According to the National Center for Education Statistics, the average cost of in-state public university tuition in the United States, as of the 2017 academic year, is $17,237 per year and $44,551 for a private 4-year universities. Over the period of ten years, between 2007 and 2017, the cost of tuition and fees, room, and board has risen at a rate of 31% for public institutions and 24% for private, nonprofit institutions, adjusted for inflation. The question many face is, “How should one financially prepare or pay for college?” Luckily, there are several opportunities available to students and parents to help. The most prominent options are public student loans, private student loans, and 529 savings plans.
Public Loans and Repayment Options
Student loans can be an option for students and parents who do not have substantial savings to pay for school out of pocket. Direct public loans can be an option for students who want flexibility in repayment options and the ability to have interest be deferred while in school. There are two types of direct public loans: subsidized or unsubsidized. Direct subsidized loans are only offered to students who demonstrate a financial need. The interest on the loan is paid by the Department of Education for as long as a student is enrolled at least half-time and for the first six months after a student leaves school. These loans can be beneficial because the interest is not capitalized into the loan, so the amount the borrower pays is based on the balance when the loan was taken, rather than the balance plus interest. Direct unsubsidized loans are different as they are not based on financial need and are available to all students. The caveat is that interest is capitalized into the balance during the time the student is in school.
Another benefit of public loans are the repayment options. The standard repayment plan is a fixed monthly payment over 10 years, but other options can be beneficial to borrowers. The income-based repayment plan (IBR), income-contingent repayment plan (ICR), and the pay as you earn repayment plan (PAYE) are all options that allow borrowers to pay between 10 and 15% of their discretionary income, updated annually. Discretionary income is generally based on the amount of income over the residential state’s poverty line. For example, if the state poverty line is $10,000 of annual income and the student earns $30,000, their annual payment would be 10% of the $20,000 that they are above the poverty line, or in other words, $2,000 annually. These payment plans can have a loan forgiveness after 240 qualified payments, but that forgiveness is taxable in the year forgiven. The downside to the various income-driven repayment plans, is that students will generally pay more over their lifetime than with a standard 10-year repayment.
Private loans are another option for students that do not have significant savings to pay for college. Private loans can be taken out at almost any bank and there is the ability to shop interest rates. Unlike public loans, there are very few repayment options for students who take out a private loan. Many private loans have variable interest rates and will generally require at least interest-only payments while the student is in school. Generally, students should use up their ability for public loans before applying for private loans.
Section 529 Plans
For those who want to have savings in place to minimize the need for loans, 529 savings plans are a very beneficial savings tool. Every state offers a state sponsored 529 plan in which parents can open savings accounts for their children. Parents can also open 529 accounts with most financial institutions. The major benefit of 529 plans for parents and students is that growth inside the account is considered tax free if it is used for qualified education expenses. Some states also provide a tax deduction for contributions into the account by parents. One downside of 529 plans is non-qualified withdrawals will be taxed as ordinary income to the student and assessed a 10% penalty tax. For this reason, it’s important to not drastically over fund this type of account. However, if an account is overfunded, the beneficiary on a 529 account can be changed to other family members to avoid penalties. Another restriction with 529 plans is the limited ability to make changes to the investments within the plan. Currently account holders are only allowed to change their investment selections twice per year or when there is a change of beneficiary. 529 plans will also impact a student’s eligibility to receive need-based financial aid.
As college costs continue to rise, the best way to stay ahead of this is proper financial planning for your goals. Your HKFS financial planning consultant can help navigate the complex landscape of saving for college or strategies for student loan payments. Everyone’s college funding needs and abilities are different, so it is always good to review and update your financial plan to help make proper decisions around college funding.