10 Groundhog Day Lessons for College Savers
Every year at 7:25am on February 2, more than 25,000 people gather in Punxsutawney, Pennsylvania to wait for a groundhog to emerge from hibernation. If the groundhog sees his shadow and burrows back into his hole, we can expect six more weeks of winter. If he doesn’t see his shadow and stays above ground, it means he is predicting an early spring.
But, Punxsutawney Phil often misses the mark. The groundhog has made over 120 predictions, yet he’s only been correct 39% of the time. Parents and grandparents also make inaccurate predictions when saving for a child or grandchild’s college education, but unlike Punxsutawney Phil’s forecast, college savings mistakes can be costly.
Here are 10 ways making wrong assumptions can hurt your child’s college savings.
1. Underestimating college costs. When saving for college, some parents only focus on tuition and forget to save for other expenses, like room and board. According to the latest Trends in College Pricing report from the College Board, student budgets for room and board costs for the 2019-20 academic year were $11,510 for public 4-year colleges and $12,990 private nonprofit 4-year colleges. Families who don’t save enough to cover total college costs may have to use student loans to fill the gap.
2. Predicting a child’s future college. Parents may dream of their child attending a certain college or type of college, but there’s no guarantee that their wishes will come true. In some cases, attending a private nonprofit 4-year college costs more than double the cost of attending an in-state public 4-year college. Parents may come up short if their child has other college plans in mind.
3. Not accounting for inflation. Looking at current college costs may be helpful when trying to set a college savings goal, but prices may increase significantly before it’s time to actually pay the college bills. Over the past year, costs of tuition, fees and room and board have increased by 2.6%, 2.5% and 3.3% for in-state public 4-year colleges, out-of-state public 4-year colleges and private nonprofit 4-year colleges, respectively.
4. Forgetting about financial aid. Parents who set a college savings goal based on a college’s sticker price may end up with leftover 529 plan funds. It’s important to consider grants and other financial aid a student may receive for a more accurate projection of future costs.
5. Counting on scholarships. Very few students get a full ride to college. Parents who don’t save for college because they assume their child will get a scholarship are putting their child’s future at risk. Without college savings, students have limited choices and may be forced to take out excessive student loans or put off going to college. Private scholarships are part of the plan for paying for college, but not the entire plan. Only about one in eight students wins scholarships to pay for college, and the average scholarship amount is about $4,200.
6. Waiting for the right time. According to a 2015 report from the United States Department of Agriculture, middle income parents typically spend over $12,000 on a child before the child reaches age two. This might come as a shock to new parents, who might decide to put off saving until their child gets older. But, unfortunately kids only get more expensive as they get older. Plus, parents who wait to start saving can miss out on potential tax-free compounding in a 529 plan.
7. Counting on a state income tax break. Many states offer an income tax break for 529 plan contributions. However, families should check their state’s rules if they plan to use their 529 plan to pay for K-12 tuition and student loan repayments. Some states consider K-12 tuition and student loan repayments to be non-qualified expenses. The earnings portion of a non-qualified distribution may incur state income tax, and any state income tax deductions or state income tax credits claimed may be subject to recapture.
8. Assuming your grandchild’s 529 plan will be used for college. Some grandparents contribute to a parent-owned 529 plan to help a grandchild save for college. But, grandparents should keep in mind that nothing stops a parent from changing the 529 plan beneficiary or using the funds for something other than college. The 529 plan account owner, not the beneficiary, has full control of the account.
9. Assuming you will get a state income tax break for helping a grandchild save for college. Over 30 states offer a state income tax deduction or state income tax credit for 529 plan contributions. However, 10 states only offer state income tax breaks to a 529 plan account owner or their spouse.
10. Not considering the financial aid impact of a grandparent-owned 529 plan account. Assets held in a grandparent-owned 529 plan do not affect a student’s eligibility for need-based federal financial aid. But, distributions from a grandparent-owned 529 plan count as untaxed income to the beneficiary and will reduce eligibility for need-based aid by as much as 50% of the distribution.
A good place to start