Today’s rising college costs are leaving families wondering how they are going to pay for four years of college. Most families I work with want to help their kids pay for college, maybe not all of it, but they do want to help. These families are also terrified of the thought of paying for college. As you can imagine, with an average four year expense of over $100,000, there is quite a bit you should know and understand.

Paying for college can be really complex, and should be planned for ahead of time. While there are many involved methods of paying for college, the average person will have four main sources of funds to draw from:

• income
• savings
• scholarships
• loans

The ideal circumstance would be for a family to have saved enough money to cover the entire cost of college, or have enough income to pay for college out of pocket. However, the reality is that very few families have the resources to fund four years of college. The average 529 plan savings is a little over $20,000, which normally won’t cover one year of school! Due to the cost and complexity, having a plan to pay for college is essential. Here are a couple of important considerations when developing a plan to pay for college.

1. Know the American Opportunity Tax Credit (AOTC)

The AOTC is a tax credit for families that are paying for the first four years of college for dependents. A tax credit is a dollar for dollar tax reduction. As long as your student meets a few requirements, you get a dollar for dollar tax credit for the first $2,000 of college expenses, and 25 cents on the dollar tax credit on the next $2,000 of eligible expenses. A student meeting the eligibility requirements for the AOTC will receive a credit up to $2,500 per year. The credit is available for each student’s first four years of college.

One important stipulation for claiming the AOTC is that funds cannot come from a 529 plan. It is possible to take funds out of a 529 plan and claim the AOTC in the same year, but they cannot be the same funds. For example, if the cost for one year is $15,000, you can take $11,000 out of a 529 plan and pay for the other $4,000 out of pocket, but you cannot take the full $15,000 from the 529 plan and still claim the AOTC. Paying the $4,000 out of pocket allows individuals to claim a $2,500 tax credit, making the true out of pocket cost $1,500. The AOTC is also refundable up to $1,000.

2. Do NOT deplete your 529 plan (or college savings) immediately

If you know beforehand that you will not be able to pay for all four years of college, then you will want to develop a plan that includes federal loans. Federal loans are available to all students with a maximum limit per school year.

1st year (Freshman) = $5,500

2nd year (Sophomore) = $6,500

3rd year (Junior) = $7,500

4th year (Senior) = $7,500

These loan amounts are not cumulative, so if you do not take any loans out your first year, you have missed out on the opportunity to take that $5,500. The maximum amount allowed to students in federal loans is $31,000 for undergraduate students.

There are many reasons to take advantage of federal loans; I have listed a few of them below.

• Subsidized loans
• Low interest rates
• Low origination fees
• Flexible repayments
• Loan forgiveness

These loans are not be confused with Parent Plus loans, which share some characteristics of student loans but not all. We typically recommend avoiding the Parent Plus loans if possible.

These are two very important reasons that families need to have a plan to pay for college. Having a plan before your child steps foot on a college campus will likely save you thousands, and possibly even tens of thousands of dollars over a four year time span. If you would like help with your college planning, or would like to know more about our college planning process, you are welcome to schedule an introductory call.

Neither Bobb Financial or RDA Financial Network nor its professionals provide tax advice. Please consult a tax professional for guidance.

Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.