Biggest factors impacting what you pay for college

It is not just the sticker price of a college that determines what the overall cost will be for you or your child. Merit and need-based financial aid can lower the cost, but interest on loans and the ever present Tax Man can drive the cost up dramatically.

MERIT AID

Some colleges offer academic merit aid to all incoming students who meet or exceed specific criteria typically based on grade point average and standardized test scores: ACT and SAT. In short, if you make the grade, then you get the aid. Other forms of merit aid may be available to a select number of students versus all incoming students, and some colleges offer specific scholarships for students in certain academic majors, like engineering or business. In addition, merit aid can be awarded for nonacademic talent in areas like music, theater, athletics and even leadership.

Take away:

Parents need to identify ahead of time which colleges offer merit aid and the criteria they require. Elite colleges like Stanford and Duke and the Ivy League colleges don’t offer academic merit aid to all incoming students with high test scores and GPAs. They only offer need-based aid, eligibility for which is determined by each family’s finances, and is very generous. This is not to say there may not be some one-off scholarship these colleges might offer to individual students.

Other colleges — like Dickinson, Harvey Mudd and the University of Chicago — offer both need-based aid and merit aid. If a family’s finances cannot be optimized to qualify for need-based aid, then the family needs to seek out colleges that offer academic merit aid in order to lower their out-of-pocket cost.

NEED-BASED AID

The second type of financial aid is called need-based because eligibility for it is based on demonstrating a need for it using the following formula: Cost of attendance – Expected family contribution (EFC) = Need.

Expected family contribution is the calculated share of the cost of college a family is expected to pay based on two primary aid formulas known as the Federal Methodology and the Institutional Methodology. The whole reason families complete the FAFSA and CSS Profile college aid forms is to then take all of the family’s financial aid and demographic information and run it through these two methodologies to spit out an amount the formulas say the family can afford to pay toward the student’s college costs each year.

If the student attends an in-state public college with a sticker price of $28,000, and the family has an EFC of $35,000 per year, then the student doesn’t show a need for aid because their EFC exceeds the cost of attendance. Conversely, if the same student attends an elite college at $65,000 per year, then the student shows a need of $30,000 for aid that year ($65,000 – $35,000 = $30,000).

Take away:

It’s ideal to identify ahead of time what your family’s EFC is and if your family’s finances can somehow be optimized for financial aid purposes through a consultative planning strategy that helps them reduce their out-of-pocket cost of college and preserve assets and income for retirement.

BORROWING

Another factor that adds to the expense of obtaining a college degree is the interest paid on borrowed funds. As simple as it is, student loan interest over the life of the loans can add tens of thousands of dollars to the overall cost of college. Parents often borrow from their homes and 401(k)s, and use Parent PLUS loans from the government. All of the interest paid years after college adds to the total cost.

Take away:

It’s very simple. Borrow as little as possible, get the lowest interest rate you can and pay it back as soon as possible.

TAXES

Most parents don’t have enough saved to pay for college, so they resort to cash-flowing a great deal of the cost. The problem is they have to pay tax on their earned income (cash-flow) before they can write the check to pay for college. For example, if parents are sending a child to a $61,000-a-year elite college and they are in the highest tax bracket, then they will have to earn $101,000 in order to net the $61,000 after-tax to pay the college bill.

Taxes on unearned income like interest, dividends and capital gains is lower for most people than their tax rate on earned income, but even at a 15% capital gains rate, the added cost still adds up to a hefty sum.

This is one reason why 529 college savings plans are such an effective tool for college planning, because the gains on the investments in 529 plans are not taxed when used to pay for qualified college expenses.

Take away:

For many affluent parents whose children will not qualify for need-based aid, tax savings may be the most effective way to reduce their out-of-pocket cost.

Troy Onink is the chief executive of Stratagee.com, where he leads the new College InSource Partner Program.