Financial Planning – How to create a baseline budget for your child’s 4-year college degree
Picking a college to educate your child is a lot like buying a home. You spend time researching different schools, programs within those schools, costs to attend, and so on. The biggest difference between the two however, are the steps most parents skip when determining what school they can actually afford. When you’re shopping for a home, the process forces you to think about your personal finances in-depth. It’s a best practice to get pre-approved from a lender before you put an offer in, there are debt-to-income limits enforced to make sure you can actually afford what you intend to buy. Oddly enough, college applications require no such review, and parents/students often find themselves burdened with student loan hardship from not taking the time to calculate what schools make the most financial sense.
To clear up the confusion and determine how best to utilize the resources on hand when paying for college, we have put together a 4-step process that outlines how you can create a true budget before your children commit to the colleges they are considering.
1. Parents – Review your savings and cash flow.
Someone who isn’t as familiar with the total annual cost to attend a university may get sticker shock when they see the total of ALL expenses necessary to attend. You may reflect on how much you’ve put away in your kid’s 529 and think there’s not enough there to make ends meet, but it’s important to consider your current cash flow in lieu of this. If you are still contributing to that 529 and comfortable with your savings, make sure you account for that. Our firm’s parents contributing to a 529 plan save on average $416/month. That’s roughly $5,000/year that could be added to your budget. In addition to your current savings for this child, consider how much you spend on them throughout the month. Between food, after-school activities, and sports – you will probably find that you spend another $200 – $400/month on your child. Add this along with your 529 savings and you’re looking at an additional $7,400 – 9,800/year!
2. Next, determine if you are eligible for the American Opportunity Tax Credit.
When paying for qualified education expenses for your child, it’s important to communicate with your CPA when your kid starts their freshman year. At the top of the year, you should receive a 1098-T that provides all the college expenses you paid for over the previous calendar year. If your MAGI (Modified Adjusted Gross Income) is less than $160k for a married couple or less than $80k for a single parent, you could be eligible for a tax credit of up to $2,500. As long as you continue to claim the student on your tax return and you’ve paid for a portion of their expenses with assets outside of your 529 account, you should be eligible for the credit.
If your household is on the brink of this $160k/$80k income limit, there may be other options for you to still qualify. First, consider your cashflow. If you have the ability to save more money, increasing your 401k or Health Savings Account contributions can be a way to reduce your MAGI. If money is tight and you don’t have the extra cash flow to save towards these accounts, consider not claiming your child as a dependent on your taxes as an alternative. By doing this you will be forfeiting the $500 credit you normally get, but you will be allowing your child to claim the American Opportunity Tax Credit on their tax return. Since this credit is refundable up to $1,000, your child could still qualify for a $1,000 credit even if they didn’t owe any federal taxes that year. Talk with your CPA to find out what options make the most sense for your situation.
3. Have an open conversation with your kids.
Whether you plan to have your child pay for some of their college or not, it’s still good for them to understand the investment that you’ll be putting toward their education. Most of the parents we work with don’t necessarily force their kids to pay for tuition and books, however they do give them a budget when it comes to their lifestyle expenses (e.g. rent, eating out, extracurricular activities, and so on). One idea to help give your kids some skin in the game is to sit down with them and help them create a monthly budget. You can let them know how much allowance you’re willing to provide them on a monthly basis and then back into the savings they should be making while working over their summer breaks. Not only can this reduce the overall cost for parents, but it’s a great habit for your kids to start before they graduate college.
4. Create the budget using steps 1-3.
Attached is a spreadsheet we use with our clients and an example of a college budget. While we know there’s potential for additional funding via student loans, scholarships, financial aid, and even money from grandparents, we tell our clients that it’s important to build a realistic budget without these resources, as they can each vary depending on family and school.
If you find the budget you created still isn’t enough to make a 4-year college education possible for your child, then stay tuned for our next monthly college blog where I will be breaking down alternative options to increase your college budget using student loans, scholarships, and financial aid.
Example BudgetCollege Budget Example
Koa Wealth Management
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