inaccurate picture for many families.

These average prices are after aid (scholarships, grants, financial aid, etc.), is for all income ranges. As an example, Northwestern University in Evanston, IL reports that the average price paid by all families was $23,279. The lowest income families ($0-$30k/yr) only paid $245. Yes, $245! Families with incomes above $110k/yr but still got financial aid paid an average of almost $42k/yr. Then there are families who paid the full sticker price of just under $80k. This is based on Federal data for 20/21.

What’s a family to do?

• First, decide what your family means by saving for college. What target are you aiming at? If you start saving at birth for 18 years, at a hypothetical 5% return per year, the monthly amount to save for 4 years at $80k/yr would be $917/mo. If your goal is to save for 4 years at $30k/yr, that monthly figure drops to $344/mo.
• Second, understand how aid works. It’s not always about grades or family finances. It’s about how much a school wants your student - NOT whether or not the school will admit your student. Families often mistakenly think that going to a public school is less expensive. Understanding how aid really works can easily mean that a family can pay less at a private school than a public. 

Third, where to save the money and how does the savings coordinate with the rest of your finances?

The most common way to save for college is through a 529 plan. These are sponsored by each state and available through a variety of financial institutions. And they do offer a number of advantages for college savings, but are the right for you?

Besides 529 plans, a family can save for college in any number of ways, including, but not limited to:

• Bank accounts (savings, checking, etc.)
• Series EE or Series I bonds
• Cash value of permanent life insurance
• Annuities
• Traditional or Roth 401k/403b
• Traditional or Roth IRAs
• Non retirement accounts with stocks, bonds, mutual funds, etc.
• Investment real estate
• Farm land
• Private businesses

The available options are truly unlimited. If someone can invest in it, you can use it for college savings. There are advantages and disadvantages to each of those options. And certainly can have different tax treatments.

How does one choose, then?

First, decide if you qualify for need-based aid.

If you are likely to qualify for need-based aid, either because your income and assets are low enough, or you apply to a college with a high sticker price, then certain types of savings vehicles are invisible to financial aid. This means that using these types of accounts can help qualify for more financial aid. For most schools, balances in retirement accounts (401k/403b/IRA) are not considered as assets for financial aid purposes. Cash value of permanent life insurance and annuities are also not considered by most schools.

There are exceptions, as the annual contribution to retirement accounts still would be considered as income (which weighs more heavily for financial aid). And school using the CSS Profile form would count annuities, but schools only using the FAFSA would not.

Ownership of the asset also matters. Assets that are owned by non-immediate family members, such as grandparents, aunts and uncles, etc. are not counted for financial aid - even if the intent of the asset is for the student’s college expenses. A great example is a grandparent owned 529 for the student. It does not count as an asset.

If a family is not likely to qualify for need-based aid, then the type of savings vehicle doesn’t matter as much, nor does the ownership.

Second, consider how college savings coordinates with the rest of your finances.

For many families, saving for college necessarily means not being able to save more for other goals, such as retirement. Thus, savings often has to serve double or triple duty. Money not used for college can be repurposed for retirement, or vice versa. College savings may need to serve as an emergency fund as well.

In these situations, the ability to access money and potential taxes and penalties or other expenses would play a bigger role in selecting the savings vehicle. As great as 529s are for college savings, this is a major disadvantage as money used for anything other than K-12 or college expenses would be subject to taxes and a 10% penalty.

Bottom line is that most families view saving for college in a vacuum - just about college. It’s not. Saving and ultimately paying for college can and will have a long term impact on the rest of the finances. Done correctly, saving and paying for college can help further your overall financial and life goals.

As I often tell families who don’t take time to think about these issues - someone ends up crying. It could be the student who applied to and got into the expensive school, but can’t go because the parents never planned. Or the parents end up crying as they realize they will take on a mountain of debt so their student can go to that expensive school because they never planned.

Neither is a good outcome. You can do better.

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