Student Loan Dodgers

If your child isn’t near college age, you still have time to plan for Junior’s post-secondary education. The Federal government has created savings vehicles that will help parents pay for college. The 529 and 530 accounts can be used to pay the cost of a college education and come with tax benefits not available with other savings vehicles. In addition, at least thirteen states offer pre-paid tuition contracts that enable parents to lock in the cost of tuition.

Parents worry that saving too much will mean that Junior won’t be eligible for financial aid. For need-based aid, that may be true, however the amount of need-based aid has been dropping steadily for the past decade or more.

With fewer need-based or income-based aid programs available, Junior is not likely to be eligible for need-based aid anyway, unless the family’s income meets strict low-income guidelines. Many parents make the mistake of thinking that the less they save, the more need they’ll be able to show when it comes time to fill out the Federal financial aid application. That’s not exactly true. Lack of savings doesn’t translate into “need” in most cases. The more likely outcome of reduced savings is increased student loans.

For example, Duke University reports that about 40% of its undergraduate students qualified for need-based aid in the 2004-05 school year. The median family income for qualifying students was $86,000. Adjusted for inflation, in 2007 dollars, that would be nearly $97,000. The university also reports that some students with high family incomes (in excess of $150,000 - $169,000 in 2007 dollars) received some need-based aid due to extenuating circumstances. Need-based aid is not limited to grants. It also includes certain types of loans.

The Federal student aid formula takes into account the cost of the institution, the income of the student, the income of the family, savings, awarded scholarships, the number of college-age students in the family, and family hardships such as long-term or catastrophic medical illness. Students with extremely low incomes – less than $40,000 ($45,000 in 2007 dollars) – were offered more grants and fewer loans. The point I’m making is that unless your family finances are minimally north of the poverty line, you’re much better off saving money in a college account of some type than you are hoping that you’ll receive grants.

The most important lesson here is that “need-based aid” doesn’t always mean “free money.” More often than not, it means subsidized Stafford Loans that must be repaid. In the long run, your student will leave college with fewer loans and a better opportunity to benefit sooner from his or her college education by using private funds saved in a 529 or 530 account, or by using a pre-paid tuition contract.