Helping Clients Plan Ahead for College Expenses
As the cost of undergraduate, graduate and professional education continues to soar, having enough money set aside to pay for college is no longer a “nice-to-have” component of financial planning. It is essential to devise a thoughtful, cohesive plan to keep clients on course toward achieving their financial goals, within the larger context of their financial situation, investment horizon, risk tolerance, and resources.
Helping clients understand how much to save based on their education goals prepares them for the cost of college.
In trying to approximate future college costs and the amount clients will need to save to pay the college costs of the future, you’ll need to help them make several assumptions and determinations:
- Type of educational institution. A great disparity exists between costs associated with a four-year private and a four-year public college, with the former costing significantly more.
- Which costs to fund? Typical college costs include tuition, as well as non-tuition items such as fees, room and board, books, meals, and living expenses. Help your clients figure out whether they want to save enough to pay for everything, or just fund some of these expenses.
- Estimate the annual cost. Once your clients decide which type of educational institution and related expenses to save for, the next step is to estimate the total annual cost in today’s dollars. A great resource to assist with this calculation is the College Board.
- Establish time horizon. Next, determine the number of years until education costs will begin, and for how many years you’ll be paying college expenses. To forecast these costs, consider the inflation rate applicable to education expenses over the family’s time horizon. Historically, college expenses have run about two times the general inflation rate.
- Figure the future funding requirement. Identify any current savings earmarked for education expenses, followed by calculating the future value of the current savings over the time horizon until the education costs occur. The net of these two figures will represent the education funding requirement in future dollars.
- Determine lump sum and periodic funding amounts. Next, discount the funding requirement to its present value to determine the lump sum and periodic payments needed to fund the total cost today. Determine the intervals most appropriate to fund your client’s education objective by assessing cash flow, the need for an emergency fund and the family’s desire to save for competing goals.
Once you help your client figure out how much they need to save over a determined period of time, you can help them save in the most advantageous way, using tax-efficient savings vehicles.
If your client has little time until they need to start paying college tuition, and they or another family member, such as a grandparent, aren’t equipped to pay the entire college expense, there are certain ways to finance a shortfall. Primarily, the student can apply for governmental or private grants and scholarships. Further, financial aid forms should be filed to allow the school to calculate the amount of eligible aid the student may receive, based on the family’s overall financial picture. The student's financial aid package may include loans from the Federal government, state government, the college or a commercial lender.
Given today’s low-interest rate environment, some clients may consider using a home equity line of credit. The loan options may differ significantly, depending on the product, so be sure to help your client carefully examine the interest rates and terms of each loan before proceeding.
If a client has retained you, and you have a clear and thorough understanding of their financial and personal goals, you can prudently research, analyze and present other possibilities. Specifically, retirement savings may be available to pay for college expenses in the form of withdrawals and/or loans. Clients may withdraw dollars from their IRAs before reaching age 59 ½, without penalty, to pay for qualified higher education expenses. Borrowing funds from an IRA is prohibited; however, you may be able to borrow from most workplace retirement plans, including 401(k)s, 403(b)s and 457 plans.
The CPA’s Role
One important caveat to keep in mind when using retirement assets to fund an education: there are always education loan options available, but there are no such loan programs existing for retirement. You, as the adviser, must carefully guide your client through this and other options and make sure the risk and consequences of a shortfall in retirement are fully understood. Short of putting all of their money on red 24 in Vegas, they will have to come up with their own money to pay for college expenses or pursue one of the savings plans described above. For more information on education planning, the AICPA personal financial planning division, in partnership with expert Bob Keebler, CPA/PFS, has created this podcast series.
Robert A. Westley, CPA/PFS, Northern Trust. Robert is a CPA financial planner with Northern Trust in New York City. He specializes in developing, implementing, and monitoring holistic financial plans and wealth management solutions for high net worth families. Robert serves on the AICPA Personal Financial Specialist Credential Committee. Contact him at firstname.lastname@example.org.
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