Saving for College is A Good Idea (Despite what you may have heard)

August 4, 2004

Howard and Matthew Greene

You may see some headlines soon picking up on the title of a new report on the impact of family savings on receiving need-based financial aid for college: "When Saving Means Losing" (Ifill and McPherson, Lumina Foundation for Education, v.5, n.2, July, 2004). As is often the case, a more complicated and nuanced report will be distilled down to one simplified and scary thought: saving for college will reduce your eligibility for financial aid. The implication is that families who want to receive aid from colleges based on their ability to pay — what is termed need-based aid — should not save money. The report itself is more complex than that, and in addition to explaining what it is really saying, we want to reassure you that saving for college is a good idea. Putting away money early to help your children afford their college dreams should be an essential part of your family financial planning and budget process.

The Lumina Foundation report does not say that families should not save for college. Rather it tries to assess the impact of savings on eligibility for financial aid based on a hypothetical family's ability to pay. That is what is known as the Expected Family Contribution (EFC), determined largely on the basis of the Federal Methodology, which takes into account parent and student income and savings, additional family members in college, and other factors. Once you know your EFC, you can compare that to a particular college's total cost of attendance and discover your financial need, which is the difference between your EFC and the total cost of a college. If your EFC is equal to or greater than a college's total cost, you will not have any financial need, and thus will not qualify for need-based financial aid.

A middle-income family may have demonstrated financial need at a high-priced private college, but not at a lower-priced in-state public university or community college. A high-income family may have no financial need at any institution. The Lumina report's most important conclusion is that low- and middle-income families should carefully consider where they are saving for college, since certain strategies will more significantly reduce the amount of need-based financial aid for which they might qualify. In particular, these families should avoid pre-paid tuition plans offered by the states and now some private groups, since that money will reduce financial aid on a dollar-for-dollar basis. Families should also put more money into tax-advantaged savings accounts (such as 529 savings plans) that are held in parents' names, since that money has less of an impact in reducing the EFC financial need assessment.

We would add several important points to encourage you to think about saving for college in a different way. Savings are good for several important reasons. First, savings will give you more college opportunities. If you have money in the bank, you will be less limited in which college options you can afford. That is because college financial aid offers often do not cover the full amount of financial need, and, when they do cover need, they usually include a significant amount of loans that the student will have to repay. With average student loan debt now exceeding $18,000, this is becoming a deterrent factor for many students unwilling to take on that long-term burden. If you put money away over the long term, you will put compounding interest to work for you, rather than having to pay interest to banks or the federal government on money you borrowed for college.

Second, the fastest growing sector of financial aid is merit-based financial aid, which is awarded without regard to financial need and on the basis of particular academic, extracurricular, or personal talents. You cannot count on a need-based award or a merit-based award covering all of your college costs, but strong students who have put away some money toward college will often be admitted by colleges and offered discounted tuition rates on the basis of merit or another non-need factor. Having some savings available to help defray college costs shows seriousness of purpose on the part of the family, helps the college spread around its financial aid budget, and indicates a higher likelihood of completing your college degree.

Finally, most students in America attend institutions that have sticker prices below $8,000 per year, since most enroll in public colleges and universities. If you are, like most Americans, a middle-income family, and you save regularly over an extended period of time, you may be able to cover the full cost of an in-state public university for your children. Or, if you are, like most Americans, only able to save part of the total cost for your child's education, you can significantly lower the amount you or your child will need to borrow. Perhaps you can save enough to cover the difference between what a college or the federal or state government provides you in need- and merit-based grants. Savings means flexibility and choices. Review carefully your savings options, but start from the premise that the debate is over how, not whether to save for college.