Higher education has the power to both broaden our knowledge and develop our technical skills. Studies show that it can also result in significantly more income over the course of a lifetime. However, the cost on an education has exploded, and the idea of paying for one—whether for yourself or your children—can be overwhelming. Education can now be nearly as expensive as a home or retirement. The good news, though, is that a long-term perspective can make higher education a manageable expense.
There are three important things that make saving for higher education a challenge.
The cost is typically an unknown. You don’t know what the price of tuition and room and board will be, or how much you’ll receive in financial aid.
There are a patchwork of funding sources, each with its own rules and challenges: saving, borrowing (from both government and private lenders), scholarships, grants, gifts.
There’s a condensed timeframe. Unlike with a mortgage, which you pay for over 30 years, or retirement, which you save for over your entire career, the bills for higher education typically come over just four years.
Paying for college requires a long-term approach that spreads the cost over decades.
Break the payment cycle into three stages: Before, During, and After.
Before: Starts at least ten years prior to the first class, and involves regular contributions to a higher-education savings account.
During: Lasts for the duration of your time taking classes—two to four years. You’ll take out loans, and look for scholarships, grants, and other forms of student aid.
After: Lasts ten years or more, and involves repaying the loans that you took out.
Add it all up and you’re looking at a process of 25 years or more.
Higher-education savings accounts
With these special accounts, the money you contribute gets invested, and you won’t have to pay any taxes on the earnings as long as they’re used to pay for higher education.
A 529 savings account offers a tax-advantaged way to save for higher education. Each state offers its own 529, and many of them include financial incentives that are reserved for their residents, but you are free to select a 529 plan from any state.
A second type of 529 allows you to buy tuition at today’s prices that you’ll use years from now when you begin taking classes.
A Coverdell Education Savings Account (ESA) is another tax-advantaged way to save for education. An ESA offers more investment flexibility than a 529 savings account does.
How to apply for financial aid
Everything starts with FAFSA! The Free Application for Federal Student Aid covers federal aid, including loans, grants, and work-study opportunities.
The FAFSA is free, and you can submit it online in about 30 minutes at FAFSA.gov. File early because aid is given first-come, first-served.
The government uses the FAFSA to determine your expected family contribution, or EFC, which is the amount it figures your family can afford to pay toward your education. Your EFC is then subtracted from the cost of attending school, which leaves your financial need.
Also fill out the College Scholarship Service Profile, which is known as the CSS. It’s used primarily by private colleges and universities for aid that comes directly from those schools rather than the government.
Some of your financial aid may be in the form of loans that have to be paid back!
The Stafford federal loan comes in two versions: subsidized and unsubsidized. With a subsidized Stafford loan, the government pays the interest while you’re enrolled (it’s available only to those with demonstrated financial need). With the unsubsidized Stafford loan, you’re responsible for the interest even while enrolled. In both cases, though, you don’t have to begin paying back your loan until you’re no longer enrolled.
The Perkins federal loan is subsidized, and it’s available only to those with financial need.
Loans from private lenders
Many people have more financial need than can be met by federal financial aid and take out loans from banks and other private lenders.
Private loans are often unsubsidized and typically come with higher interest rates than federal loans.
Education loans are a lifesaver for many students but they can be very “sticky”
Unlike many forms of debt, the student loans of today can be hard to untangle from if you have financial hardship. You won’t necessarily be able to rid yourself of the debt by declaring bankruptcy.
The tax benefits of paying back your student loan
The Student Loan Interest Deduction allows you to deduct some of the interest you pay on your student loans.
The Lifetime Learning Credit is tax credit for a student or the person paying for a student’s higher-education expenses.
The American Opportunity Tax Credit is a tax credit for some higher education expenses. It’s available only in the first four years of post-secondary education. (You can’t claim both the Lifetime Learning Credit and the American Opportunity Tax Credit for the same student in the same year.)