Paying for College

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Making the Most of Your Personal Resources

Controlling and Reducing Household Expenses

Budgeting

A budget is really just a way to organize and determine how much you plan to spend, and actually spend, on your household expenses each month. Most budgets are organized by categories such as transportation, housing, groceries, utilities, clothing, recreation, etc. The goals of a budget are to keep your finances organized, keep track of where you are spending your money and help you to save as much as possible while maintaining your lifestyle.

Cost-cutting

When you have a budget it is easier to identify categories in which you can cut costs so that you can save more each month or add to another area of the budget. But, as the Salada tea bag says, "The cost of living is the difference between your net income and your gross habits." Cost-cutting is not always easy. It requires determination and discipline, just like exercise, studying and most other things in life that require commitment. Some habits are hard to break, but the payoff is worth the effort.

For example, eliminating a $3.33 expense every day (cup of premium coffee), equates to about $100 per month in savings. Assuming an annual return of 8% per year, that $100 per month savings can translate into an additional $31,000 for education costs fourteen years down the road when you enroll your child in a private high school.

If you just can't give up that great cup of coffee every morning because you have been up all night with a newborn, you might be able to save $100 a month in one of these areas: Insurance premiums, vehicle payments, cell phone plans, eating out, clothing, dry cleaning, memberships, subscriptions, movie rentals, etc. Challenge yourself to see if you can save $25 a month to start with and then increase it.

A young guy I know saved enough for the down payment on his house by what he called "putting an end to loose change larceny." He said that by not paying attention to where the "loose change" in his finances was going, he was stealing from himself. He created a budget, cut out the cost of little, non-essential items and saved that "loose change." This helped him get his first house and have less debt against it.

Debt reduction/elimination

If you have debt, you have to have cash flow (income) to make the payments on that debt. So if you can reduce or eliminate that debt, your cash flow can be used for something else.

The most effective ways to reduce debt are typically thought to be 1) paying off the highest interest loans first and 2) paying off the loan with the smallest balance first, then adding what was being paid on the first loan as an extra payment on the loan with the next highest balance. In the example above, an extra $100 a month can go a long way toward saving money or, in this case, reducing your debt.

In my experience, the families that consistently come out on top are not the ones with the highest paying jobs or the best mutual fund returns, but rather the families that live within their means and save regularly.

Enhancing Cash Flow (Income)

Your monthly cash flow, or income, is what drives your budget and gives you the ability to pay your bills. There are two general types of income: income from working (earned income) and income from investments (unearned income). An increase in either one can increase your expected family contribution and decrease your financial aid eligibility. However, don't let the financial aid "tail" wag the income "dog." Make as much money as you can!

Make more money

If you have the opportunity to make more money by working some overtime, earning a bonus or getting a bigger commission check from a few extra sales, then go for it. Some parents take on a second job or consulting work to make a little extra to help with private school and college costs, while some stay-at-home parents who have been caring for the children who are now in school or college will actually go back to work part-time or full-time. These are all examples of you at work. Now let's talk about how to put your money to work to enhance your cash flow.

Use your investments to generate cash flow

Unearned income includes the dividends, interest and capital gains that come from savings and investment products like stock, mutual funds, bonds, CDs and savings accounts. This income can be reinvested back into the account to help it grow, or you may choose to have it paid out to you. Instead of reinvesting this unearned income, you can take it out of the account (aka: taking the growth off) and use it to help fund education costs, make payments on loans or whatever is most advantageous in your specific situation.

For example, a $50,000 bond with a 7% yield will generate $3,500 in interest each year, which could be used to help pay education costs directly instead of taking a $3,500 Stafford Loan. Or you could use the cash flow to make the payments on a loan if you need to take one.

Re-direct contributions to savings and retirement accounts

Let's say that you have been saving money for your son to attend an independent high school. When the time comes to start paying for that school you could choose to stop making contributions to the investment account and re-direct those contributions and use the money to pay for tuition instead. Likewise, you could reduce, or pause, contributions to your 401k retirement plan instead of taking a loan from your 401k. The nice thing about this tactic is that you can make changes anytime you like.

Payment plans

Many families use the tactics discussed above to improve their cash flow. But when large tuition bills come due all at once, families often turn to tuition payment plans to "spread out" those larger bills over a period of months instead of borrowing the money or liquidating an investment account.

Tuition payment plans are offered through the schools, but are usually administered by outside payment plan companies. These plans are a good solution for many families that may have an adequate income stream to pay the bill, but just can't do it all at one time. Commonly there is an annual fee of between $35-$75 dollars per student to administer the plan, but neither the school nor the plan will charge any interest for the convenience of being able to pay tuition bills over a series of months.

Direct Gifts and Prepayments

Some parents and grandparents can benefit from making direct gifts of cash to pay for tuition because it removes assets from their taxable estate which may help them reduce income and estate taxes in the future. Recent events have opened the door for prepaying tuition as well.

A word of caution is warranted here. If parents or students receive gifts of money, the amount of the gifts will likely decrease the student's eligibility for need-based financial aid, which may or may not be of concern to the family.

Direct Gifts for Tuition

Annual gifts of up to $13,000 per person ($26,000 for joint returns) can be made annually without having to pay gift tax. However, special gift tax rules exempt payments for qualified medical and education expenses from gift tax. These non-taxable gifts are an excellent way to provide substantial value to the person receiving the gifts (donees) and favorable tax benefits for the people making the gifts (donors). To qualify for the exception for education expenses, payment must be made directly to a qualified educational institution and must be for tuition only, and not room and board.

Qualified educational institutions include K-12 private schools; colleges and universities; and proprietary (privately owned profit making) secondary institutions.

Making direct gifts to pay for tuition does not impact the ability to make annual tax-free gifts of $13,000 or less under the annual exclusion. So a wealthy grandparent can make direct payments of tuition to a grandchild's K-12 private school as well as gift $13,000/$26,000 to the same grandchild in the same year without having to pay gift tax.

Prepayment of Tuition

If a little is good than more must be better. A recent development relating to the direct payment of tuition involves prepaying tuition expenses for multiple years in advance instead of just the current year. The IRS ruled in a private letter ruling on 1/13/2006 (number 200602002) that, subject to certain conditions, multiple year prepayments of tuition are not considered taxable gifts for gift or Generation Skipping Tax (GST) purposes.

Essentially prepayment of tuition follows the same rules as direct gifts with the following conditions: The taxpayer should not receive any discounts or refunds (even if the student stops attending the school/college) and the payments should not guarantee enrollment or offer any special consideration to the student or donor.

Because of the nature of the IRS ruling, prepaid tuition gifts should be completed carefully and with legal advice regarding the non-taxability of the gift. The prepayment of tuition obviously involves the risk of loosing the prepaid money if the child chooses not to attend the school that the prepayment was made to or if he transfers, drops out, or is expelled from the school. Once the money is prepaid it belongs to the school and cannot be recovered.