Every grandparent that has the means wants to help their grandchildren through some type of financial support. It is estimated that over $35 billion is spent or saved annually by grand-parents on behalf of their grandchildren.Those numbers are expected to grow drastically over the next five years, which bodes well for parents, who could use the help. College costs are on the rise, with no signs of slowing down. In some states, such as Massachusetts, the cost of public colleges rose more than 25% over the past two years. All the while, average income growth has crept up by a few percentage points per year, not nearly keeping up with education.
I recently caught up with Arman Rousta, Founder and President of 401kid, Inc., to address the scary topic of Education Financial Planning. 401kid is a financial advisory firm based in New York City that produces web-based software that helps families plan and save for their children’s education.
Q: Hello Arman, it’s nice to see you again.
A: Likewise Rick, thank you for having me.
Q: What are some trends in education that grandparents should be aware of?
A: Traditional education is becoming more difficult to afford, while distance learning is opening up new doors to what I believe will be a more dynamic educational experience. Grandparents can help simply by being aware of these trends and working with their children and grandchildren to plan effectively and as early as possible. Here we are, in the land of opportunity, and an education is rapidly becoming unaffordable for a large segment of the population. Nearly one million qualified high school graduates in 2004 could not attend college due to lack of funding. Moreover, for those that do go on to college, they are graduating with more debt than ever, some in holes as deep as $80,000. More than half of college graduates enter the job market with over $20,000 in debt. To make matters worse, the government is cracking down on outstanding student debt, which puts more pressure on graduates to pay up sooner. What a way to start a career, in the hole!
Q: That doesn’t sound too fun. So tell us what grandparents are doing to help their grandchildren ease that burden when it comes to education?
A: Well, there is no question that grandparents take education very seriously. In fact, more than half of grandparents help in some fashion to pay for their grandkids’ education. Most grandparents that have the means are more than willing to help. The problem is, they are typically not very sure as to how to go about that most effectively. Between joint accounts, custodial accounts, IRAs, trusts, savings bonds, and 529 plans, it can be pretty confusing without some research and guidance.
Q: Can you elaborate on that? How can grandparents invest wisely and what are they currently doing wrong?
A: Using 529 plans, which grow tax-free like Roth IRAs, is highly advisable but most grandparents are still not doing it. These plans, for those who have not heard about them, allow grandparents to gift $11,000 per year or $22,000 for a couple, to each of their grandchildren without incurring gift taxes. Also, grandparents who have the means can invest up to five years worth, which comes to $55,000 or $110,000 for couples, in 529 plans without getting hit with gift taxes. This gift also reduces the size of the estate, which will be a huge savings for the family when it comes to estate taxes. Most grandparents who have the funds keep the money in trust funds, which is not nearly as effective.
Although each particular situation should be approached differently, the broad advice for grandparents here is to consider opening 529 plans directly for each of your grandchildren that is likely to be collegebound. Further, if you work with an advisor, make sure that they are objective in how they advise you into such plans. Oftentimes, plans that don’t offer advisors large commissions may be the best for a family, but they may not get that advise from their advisors.
Q: Then how does one go about evaluating savings plans or make sure that they are getting objective advice?
A: What I say to parents and grandparents alike is “do your homework, try to find some independent sources of advice and do not just go with the first option that someone presents to you.” It is better to take your time and ensure that you are in the right investments for your situation than to rush it and risk getting into an unfavorable plan.
Secondly, do not hesitate to open more than one plan, which reduces the risk of relying completely on one fund manager, which can be dangerous - just look at the recent SEC scandles. Further, there are a lot of questionable sales tactics being utilized by financial advisors, which can compromise your investments. That being said, there are a good deal of ethical and knowledgeable financial advisors out there, including commission-based advisors. As long as they are upfront about how they get compensated, and investors fully understand it, the relationship can be beneficial. Just make sure that you always ask advisors about their compensation.
Lastly, on our website, 401kid.com, we have a list of all the available 529 plans, which are governed by the various states. Most of the resources on the site are free, including information about the plans. To save time and receive objective advice from a staff of Education Planners, grandparents can pay a small fee of $29.95/year through the website. For that fee, families get specific advice on which plans and investment options within those plans are most suitable, and given their financial situation, how much they should invest. If they wish, the 401kid Education Planners can also help them with the paperwork and administration of opening the various plans.
Q: Sounds like a nice service, and good plug. Now, what if someone does not get good advice on 529 plans and wants to make amends? Is that possible?
A: Yes, of course. Once per year, an account holder is able to rollover their 529 plans into new plans with different fund managers. Also, if someone feels that their investments are too risky, as in all stock mutual funds, they can alter the asset allocation in their portfolios to shift to more conservative funds. Sometimes, commission-based advisors put unwitting investors into Class B Share funds, which have backend sales fees; what that means is, on top of annual expenses for managing your money, the funds charge you if you withdraw funds within five or six years. This is a very tricky and harmful sales tactic, which most people just don’t know about.
Again, the unbiased 401kid Education Planners can provide guidance when it comes to righting a non-optimal portfolio. Otherwise, for those who want to work face-to-face with financial planners, I would advise identifying a fee-only, objective planner from NAPFA (National Association of Personal Financial Advisors), from their website, www.napfa.org. There is a a higher standard of ethics in how they deal with clients that I believe people will find a refreshing change of pace from the wheeling-and-dealing Wall Street brokers.
Q: What other college funding strategies would you advise families to investigate?
A. There are several things to look at in terms of alternative funding strategies. Students can always work during college, through off-campus jobs or work-study grants that directly reduce their tuitions. ¼br /> In the years leading up to college, academic and extracurricular performance open up funding options significantly. As a grandparent, encouraging your grandchildren to pursue their hobbies and interests, join the groups that they have inclinations towards, and keep up their grades, can go a long way in terms of receiving grants and scholarships. ¼br /> In fact, two dozen states now offer performance grants that reduce or even eliminate tuition for students who maintained certain academic standards during high school. Georgia’s Hope Scholarship is the best example of this. Any high school student in Georgia that achieves at least a B average has the opportunity to attend a Georgia state college for free! Not a bad deal, right?
Q: How can the states afford that?
A: Well, it’s a long-term investment in their own communities and an effort to keep talented youth close to home during college and subsequently, during their careers. Like any legislation though, this can change at any time. I hope that it proves to be economically viable for the states, as it offers a meaningful incentive and cost savings for students and families.
Another benefit for families in this scenario of going to college in-state is that they save money on travelling, long distance and boarding, especially if students live at home during college. Each student and family has to weigh their options and see what is affordable. Going away to college can also be a tremendous growth experience, but families need to ask themselves, at what and whose expense?
Q: So how would you advise families to deal with a situation where it is more practical for the students to go to college in-state but the student gets into a good out-of-state school and wants to go?
A: That’s a tough one, and each situation is unique, but there are some good ways to handle it. Again, it starts with the economics - the question of affordability and a family’s comfort-level with taking on debt. Remember, most financial aid, especially for families in the $70,000 and up income category, comes from loans. Since 17 year-old kids are not typically equipped to make such financial decisions on their own, it is incumbent upon parents and grandparents to collaborate on these decisions. This is a great chance to start educating kids on finances and transfering some fiscal responsibility to them.
A smart thing to do is to set a budget for contributions from parents, grandparents and other contributors, and then present the collegebound student with the following choice: We are able to contribute $100,000 to your education over the next four years. You can either A) Attend the state school for four years, live at home and get a car or keep the balance in your account; B) Attend a state school for two years and then transfer to the out-of-state private school, taking out student loans or working to cover the balance; or C) Go to the private school for four years and take out student loans and work to cover the balance.
By setting the budget and giving the student choices, it takes some pressure off the parents and puts the honus on these young adults to start taking accountability. If parents simply cover all costs without involving the students, they typically do not take school as seriously nor value the education quite the same as those who had to sweat a little bit to get there.
Q: Talk a little bit about financial aid. First off, is there anything that grandparents can do to help improve chances of aid for their grandkids? Next, what kinds of aid are out there these days and how can families qualify?
Great question, and the answer is a resounding YES, grandparents can come through in a big way by planning well and in sync with parents and students. Regardless of a family’s financial circumstances, parents should always apply for financial aid for each student, every year that the student is in college. The financial aid formulas basically take four factors into account when determining what type of “need” a student has - parents’ assets, parents’ income, student’s assets and student’s income. Notice how there is no mention there of grandparents’ assets? Therein is where the opportunity lies. The 529 plans that we mentioned are financial aid friendly savings vehicles, because the assets within them do not get counted against the family in the financial aid formulas. Just about the worst thing for financial aid purposes is to have assets in custodial accounts (UGMAs) under the student’s name. Anything that is a student asset gets earmarked by colleges as an asset that should go, in large part, towards paying tuition.
Grandparents can also pay a grandchild’s tuition (not room, board, or books) directly to the school he or she is attending and incur no taxes. Again, this is much more effective for financial aid purposes than gifting money to the students, which increases student assets and decreases aid.
There are a number of aid sources out there, over $70 billion worth each year, which is a whole separate discussion. Pell grants are available for lower income families, while Stafford, Perkins and PLUS loans are available to students and parents at reasonable interest rates. There is a financial aid section on 401kid.com which gives a more in-depth overview on aid sources. Further, within the same annual $29.95 fee, a 401kid Education Planner gives collegebound students specific advice on which financial aid sources are viable and how to go about applying. Further, for families with younger children, future financial aid projections are available, which is great information for planning purposes. Since most families don’t pay attention to the financial aid “headache” until the college years arrive, they remain in the dark as far as what kinds of support might be available to their children.
Financial aid applications can be as complex as tax forms, so some guidance and timeliness are important here. Some financial aid consultants charge over $1,000 just to fill out forms for families, which like a good accounting service, can be worthwhile. Also remember that college applications range from $75 - 150 per school. ¼br /> Grandparents can be of great assistance in identifying and paying for such “hidden” costs in the education planning process.
Q: Are there areas of the country where college is more affordable, that families should consider?
A: Families living in the northeast generally pay much greater proportion of their annual income to pay for college expenses, partially due to less government support in that region. For instance, to attend a 4-year private college or university in Massachusetts, it requires over 81% of average annual family income. Maine and New York are not far behind, both registering 78%. Scary numbers, huh? On the side of affordability, Utah and Idaho require 21% and 29%, respectively.
Q: How can there be such a disparity in college cost from state to state?
A: Our view is that marketing and reputation have a lot to do with it. The northeast has always been known for first rate colleges and the way schools are run, with billion dollar endowments, education marketing is like an arms race, chasing the “best and brightest” students. Here we find the basic laws of supply and demand at work, as college applications are up every year. Schools, banks and governments all know this, and therefore, have mixed incentives to make college more affordable, depending on the particular state and local government policy.
Q: Let’s go back to the future and discuss how distance learning may impact education going forward? Specifically, what will the impact be on costs of education?
A: This is an intriguing area and the major educational institutions of the world have already taken note, to the tune of billions spent on distance learning technologies. Distance learning, through the Internet, is taking off, and I expect new models of web-based learning to be introduced over the coming years. These new models should help to lower the cost of delivering lessons, collaborating virtually in groups or classes, and ultimately, achieving a meaningful degree.
It is best to consider distance learning as a tremendous complement to traditional, classroom-based education. We will have more options, in terms of cost and method of education in the future. Hopefully, this will put pressure on traditional institutions to lower or at least halt tuition inflation. ¼br /> Lastly, we should consider the fact that there are different learning styles, which our traditional educational system has not been flexible enough to support. Since each student is inclined to a different learning style, it is important for them to have exposure to new learning models, such as distance learning, which may be more conducive to them. The net result is that new technology has opened up the world to a new form of knowledge sharing and learning, which should help students learn a wide variety of subjects more completel
