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'Late Stage' College Planning

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Advisors don’t need to be reminded how much of an expenditure paying for college has become for their clients. We’ve all seen examples of how college bills can damage a family’s nest egg. Advisors need to realize that college planning is retirement planning. How parents pay for college will have a significant effect on when and how they will be able to retire. After all, for every $100,000 parents spend on educating a child, there is that much less money available to compound over time for retirement. The parent’s retirement fund is robbed of approximately $300,000 if one considers the loss of being able to invest that $100,000 at 8 percent over 15 years — and that’s only taking into account one child’s cost of education!

I know from first hand experience the feeling that dogs many parents as they watch a bright student progress through school. As our high school junior and his counselor began dropping names like Cornell, Northwestern, Boston College and (gulp) NYU, we tried not to gasp but determined to help him realize his full potential — even if it meant raiding our retirement savings.

I was fortunate to hear Deborah Fox, a long-time financial advisor and founder of Fox College Funding in San Diego, speak at an industry conference. Fox College Funding ( is a national network of financial advisers who specialize in late-stage college funding planning for higher-income families who do not qualify for financial aid.

As Deborah explained how she helped affluent families whittle down college costs, it was hard to contain my hope. While I can’t share the details of my own family’s late-stage college funding plan, Deborah was kind enough to provide a real-life client example. Here are my questions, and Deborah’s answers.

What is “late stage”college planning?

Late-stage college planning occurs when families lack much time to save — typically the high school years when many parents realize that college bills are just around the corner and that they haven’t saved anywhere near the amount they’ll need. Parents also assume, incorrectly, that it’s too late to do any meaningful planning. Instead, they begin praying for a large scholarship.

Your company specializes in providing planning services to families who won’t qualify for need-based financial aid. Is there a specific issue these families face when it comes to higher education?

Low- and middle-income families have the potential to fill the college-funding gap with financial aid. High-middle-income and affluent families who top the financial-aid thresholds are left to fend for themselves. Since college expenses are paid for with after-tax dollars, they must earn significantly more than the actual cost of an education. For instance, parents in a 33 percent combined federal and state income tax bracket with a college cost of $25,000 per year will have to earn over $149,000 in pre-tax dollars to cover the four-year expense. These parents may be earning healthy incomes; however, after paying taxes, they have far less available than one might expect. Without the availability of financial aid, many of these families will feel the cash-flow pinch.

AllianceBernstein recently released survey results showing that, despite their best intentions, parents are unprepared to cover the real costs of a college education. Parents have unrealistic expectations regarding the availability of financial aid, scholarships and grants. Most parents do not know how to shore up this important time in their financial life.

I’m assuming you show families there is a light at the end of the tunnel?

There are dozens of strategies these late-stage families can implement to potentially reduce their out-of-pocket college expenses — often by tens of thousands of dollars. In fact, the typical family we plan for will be able to reduce what education costs by an average of $20,000 to $40,000 over four years.

That is significant. Can you share some examples?

There are three planning strategy categories high-income families can utilize to reduce college expenses: Academic, cash-flow and tax-reduction strategies. The client I’ll use as an example is a family of four. The parents, now in their early fifties, have one daughter who is a sophomore at a college in the Northeast; the other is a high school senior currently waiting for an early-admissions decision from her first-choice school. The father nets over $200,000 per year through his own consulting business while the mother works part-time and earns $15,000 per year in W2 income. The parents have a million-dollar trust account comprised of appreciated securities. They also have $200,000 in real estate limited partnerships, a natural gas investment that is spewing off $25,000 per year of income, a combination of IRA and 401(k) accounts totaling $400,000. The older daughter will soon deplete the $20,000 left in her 529 account, while the high school senior has $90,000 in her 529. The parents own a home worth $700,000, but owe $293,000 on a first mortgage at 6.5 percent and a second mortgage of $78,000 at 7.75 percent. The parents’ goal is to minimize out-of-pocket expenses when the 529 plans run out.

What strategy do you recommend this family use?

This family needs to know that they don’t need to pay full sticker price. Colleges compete for good students, and many offer tuition discounts to entice the right students. High school seniors need to match their profiles with colleges trying to attract students like them; they should apply to a few of these schools as a back-up to their first choice schools. As part of our planning process, my firm will perform a college match. Scholarship awards like these have nothing to do with the family’s finances; they are merit-based scholarships (based on things such as academic achievement, talent, declared major or extracurricular activities) — not needs-based financial aid.

Due to the high level of competition between colleges, they offer incentives to attract the students they want. Over 1,000 colleges offer guaranteed merit scholarships if the student can meet certain GPA and test score requirements, and a student doesn’t need to have a 4.0 GPA to qualify. Even “a solid B student” can qualify for scholarships — which can range from a few thousand dollars up to $15,000 per year.

How about a cash-flow planning tactic for this family?

One idea that immediately came to mind during the data-gathering process was to look at restructuring the family’s mortgage debt. By having the parents consolidate their first and second mortgage into a new first mortgage at 6 percent, they will free-up an additional $7,200 annually and redirect those funds to pay for college.

You also mentioned tax-reduction strategies. What more can this family do?

Families can pay for college expenses with pre-tax dollars by using income-tax reduction strategies to create new tax deductions that generate additional cash flow. One strategy is to use the tax capacity of the children to reduce income taxes. In this case, the parents have $25,000 of taxable natural gas investment income being generated each year. To lower their taxes and generate additional cash flow, they can gift this income to their children. In this case the parents will actually zero out taxes on this income by having the daughters file their own tax returns. With the parents in a 40 percent combined federal and state tax bracket, this strategy creates $10,000 per year in tax savings.

Another tax-reduction strategy that would work well for this family is to gift a portion of the appreciated stock held in their trust to the children, who will then sell the shares during their college years. The daughters will pay no income taxes on the capital gains due to the standard deduction, personal exemption and education tax credits. This strategy will also help reduce the concentrated stock positions they own. The gifted stock can not only be used to pay for college expenses, but any leftover funds can be diversified and reinvested at a new cost basis. With a gift of $48,000 of stock for 2007 that has $32,000 in capital gains built in ($24,000 to each of the girls), $4,800 of capital gains taxes can be avoided for the year.

You can see just from the handful of strategies we discussed here, without even considering any potential scholarship awards, that this family could easily reduce out-of-pocket costs by $22,000 in the first year alone. The amount of savings can greatly multiply over several years by including additional strategies. After implementing our plan, these parents should be able to fund college and save for retirement without affecting their current standard of living — and all without qualifying for financial aid!

Marie Swift is president of Impact Communications and the co-author of Just Give Me the Answer$: Expert Advisors Address Your Most Pressing Financial Questions with Sheryl Garrett.


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