Managing College Expenses eBook

LifeFocus.com T. Young info@lifefocus.com www.LifeFocus.com

Managing College Expenses

March 28, 2010

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Table of Contents Managing Expenses During the College Years ................................................................................................ 8 Introduction .............................................................................................................................................. 8 Savings .................................................................................................................................................... 8 Financial aid ............................................................................................................................................. 8 Education tax credits and deductions ...................................................................................................... 8 Out-of-pocket contributions ...................................................................................................................... 9 Other creative solutions ........................................................................................................................... 9 Paying the Bill Out-of-Pocket ............................................................................................................................ 10 What is paying the bill out-of-pocket? ...................................................................................................... 10 Applying for Financial Aid ..................................................................................................................................12 What is financial aid? ............................................................................................................................... 12 Who offers financial aid? ..........................................................................................................................12 Overview of the financial aid process .......................................................................................................12 The two formulas for calculating EFC ...................................................................................................... 13 How exactly is my EFC calculated under the federal methodology? ....................................................... 13 Steps to reduce your EFC under the federal methodology ...................................................................... 16 The institutional methodology vs. the federal methodology ..................................................................... 16 Steps in applying for financial aid .............................................................................................................17 Types of financial aid programs ............................................................................................................... 20 Do colleges award financial aid resources in a specific order? ................................................................21 Should you apply for financial aid even if you don't think your family will qualify? ...................................21 Positioning Your Income/Assets to Enhance Financial Aid Eligibility ................................................................22 What does it mean to enhance your financial aid eligibility? ....................................................................22 Strengths ..................................................................................................................................................22 Tradeoffs .................................................................................................................................................. 22 Strategies to reduce available income ..................................................................................................... 23 Strategies to reduce available assets ...................................................................................................... 23

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Financial Aid: Loans ..........................................................................................................................................25 What is a financial aid loan? .................................................................................................................... 25 Are there different types of student loans? .............................................................................................. 25 How do I know who holds my student loans? .......................................................................................... 26 Financial Aid: Grants .........................................................................................................................................28 What is a grant? ....................................................................................................................................... 28 How do grants fit into the financial aid picture? ........................................................................................28 Tax implications ....................................................................................................................................... 29 Federal grants .......................................................................................................................................... 29 State grants ..............................................................................................................................................30 College grants .......................................................................................................................................... 30 Other grant sources ................................................................................................................................. 30 Financial Aid: Scholarships ............................................................................................................................... 31 What is a scholarship? ............................................................................................................................. 31 How do scholarships fit into the financial aid picture? ..............................................................................31 Tax implications ....................................................................................................................................... 32 Federal scholarships ................................................................................................................................ 32 State scholarships ....................................................................................................................................32 College scholarships ................................................................................................................................ 32 Other scholarship sources ....................................................................................................................... 33 Financial Aid: Work-Study .................................................................................................................................34 What is work-study? .................................................................................................................................34 The federal work-study program .............................................................................................................. 34 State work-study programs ...................................................................................................................... 34 Financial Aid Considerations for Graduate School ........................................................................................... 35 What are the special financial aid considerations for graduate school? .................................................. 35 Are there any other funding considerations that graduate students should be aware of? ....................... 36 Does the deduction for student loan interest apply to graduate loans? ................................................... 36 Does the Lifetime Learning credit apply to graduate studies? ................................................................. 36

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Implementing Other Creative Solutions to Cover Higher Education Costs ....................................................... 37 What are creative solutions to help pay for college? ................................................................................37 What are the specific creative solutions I can implement to lower the cost of college? ...........................37 Strengths ..................................................................................................................................................39 Tradeoffs .................................................................................................................................................. 39 Saving for College and Retirement ................................................................................................................... 40 What is it? ................................................................................................................................................ 40 First, determine your monetary needs .................................................................................................... 40 You've come up short: what are your options? ........................................................................................ 40 How do you decide what strategy is best for you? ...................................................................................42 Can retirement accounts be used to save for college? ............................................................................ 43 Education Tax Credits and Deductions .............................................................................................................44 What are the tax credits and deductions relating to higher education? ................................................... 44 Hope credit (American Opportunity credit) ...............................................................................................44 Lifetime Learning credit ............................................................................................................................44 Deduction for qualified higher education expenses ................................................................................. 44 Student loan interest deduction ................................................................................................................45 Comparison of Federal Higher Education Loans .............................................................................................. 46 Comparison of Education Tax Credits and Deductions .................................................................................... 48 Financial Aid Calendar ...................................................................................................................................... 50 Finding the Funds to Pay for a College Education ............................................................................................51 College Application and Financial Aid Calendar ............................................................................................... 52 Finding Money to Pay College Bills Out of Pocket ............................................................................................53 Your paycheck ......................................................................................................................................... 53 Your savings and investments ................................................................................................................. 53 Your home ............................................................................................................................................... 53 Your life insurance ................................................................................................................................... 54 Private loan/PLUS Loan ...........................................................................................................................54 Your retirement plans ...............................................................................................................................54

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Your child's piggy bank ............................................................................................................................ 54 ABCs of Financial Aid ....................................................................................................................................... 55 What is financial aid? ............................................................................................................................... 55 Need-based aid vs. merit aid ................................................................................................................... 55 Sources of merit aid ................................................................................................................................. 55 Sources of need-based aid ...................................................................................................................... 55 How is my child's financial need determined? ......................................................................................... 56 How does financial need relate to my child's financial aid award? .......................................................... 56 How much should our family rely on financial aid? .................................................................................. 57 529 Plans and Financial Aid Eligibility ...............................................................................................................58 First, why should you be concerned? .......................................................................................................58 A general word about financial aid ........................................................................................................... 58 How is your child's financial need determined? ....................................................................................... 58 The federal methodology and 529 plans ..................................................................................................59 The federal methodology and other college savings options ................................................................... 59 The institutional methodology and 529 plans ...........................................................................................59 Student Loan Basics ......................................................................................................................................... 61 First, remember the grace period .............................................................................................................61 Understand your repayment options ........................................................................................................ 61 Consider a deferment, forbearance, or loan cancellation if you can't pay ............................................... 62 Keep track of your paperwork .................................................................................................................. 62 Investigate the student loan interest deduction ........................................................................................62 Sticker Shock: Creative Ways to Lower the Cost of College ............................................................................ 63 Ask about tuition discounts and flexible repayment programs ................................................................. 63 Graduate in three years instead of four ....................................................................................................63 Earn college credit while still in high school ............................................................................................. 63 Think about cooperative education .......................................................................................................... 63 Enroll in a community college, then transfer to a four-year college ......................................................... 63 Defer enrollment for a year ...................................................................................................................... 64

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Live at home ............................................................................................................................................ 64 Consider distance learning .......................................................................................................................64 Work part-time throughout the college years ........................................................................................... 64 Join the military ........................................................................................................................................ 64 Go to school in Canada ............................................................................................................................64 Check to see if your employer offers any educational assistance ........................................................... 64 Have grandparents pay tuition directly to the college .............................................................................. 65 Education Tax Credits .......................................................................................................................................66 Hope credit (American Opportunity credit) can help with college expenses ............................................ 66 Lifetime Learning credit can help with college, graduate school, and individual course expenses ..........66 My child is in college--how do I know which credit to take? ..................................................................... 67 How do I claim either credit on my tax return? .........................................................................................67 Now that my child is in college, am I entitled to any education tax credits? ......................................................68 How do I know if I'm eligible for federal financial aid? .......................................................................................69 How can my child find scholarships for college? ...............................................................................................70 How do I apply for financial aid? ....................................................................................................................... 71 How does the federal financial aid process work? ............................................................................................ 72 Are my student loan payments tax deductible? ................................................................................................ 73 Should I use my 401(k) to fund my child's college education? ......................................................................... 74 What happens if our child's college does not give us all the financial aid we need? ........................................ 75 Can we negotiate our child's financial aid award? ............................................................................................ 76 Are there any assets that are not counted for financial aid purposes? ............................................................. 77 Do colleges offer financial aid? ......................................................................................................................... 78 What are the major federal financial aid loan programs? ..................................................................................79 Are any financial aid programs tailored especially to parents of post-secondary students? .............................80 Is there anything I can do now so that my child can obtain more financial aid later? ....................................... 81 Help! My child is only two years away from college and we haven't saved much. What should we do? .......... 82 What is a Stafford Loan? .................................................................................................................................. 83 Can anyone get a Pell Grant? ...........................................................................................................................84

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Should I withdraw money from my IRA to pay for my child's college tuition? ................................................... 85 Can a grandparent pay a grandchild's tuition directly to the college without any gift tax problems? ................ 86 I'm having trouble paying my student loans. What should I do? ....................................................................... 87 What expenses are included in the annual cost of college? ............................................................................. 88 Are there any ways to lower the cost of college? ..............................................................................................89 How will I ever pay off my student loans? ......................................................................................................... 90 Can I refinance my student loan? ..................................................................................................................... 91 Should I pay off my student loans early with a home equity loan? ................................................................... 92 Is student loan interest deductible? .................................................................................................................. 93 Are scholarships and grants subject to federal income tax? .............................................................................94 What are the Hope credit and the Lifetime Learning credit? .............................................................................95

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Managing Expenses During the College Years Introduction For most parents, paying for a child's college or graduate school education is a major event. For some parents, it rivals only the purchase of a home in number of dollars spent. As the cost of college continues to rise, it's little wonder that parents view their ability to pay college costs with some apprehension. Yet, in all but the most affluent families, paying for college does not involve a 100 percent out-of-pocket contribution from parents.

Rather, the average family uses a combination of strategies to pay higher education costs--savings, financial aid, education tax credits, out-of-pocket contributions, and other creative solutions.

Savings Hopefully, you're one of the parents who have been saving money for their child's college education on a regular basis. If so, now's the time to use those funds. But in many cases, this won't be enough to cover all the bills.

Financial aid The majority of college-bound students qualify for some type of need-based financial aid (as opposed to merit-based financial aid like athletic scholarships), and this can supplement your savings. The largest provider of need-based financial aid is the federal government, followed by colleges.

Need-based financial aid consists of loans, grants, scholarships, and work-study jobs. Loans eventually need to be repaid by you or your child, while scholarships and grants do not. Work-study jobs are paid jobs performed by students and are subsidized by the federal government or the individual college.

Every college that accepts a student will try to create a financial aid package for that student. Typically, loans make up the biggest portion of any financial aid package (approximately 60 percent), though the exact percentage will vary by student. Most students take out at least some student loans, which lessen the financial burden on their parents., All students should apply for federal financial aid, even if they're not sure they'll qualify, because eligibility criteria may change slightly from year to year and filing the federal government's aid application (called the FAFSA) is often a prerequisite for obtaining other types of aid, such as college aid.

After you become savvy about the financial aid process, you can learn about legitimate steps to take to position your income and assets to enhance your child's financial aid eligibility. Though it's best to become familiar with these steps while your child is still in high school (allowing time to implement them), you can also take advantage of these suggestions while your child is in college because financial aid must be reapplied for every year.

One final note: graduate students may not have the same breadth of financial aid programs available to them, or, conversely, they may have certain programs available to them that are not available to undergraduates. For example, the federal government's grant programs are limited to undergraduates, but universities may offer special grant programs to graduate students that are not available to undergraduates.

Education tax credits and deductions There are several education tax credits and deductions that can help families weather college costs--the Hope credit (renamed the American Opportunity tax credit for 2009 and 2010), the Lifetime Learning credit, the deduction for qualified higher education costs, and later, the student loan interest deduction. As a general rule, a tax credit is more favorable than a deduction because it results in a dollar-for-dollar reduction of taxes owed.

The American Opportunity credit is worth up to $2,500 per student per year for the first four years of a child's

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undergraduate college education. The Lifetime Learning credit is worth up to $2,000 per tax return (regardless of the number of family members who qualify) per year for undergraduate or graduate courses taken throughout a student's lifetime. The catch is that the credits are mutually exclusive; that is, they cannot both be taken in the same year for the same individual.

The maximum American Opportunity tax credit is available to single filers with a modified adjusted gross income (MAGI) below $80,000 and joint filers with a MAGI below $160,000. A partial credit is available to single filers with a MAGI between $80,000 and $90,000 and joint filers with a MAGI between $160,000 and $180,000. The maximum Lifetime Learning credit is available to single filers with a MAGI below $50,000 and joint filers with a MAGI below $100,000. A partial credit is available to single filers with a MAGI between $50,000 and $60,000 and joint filers with a MAGI between $100,000 and $120,000.

In addition, a deduction for higher education costs is available to qualifying individuals in 2009. Individuals with an adjusted gross income (AGI) of $65,000 or less, or married couples filing jointly with an AGI of $130,000 or less, can take a deduction up to $4,000. A deduction of $2,000 is available for single filers with an AGI between $65,000 and $80,000, and for married couples filing jointly with an AGI between $130,000 and $160,000.

Unfortunately, the deduction for qualified higher education expenses cannot be claimed in the same year that the Hope credit or the Lifetime Learning credit is taken for the same student. Also, the deduction cannot be taken for the same education expenses that were paid with a tax-free distribution from a Coverdell education savings account or a 529 plan. This deduction is not available for 2010.

Finally, when it's time for your child to repay student loans, he or she may be eligible for the student loan interest deduction, which allows an individual to deduct from gross income a portion of the interest paid on a student loan during the year. The maximum deduction is $2,500. .

Out-of-pocket contributions Your child is eligible for financial aid, she has chosen an accelerated program that allows her to graduate in three years, and you will qualify for the Hope credit during her freshman year. But even with these cost-cutting measures, many parents will need to pay a portion of the college or graduate school bill (sometimes a substantial portion) from their own pocket.

The way you pay the bill from your own pocket can range from the simple to the complex. It may mean tapping funds from any number of sources--your current weekly paycheck, your savings and investments, your IRA or employer retirement plan, your home equity, other loan sources such as banks or brokerage houses, or other assets such as cash value life insurance. The commonality is that the money comes from you and is a drain on your financial net worth.

An important reminder: Paying for college out of pocket can conflict with other important financial goals, most notably saving for your retirement. It can be hard to manage both goals, but it is possible to save for college and retirement.

Other creative solutions Finally, there are other creative ways for parents to lower their college costs by lowering the actual cost of school.

For example, a student could choose an accelerated program and graduate in three years instead of four; a cooperative education where education is interspersed with paid internships; or a live-at-home arrangement where money is saved on room-and-board costs.

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Paying the Bill Out-of-Pocket What is paying the bill out-of-pocket?

Paying the bill out-of-pocket is one way to fund your child's college or graduate school education. It literally means the money comes from your own pocket via your paycheck, your savings and investments, your assets, or your retirement accounts.

In most cases, paying the bill out-of-pocket is combined with other methods to finance higher education, such as securing financial aid, implementing other creative solutions to lower the actual cost of college, and taking available tax credits.

Not surprisingly, out-of-pocket expenditures by parents for their child's college and/or graduate school expenses can present cash flow problems. Rare are the parents who can absorb these bills without a ripple in the budget (and rare is the child who receives a full scholarship). Parents may find themselves caught in a juggling act as they pick and choose from various sources to find available money to put towards their child's education.

Following is a list of your most important sources to find that out-of-pocket money for college or graduate school.

Pay from cash flow Paying from cash flow involves setting aside a certain amount of money from your paycheck each week (or any other steady income source, such as rents or child support) and applying it toward your child's college or graduate school tuition. Most schools bill twice per year, once for the fall semester and once for the spring semester. However, others may bill you quarterly or allow you to pay in 12 equal installments. Unfortunately, this consistent outflow of cash over a period of years may leave parents unable to invest toward other goals.

Withdraw from savings and investments If you have savings and investments from which to draw, you might consider using these funds for your child's college education. Withdrawing from your savings account is the easier route; withdrawing from investments may be more complicated.

Withdraw from IRAs Traditional IRA and Roth IRA: Withdrawing from your IRAs just became more inviting. You can now make withdrawals from a traditional IRA or a Roth IRA to pay higher education expenses without incurring the 10 percent penalty (called the premature distribution tax) that normally applies to withdrawals before age 59½.

Coverdell Education Savings Account (Coverdell ESA): If you established a Coverdell ESA for your child, you can make periodic or lump-sum withdrawals for higher education expenses. If the money is used for qualifying educational expenses (including elementary and secondary school), it is tax free upon withdrawal.

Borrow or withdraw from employer retirement plan If you have an employer-sponsored retirement plan, such as a 401(k) or 403(b), you may be able to borrow or withdraw from the plan to obtain funds for your child's college education. Many plans allow you to borrow a certain percent (typically 50 percent) against your own contributions (and any accumulated earnings), and some may allow you to borrow a certain percent against any contributions made by your employer, as long as the contributions have vested. In addition, many plans allow discretionary withdrawals for certain purposes.

Use your home equity If you own a home and have equity in it, you might consider using your home equity by taking out a home equity loan or a mortgage refinancing. A home equity loan is a loan secured by your home. By contrast, a mortgage

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refinancing refers to the process of taking out a new home mortgage and using some or all of the proceeds to pay off an existing mortgage. The main purpose of refinancing is to save money by taking advantage of lower interest rates or to lower monthly payments by extending the term of the loan.

Use your cash value life insurance If you own a cash value life insurance policy, you may be able to either borrow or withdraw against the cash value to obtain funds for your child's college or graduate school tuition. Unfortunately, this strategy works only if you have held the policy for a number of years. If you have just recently acquired a cash value policy, it may take years before your policy cash values begin to accumulate to sizable amounts.

Gift assets to your child If you own an asset that has appreciated substantially in value (such as stock) or if you own an income-producing asset (such as an apartment building), you may want to gift the asset to your child. The benefit is that the child pays tax on the gain or income at his or her lower tax bracket. However, special rules commonly referred to as the "kiddie tax" rules apply when a child has unearned income over a certain amount. The kiddie tax rules may reduce the effectiveness of gifting as a strategy.

Have one spouse return to work In some instances, the paycheck of one parent or both parents may not be enough to meet tuition expenses. In this case, parents may need to consider whether a previously stay-at-home spouse should return to the workforce or whether a previously working spouse should increase his or her hours or obtain another job with better compensation.

Utilize other loan sources If you've exhausted your discretionary income, savings and investments, and any other assets you have, you may need to utilize other loan sources, for example from a financial institution or other source. This loan is in addition to any financial aid loans you or your child may receive. It can be a personal loan, a collateral loan, or a margin account loan.

Take advantage of unique strategies for business owners Finally, if you are a business owner, you may be able to take advantage of certain strategies unique to business owners. For example, you may be able to arrange a gift-leaseback transaction with your child or put your child on the company payroll. These strategies can be rather complicated, so you may need to consult an attorney.

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Applying for Financial Aid What is financial aid?

Financial aid is money given by colleges and federal and state governments to help students pay for college or graduate school. This money is in the form of loans, grants, scholarships, and work-study. Loans and work-study must be repaid either through financial obligation (loans) or service to the college (work-study). By contrast, grants and scholarships do not have to be repaid.

There are two types of financial aid: need-based, which is based on your family's ability to pay, and merit-based, which is based on a student's academic, athletic, or special talent. Most financial aid is need-based, and the discussion here focuses on need-based aid.

Who offers financial aid?

There are many players in the financial aid arena. Along with you (and your own savings and loans), think of these financial aid providers as pieces of a puzzle that must fit together to create a fully-funded college education.

Federal government The federal government is the largest dispenser of need-based financial aid for higher education. The federal government funnels money to colleges and banks, and directly to students for loans, grants, scholarships, and work-study programs.

Colleges Colleges constitute the second largest provider of financial aid. The money can come from the college's own reserves (private colleges generally have greater endowment funds than public colleges), or from federal and state government agencies. Colleges may also direct students to a particular bank that coordinates loans with that school. Colleges that accept a student who is eligible for financial aid will create a financial aid package for that student.

State governments Most states offer financial education assistance to state residents, to students attending in-state public schools, and to colleges and banks located within their borders.

Other players A vast number of corporations, foundations, and associations of all kinds offer merit financial aid. Most organizations seek students with specific qualifications, backgrounds, and future plans--for example, a Nebraska high school graduate who plans to major in pre-med. In recent years, the Internet has become a valuable tool to search for grants and scholarships.

Overview of the financial aid process To understand how the financial aid process works, it's important to understand how your child's financial need is determined. This process is called needs analysis.

Under needs analysis, household and financial information submitted on your child's financial aid application is used to calculate your family's expected contribution to college costs. Two primary formulas are used to calculate the expected family contribution (EFC): the federal methodology and the institutional methodology (these formulas will be discussed later in greater detail). The EFC is the minimum amount that a family is expected to contribute toward their child's college costs. The difference between the cost of attendance at your child's college

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(a variable) and your EFC (a constant) equals your child's financial need.

Example(s): If the cost of attendance at State University is $20,000 per year and your family's EFC is $8,000, then your child's financial need would be $12,000.

Colleges aren't obligated to meet 100 percent of your child's need. If a college meets only part of your child's financial need (as is the practice at many colleges), then you have been "gapped" by the college. The remaining portion is called unmet need, and you are responsible for meeting it.

Example(s): Assume that your child's financial need is $12,000. State University offers your child $10,000 of financial aid. The result is an unmet need of $2,000. So, your family would be responsible for both the EFC of $8,000 and the unmet need of $2,000.

The two formulas for calculating EFC The two primary formulas for calculating a family's EFC are the federal methodology and the institutional methodology.

Federal methodology The federal methodology is used by the federal government to calculate your EFC to determine eligibility for federal financial aid programs. The federal methodology is also used by colleges when federal funds are being distributed. It is codified in the federal government's aid application, called the Free Application for Federal Student Aid, or FAFSA. Congress may modify the federal methodology slightly from year to year.

Institutional methodology The institutional methodology is an alternative to the federal methodology. It is administered by the College Scholarship Service, a private company that provides educational services to colleges and the public. The institutional methodology is used by some 3,000 colleges to calculate your EFC when the college's own private funds are being distributed. So, a college may use the institutional methodology to distribute its own funds and the federal methodology to distribute any federal financial aid funds at its disposal. You submit your information for the institutional methodology on the PROFILE form application rather than on the FAFSA. In some instances, a college will not use the institutional methodology when distributing its funds, but will use its own individual formula. In this case, you will need to obtain the college's particular financial aid application form.

There are differences in the way the EFC is calculated under the federal methodology vs. the institutional methodology (discussed in greater detail below). As a general rule, the institutional methodology digs deeper into a child's financial background than the federal methodology because colleges want to make sure that their own funds go to the neediest students.

How exactly is my EFC calculated under the federal methodology?

The federal methodology examines your family's income, assets, and household information to calculate the EFC. Since most students are dependent, the discussion here focuses on dependent students and their parents, except where noted. To determine your dependency status, see the section below entitled What are the Steps in Applying for Financial Aid? Income The income component of the federal methodology consists of the adjusted gross income (AGI) of both parents and student from the previous tax year, plus any untaxed income and benefits, minus any applicable deductions.

For independent students, only the student's AGI and untaxed income and benefits are counted, along with those of a spouse, if any. The previous tax year is known as the base year. For example, the base year for the 2009/2010 academic year is 2008.

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The AGI figure is simply taken from a line on your federal tax return. The untaxed income and benefits portion is a bit trickier. The major untaxed income and benefits that must be added back to your income for financial aid purposes include (see the FAFSA for others) deductible retirement plan contributions made in the base year, tax-exempt interest income (e.g., municipal bond interest), untaxed Social Security benefits, child support received, earned income credit, workers' compensation, and disability payments.

After a total income figure is determined, certain deductions can be taken. One example of a deduction is any federal and state taxes you paid in the previous year, including Social Security taxes (see the FAFSA for more deductions).

Perhaps the two most important deductions, however, are the income protection allowance and the employment expense allowance. The income protection allowance is an allowance for shelter, food, clothing, car maintenance, insurance, and basic medical care. For parents, the allowance depends on the total number of household members and the number of children in college.

The employment expense allowance is an allowance for parents only for employment expenses.

In addition, the FAFSA will ask you for the amount of any education tax credits ( Hope credit, renamed the American Opportunity tax credit for 2009 and 2010, and Lifetime Learning credit) you took in the base year in order to provide offsets for them.

A family's total financial aid income (AGI plus untaxed income/benefits minus deductions) is assessed at a 50 percent flat rate under the federal methodology.

Example(s): The Walker's total financial aid income is $40,000. They will be expected to contribute $20,000 to college costs.

Assets The federal methodology counts some assets and excludes others in arriving at your EFC (these assets are called assessable or non-assessable assets). Your assets for financial aid purposes are those you own at the time you sign the FAFSA. The more assessable assets your family has, the more money your family will be expected to contribute toward college costs.

The following assets are not included in the federal methodology: • Retirement accounts (e.g., 401(k)s, IRAs) • Annuities • Cash value life insurance • Personal items (e.g., car, clothes, furniture, household items) • Home equity in primary residence • Family farm Assessable assets are all other assets of the parents and student. These include items such as checking and savings accounts, money market accounts, certificates of deposit, stocks, bonds, mutual funds, U.S. savings bonds, tax-exempt bonds, custodial accounts, trusts, limited partnerships, vacation homes, investment properties, and business and farm assets. After total assets are determined, you can then offset these assets with any investment or real estate debt (e.g., a mortgage on an investment property or a margin account loan with your broker).

Example(s): Assume the Noodle Family has IRAs worth $50,000, an annuity worth $250,000, $60,000 in home equity, and a checking account worth $1,000. Their total assets under the federal methodology are $1,000.

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An important note to keep in mind is that the federal government does not care about any consumer debt you may have. In other words, your assessable assets are not reduced by the amount of your outstanding consumer debt.

Example(s): The Bensons have $100,000 in stocks, an IRA worth $50,000, and $75,000 in long-term debt. Their total assets are $100,000 under the federal methodology.

Example(s): The Carlins have $20,000 in U.S. savings bonds, an IRA worth $40,000, a $300,000 cash value life insurance policy, and no consumer debt. Their total assets are $20,000 under the federal methodology.

Technical Note: Regarding trust funds and custodial accounts, the income is valued as of the base year (the year before the FAFSA is submitted) and the assets (corpus) are valued as of the date the FAFSA is signed. If a trust has more than one beneficiary, only that portion attributable to the student or parent is reportable. You may need to consult a financial professional to determine income and asset values for trust funds and custodial accounts.

When a family's total assessable assets are determined, the federal methodology gives parents an asset protection allowance that allows them to exclude a certain portion of their assets from consideration (students don't get an asset protection allowance). The asset protection allowance varies depending on the age of the older parent at the time the student applies for aid (the older the parent, the greater the allowance).

When a final asset figure is reached for parents and student, parents must contribute a maximum of 5.6 percent of their assets toward college costs and the student must contribute 20 percent of his or her assets toward college costs.

Example(s): The sum of $50,000 in your child's bank account equals a $10,000 expected contribution to college costs ($50,000 x 20 percent), whereas the same $50,000 in the parents' account equals a $2,800 contribution ($50,000 x 5.6 percent).

Tip: There is one situation in which the federal methodology does not factor in any assets of parent or student. This is when the parents' AGI (or an independent student's AGI) is below $50,000 and the parents are eligible to file a 1040EZ or 1040A. In this case, the EFC is calculated using only income under the Simplified Needs Test. The result is generally a lower EFC and thus more financial aid.

Caution: Although you qualify for the Simplified Needs Test under the federal methodology, colleges and your state may still require you to list your assets in order for you to be eligible for college or state funds.

Household information If the parents are both living and married to each other, the income and asset information for both parents is listed on the FAFSA. If the parents are living together but not formally married, they should file the application as if they are separated (see below), unless their state recognizes common law marriage.

If the parents are separated (living apart for an indefinite period) or divorced, then only the income and assets of the parent with whom the child lived the majority of time during the past 12 months is listed on the application. If the parent has remarried, then the stepparent's income and assets are listed on the application as though this person were the natural parent; the noncustodial parent's income and assets are not listed.

Tip: Under the federal methodology, the federal government does not recognize legal agreements that absolve a stepparent from contributing to college costs or that make the noncustodial parent responsible for college costs. Under the institutional methodology, however, colleges may inquire about the resources of the noncustodial divorced parent or ignore the resources of the stepparent.

On a related note, legal guardians are no longer included on the FAFSA, which means their income and assets are not automatically included. A student whose parents are deceased will be considered an independent student, regardless of any legal guardianship. By contrast, a student whose parents are living will file as a

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dependent student, but the FAFSA will reflect the financial information of the appropriate parent(s) rather than the legal guardian, unless the financial aid officer exercises "professional judgment."

The federal methodology also requires you to list the number of people in the household whom the parents will support between July 1 and June 30 of the upcoming college year. This includes the student, parents, siblings, an unborn child, and others who get more than half their support from the parents and who will continue to get this support in the upcoming college year. From this number, students must also report the total number of household members enrolled in college in the same year. The student is always counted. In addition, parents and other siblings are counted if they are enrolled at least half time in a program leading to a degree or certificate.

Tip: If additional household members are in college, the EFC is greatly reduced. Specifically, the parents' total EFC is divided by the number enrolled in college.

Example(s): The Smart Family's EFC is $12,000. They will have two children enrolled in college in the same year, a freshman and a sophomore. As a result, their EFC for each child is $6,000.

Steps to reduce your EFC under the federal methodology There are legitimate steps you can take to position your income and assets to enhance your child's financial aid eligibility under the federal methodology. The idea is to lower your EFC, which, in turn, raises your child's aid eligibility. Examples of these strategies include deferring income and bonuses, avoiding the sale of investments that will result in capital gains in the base year, and paying down consumer debt. It should be noted that these suggestions are legal and are not meant to subvert the financial aid system in any way. To implement these suggestions, you should become familiar with them at least a couple of years before the year you complete the FAFSA.

The institutional methodology vs. the federal methodology There are several differences in the way the EFC is calculated under the federal methodology (FM) vs. the institutional methodology (IM).

Regarding the institutional methodology, some of the negatives are: • The IM formula does not recognize a simplified needs test for parents whose incomes are below $50,000.

• The IM formula requires a minimum student contribution from the student's income and does not give students an income protection allowance.

• The IM formula includes home equity and family farm assets in its calculations (and may require parents to borrow against it before aid is distributed).

• The IM formula requires parents to report any savings accounts in the names of the student's siblings (to discourage the shifting of assets among siblings) and requires students to list any retirement accounts they have.

• The IM formula requires parents to report how much they contribute to flexible spending accounts for child care and medical care.

• The IM formula requires parents to report how much money they expect to earn in the coming year.

Similarly, students must report any outside scholarships they expect to receive and any relative's contributions.

• The IM formula (at a college's discretion) may only allow dependent children (not parents) to be counted as members of the household enrolled in college.

• The IM formula (at a college's discretion) may not allow losses from tax return Schedules C, D, E, or F

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that lower AGI and may not allow certain depreciation expenses.

• The IM formula (at a college's discretion) may require business or farm balance sheets for the prior two years, and detailed projections of future income.

On the positive side: • The IM formula includes an allowance against income for any unreimbursed medical expenses that exceed 4 percent of the parents' financial aid income.

• The IM formula (at a college's discretion) may have an allowance against income for the private school tuition of other household members and for a parent's own student loans.

• The IM formula (at a college's discretion) may consider a noncustodial parent's assets and income.

Steps in applying for financial aid There are several steps in the financial aid application process: Step 1: The first step is for your child to apply to and be accepted by (hopefully) a number of colleges. This allows your student to compare and negotiate financial aid awards from several colleges. Keep in mind that the financial aid timeline and the admissions timeline are different.

Caution: From a financial aid perspective, it is often recommended that students not apply to college on an early-decision basis. The reason is that if a college knows the student is committed to the college, it may be less inclined to award a favorable financial aid package. In addition, the student will have to examine and respond to the financial aid award before receiving awards from other schools.

Step 2: The next step is to file the appropriate financial aid applications by the stated deadlines. Unfortunately, you must apply for financial aid at each school before you learn whether you have been accepted for admission at that school. Note that students must reapply for financial aid each year.

The two basic financial aid applications are the (1) FAFSA and (2) the PROFILE. The FAFSA is used by the federal government and colleges when federal financial aid funds are being distributed; it calculates your EFC under the federal methodology. The PROFILE is used by most colleges (approximately 3,000) when their own funds are being distributed; it calculates your EFC under the institutional methodology. In addition, some colleges use their own institutional aid forms in place of the PROFILE. If so, you will need to obtain a copy of that application from the financial aid officer at that particular college.

There are actually three different types of FAFSAs: (1) for dependent students, (2) for independent students without dependents (a spouse is not considered a dependent), and (3) for independent students with dependents.

The federal methodology will vary slightly depending on what form is used. The main difference is that the dependent student FAFSA uses both parent and student financial data to arrive at the EFC, and the two independent student FAFSAs do not use parental data to arrive at the EFC. To fill out the correct FAFSA, you must first determine your child's dependency status. A dependent student is one who is at least partially dependent on his or her parents for support. If your child is just graduating from high school or less than 24 years of age, most likely he or she will be classified as a dependent. By contrast, an independent student is not dependent on parental support. The federal government considers you independent if you meet any one of the following conditions: • You are 24 years of age by December 31 of the award year • You are an orphan or a ward of the court, or were a ward of the court until age 18 • You are married or have legal dependents other than a spouse

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• You are a graduate or professional student • You are a veteran of the U.S. Armed Services • You are an active member of the armed forces • You are deemed independent in the professional judgment of the financial aid administrator (FAA) based upon documented unusual circumstances Tip: Most states and colleges go beyond this federal test when determining whether you are truly independent. For example, they may ask for written proof that your parents are unable to provide you with any financial support whatsoever. Once you have determined your dependency status, you can then obtain the correct FAFSA. The FAFSA is available at high school guidance offices or college financial aid offices. The earliest date it can be filed is January 1 in the year your child will be attending college. This is because the application relies on your previous year's tax return. The federal deadline for filing the FAFSA is June 30, but many colleges have an earlier deadline. There is no fee for submitting the FAFSA. Tip: Parents should submit the FAFSA as close to January 1 as possible because many financial aid programs operate on a first-come, first-served basis. Because most parents have not yet completed their federal income tax returns by early January, it is recommended that parents hire a professional tax preparer to complete an estimated income tax return, a practice the federal government considers acceptable. However, parents will still need to complete their final income tax return as soon as possible because the college will likely require a copy at the time it prepares the student's financial aid package.

When it's complete, a FAFSA can be filed in four ways: (1) manually completing the form and mailing it to the regional processor listed on the form, (2) filing electronically through the college (not all colleges have this capability), (3) filing electronically using the U.S. Department of Education's FAFSA Express software (this software can be downloaded from the Internet at www.ed.gov, and (4) filing on the Internet by contacting www.fafsa.ed.gov.

Paper FAFSAs take approximately four to six weeks to process; electronic FAFSAs take only one week.

However, if you file an electronic FAFSA, you still need to print out the certification page, sign it, and mail it to the designated processor within 21 days of transmitting your data (or the processing of your application will be delayed).

The PROFILE is available at high school guidance offices, college financial aid offices, or on the Internet at www.finaid.org. Like the FAFSA, there are three different PROFILE applications that depend on whether you are a (1) dependent student, (2) independent student without dependents, or (3) independent student with dependents. You determine your dependency status the same way as for the FAFSA. Also like the FAFSA, each college may have its own deadline for filing the form.

Unlike the FAFSA, there is a processing fee for filing the PROFILE application. In addition to the FAFSA and PROFILE forms, you will also need to submit any other financial aid applications (college or state) to the appropriate institutions at this time.

Step 3: Four to six weeks after the FAFSA is filed (one week if you filed your FAFSA on-line), your family should receive a Student Aid Report or SAR (or Acknowledgment Report when the PROFILE is filed). This form indicates your EFC in the upper right-hand corner of page one of the report. For example, "EFC6000" means that your expected family contribution to college costs is $6,000. The SAR will also be sent to each college you listed on the FAFSA. You should review the SAR to make sure the EFC was calculated using accurate information. Any corrections should be made immediately and sent back for reprocessing (e.g., updating estimated tax information, arithmetic errors, or clerical errors).

Tip: If there is an asterisk (*) next to the EFC reported on the SAR, your family has been chosen for verification. Verification can range from providing tax returns and household information to

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providing appraisals for certain assets listed on the FAFSA. Don't take it personally if you are chosen--nearly 30 percent of all FAFSAs are verified.

Step 4: After you (and the colleges) receive the SAR, the college's financial aid administrator (FAA) goes to work.

The administrator subtracts your EFC from the cost of attendance at that particular college to arrive at your child's financial need. The FAA then attempts to create a financial aid package to meet that need. The package will include various combinations of loans, grants, scholarships, and work-study programs (the type and order of financial aid resources typically used to fulfill a student's financial need is discussed in greater detail below).

Tip: Your goal is to have your child's financial need met with the highest amount of gift aid (scholarships and grants) and the least amount of self-help aid (loans and work-study). Private colleges tend to provide more gift aid than public colleges so they can better compete with their less expensive counterparts. As a guide, the average financial aid package consists of 60 percent loans that must be paid back. Unfortunately, as college becomes more and more expensive, the trend is to meet a student's financial need with a higher percentage of loans than gift aid.

Caution: As mentioned previously, colleges are not obligated to meet all of your child's financial need. Colleges have limited financial aid budgets and tend to offer the most aid to those students who meet their specific enrollment goals (e.g., improve the women's hockey program or the debating team). If the college does not meet all of your child's needs, then you have been "gapped" and you are responsible for the shortfall.

Step 5: Sometime in March or April, the FAA notifies the student of the financial aid package in an award letter (the student must first be accepted to the college). The award letter states the specific amount and type of financial aid being offered, and a date by which the letter must be returned.

You may accept, decline, or attempt to renegotiate any part of the financial aid award. It is important to reply by the required date because otherwise your child's award will be cancelled and the money freed up for some other student. Note that accepting the award does not commit your child to attending that school; it just safeguards the award.

Ideally, students will want to have all of their award letters from various colleges on hand before making a decision. This is sometimes easier said than done, however. The financial aid process and the admissions process operate on different schedules, and occasionally students must make a decision to enroll at a particular college before they know the contents of their award letter. Similarly, a student may not have received all of his or her outstanding award letters before being called on to make an acceptance decision at a college from which an award letter was received. In either case, the student or parent should contact the appropriate FAA to see if you can expedite the consideration of the aid package.

Step 6: If you want to appeal all or part of your child's financial aid award, follow the instructions in the award letter. This usually involves a polite business letter to the FAA and a follow-up telephone call or meeting.

The process of renegotiating your child's financial aid package has been much publicized as of late, with descriptions ranging from haggling to dialing for dollars. Rare a decade ago, negotiating is now so much part of the picture that some colleges have set aside funds specifically for maneuvering at season's end. Some educational professionals have criticized this process on the grounds that those parents that yell the loudest reap the biggest rewards. This is not necessarily true. In fact, you'll do much better if you approach the FAA without carrying a big stick.

Your chances of successfully renegotiating your child's aid package are best if you can document a special circumstance that affects your ability to pay the EFC (rather than a simple plea of inability to pay). Such special circumstances may include the recent death or disability of a parent, divorce, prolonged unemployment, unusually high medical expenses, or a natural disaster than destroyed certain assets. In addition, more obscure circumstances may be the reason for negotiation. For example, your income on last year's tax return may have been higher than usual because you converted a traditional IRA to a Roth IRA or because you received a one-time windfall, such as a special bonus, insurance settlement, or inheritance. Make sure to document any change with the appropriate paperwork.

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In addition to a special family circumstance, many parents and students attempt to play one college's aid package against another college's aid package. This strategy has the best chance of success if College A and College B are direct competitors and you have the qualities that College A is looking for. If College A is an Ivy League school and College B is a small state university, chances are that one will not be persuaded by the aid package of the other. As a matter of fact, public institutions rarely haggle, so your best chances for a deal will be at one of the approximately 1,600 private colleges.

Keep in mind that the college market, like the housing market, can be a seller's market or a buyer's market, and that this can affect the negotiation process. Currently, there are more students than college spaces as the children of the baby boomers reach college age.

Types of financial aid programs There are several types of financial aid programs. The most common financial aid programs are those offered by the federal government. The main federal programs are as follows: Pell Grant and Supplemental Educational Opportunity Grant (SEOG) The Pell Grant is available to undergraduate students. It is an entitlement program, which means the grant is available to all students who qualify.

The SEOG is reserved for undergraduate students with the most financial need (Pell Grant recipients are given priority). The SEOG is a campus-based program, which means that each college receives a limited amount of money for this program and the FAA at each college decides which students will receive this grant. Once the funds are awarded, there are no more until the following year. This is an example of a first-come, first-served program.

Also, there are two relatively new federal grant programs available to full-time undergraduate students who qualify for a Pell Grant and meet other requirements. Grants available to first- and second-year students are called Academic Competitiveness Grants, and grants available to third- and fourth-year students are called National Science and Mathematics Access to Retain Talent (SMART) Grants and are available only to those students majoring in certain subject areas. Both grant programs are scheduled to sunset at the end of fiscal year 2010.

Stafford Loan, Perkins Loan, and PLUS Loan The federal Stafford Loan is a low-interest loan made to both undergraduate and graduate students. Your lender can be either the federal government or a private financial institution, depending on which lending program a particular college participates in. The interest rate is set each June.

A Stafford Loan may be subsidized or unsubsidized, depending on whether you have a financial need. With a subsidized federal Stafford Loan, the federal government pays the interest on the loan while you are in school, during deferment periods, and for six months after you leave school. Like the Pell Grant, the subsidized Stafford Loan is an entitlement program and is thus available to all students who qualify. With an unsubsidized federal Stafford Loan, you (not the federal government) are responsible for paying the interest during the school year and deferment periods. Regardless of whether the loan is subsidized or unsubsidized, there are limits on the amount of money that can be borrowed each year, as well as limits on the total debt that may be incurred.

A Perkins Loan is a low-interest loan available to both undergraduate and graduate students with the lowest EFCs. Like the SEOG, the Perkins Loan program is campus-based, which means each college receives a certain amount of money for this program, and you borrow the money directly from the college. When the funds run out, there are no more until the following year. This loan is subsidized; that is, the federal government pays the interest while you are in school, during deferment periods, and for nine months after you graduate.

The PLUS Loan is a non-need-based program; that is, you can qualify without financial need. The loan is for parents with good credit histories who want to help pay for their child's education and for graduate and professional students. Borrowers are eligible to borrow up to the full cost of their education, minus the EFC and any other financial aid received. This loan is obtained through financial institutions.

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Work-study The federal work-study program is a need-based program that subsidizes jobs for both undergraduate and graduate students. Like the SEOG and Perkins Loan, the federal work-study program is campus-based. The funds are distributed on a first-come, first-served basis. Often, these jobs involve community service work and can be related to your course of study.

Do colleges award financial aid resources in a specific order?

Generally, yes. Colleges usually fulfill a student's financial need by awarding financial aid resources in the following order: • Federal Pell Grant (for those students who qualify) • State grant • Federal Stafford Loan (subsidized) • Company and organization scholarships and grants, military financial aid programs, or any other outside financial aid resources • Perkins Loan, SEOG, or federal work-study (funds for these programs are allocated to colleges by the federal government for allocation to students; whether a student receives any of these funds depends on timing of application, financial need, and availability of funds) • College grant or tuition discount (at the college's discretion) Although this is the typical order, it may vary according to the availability of funds at a particular college and/or the particular student's merit. The more merit a student has, the better types of financial aid he or she will likely receive (e.g., less loans, more grants).

Should you apply for financial aid even if you don't think your family will qualify?

Generally, yes. No matter how high your income or asset base is, your family should apply for financial aid. At the very least this means filing the FAFSA. In addition, you may choose to file the PROFILE or other individual college application. There are a few reasons for this suggestion.

First, it can be difficult to predict whether your child will qualify for financial aid without actually filing the FAFSA because the federal government's eligibility criteria for certain aid programs may change unexpectedly from year to year. Second, some financial aid programs are not based on need--such as the federal government's PLUS Loan and certain state programs--yet you must still file a FAFSA to be eligible to borrow funds. Third, you really lose nothing (except a few hours of your time) for filing the FAFSA because it is a free form that costs nothing to process.

Although the PROFILE application does have a processing fee, it is a small investment to make for the opportunity to learn whether your child qualifies for a college's own aid programs. The worst that can happen is that you discover you don't qualify for any financial aid. In that case, you won't be left wondering whether you should have applied. Considering that your child may be awarded gift aid that you won't have to repay, the investment of your time may well be worth it.

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Positioning Your Income/Assets to Enhance Financial Aid Eligibility What does it mean to enhance your financial aid eligibility?

If you qualify for federal financial aid, there are a number of strategies you can try to implement to enhance the amount of aid your child will receive when you apply for financial aid. The idea is to lower your expected family contribution (EFC), which in turn raises your child's aid eligibility. Although some of these strategies can be employed as late as the base year--the year prior to the year you fill out the Free Application for Federal Student Aid form (FAFSA)--others can be implemented years before your child will be starting college.

It is important to note that these strategies are perfectly legal and are not in any way meant to undermine the federal financial aid process. These strategies simply examine the federal methodology and take advantage of its rules regarding which family assets and income are included in determining a student's financial aid eligibility.

Strengths You increase your child's eligibility for federal financial aid By implementing strategies that lower your assessable income and assets under the federal formula for financial aid, you decrease the amount of money your family is expected to contribute to college costs. A decrease in your EFC, in turn, means your child will be eligible for more financial aid. This translates into less current out-of-pocket costs for you.

You may reap incidental financial benefits that are important to you By implementing certain strategies tailored to the federal methodology for financial aid, you not only increase your child's aid eligibility but also may place yourself in a better financial position. For instance, by paying down your mortgage, you not only increase your child's federal aid eligibility because home equity is not counted as an asset under the federal formula, but you also benefit by saving on mortgage interest and owning your home sooner.

Tradeoffs Colleges don't use the same formula as the federal government in determining aid eligibility The primary drawback of implementing specific strategies to take full advantage of federal financial aid is that you increase your chances for aid under the federal system only. Colleges have their own formula for determining which students are most deserving of campus-based aid, and this formula may not recognize a strategy that is successful under the federal methodology. For instance, under the federal methodology, the federal government does not consider your home equity in calculating your total assets. However, most colleges do consider home equity in determining a family's ability to contribute to college costs, and some may even expect parents to borrow against it.

The increased financial aid may consist entirely of loans If you are successful at reducing your total income and assets under the federal methodology and thus increasing your child's financial aid package, there is no guarantee that a portion of the increased aid package will consist of grants or scholarships (which do not have to be paid back). Instead, your child's additional aid package could consist entirely of loans that will need to be paid back by you or your child.

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You may not want to disrupt an otherwise sound investment program It is generally not a good idea to drastically change your overall financial planning scheme for financial aid reasons only. Ideally, any changes you make should be in line with your overall financial planning picture.

Strategies to reduce available income There are a number of steps you can take to reduce your adjusted gross income (AGI) under the federal methodology for determining financial aid. The lower your AGI, the less money you will be expected to contribute toward college costs and the higher your child's aid eligibility.

Tip: Remember, you apply for financial aid each year. Thus you should consider the following strategies for each of the years you will be applying for aid, not just for the initial application.

Time the receipt of discretionary income to avoid the base year Your income in the base year will directly affect your child's financial aid eligibility in the following year. Although it is highly unlikely you will be able to defer your weekly (or monthly) paycheck, it may be possible to defer other types of discretionary income beyond the base year. For example, if possible, you should try to: • Defer receiving employment bonuses until after December 31 of the base year.

• Avoid selling investments that will have taxable capital gains or interest, such as mutual funds, stocks, or savings bonds, until after December 31 of the base year. To avoid taking an untimely distribution from an investment that is earning a favorable rate of return, use the investment as collateral for a low-interest loan instead.

• Sell investments that can be taken at a loss during the base year, as long as the investments are not expected to recover.

• Avoid pension and IRA distributions in the base year.

• If you are on an expense account, ask your employer to reimburse you directly so that any reimbursement amounts do not artificially inflate your income.

Pay all federal and state income taxes due during the base year This strategy is advantageous for two reasons: It reduces the amount of available cash on hand, and you can deduct the total amount of federal and state taxes you pay during the base year on the FAFSA. Leverage student income limit For the academic year 2009/2010, the first $3,750 of income a student earns is not considered in determining a child's total income. This is known as the student's income protection allowance. However, everything a student earns beyond the allowance is first taxed and then assessed at 50 percent for financial aid purposes. In other words, the federal government expects your child to contribute 50 percent of all income earned over the allowance (after taxes).

To avoid this result, parents may want to consider having their children perform volunteer work once their kids reach the allowance limit. However, some children may balk at this suggestion because they want a job to earn extra spending money.

Strategies to reduce available assets There are a number of steps you can take to reduce the amount of assets that will be included under the federal methodology. Under this formula, the federal government includes some assets and excludes others in arriving at

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your family's total assets. The lower your assessable assets, the less money you will be expected to contribute toward college costs and the higher your child's aid eligibility.

It is important to remember that the relevant date for determining whether you own a particular asset is the date that you submit the FAFSA. Consequently, the following strategies can be implemented up to the time you complete the FAFSA. Use cash to pay down consumer debt The federal methodology does not care about the amount of consumer debt you may have. So if you have $10,000 in assets and $10,000 worth of consumer debts, the federal government still lists your total assets as $10,000. When you use available cash to pay down consumer debt, you reduce the amount of your cash on hand.

Tip: It is usually a good idea to retain three to six months worth of liquid assets for emergencies.

Use cash to make large purchases Another strategy to reduce cash on hand (an assessable asset) is to make large planned purchases the year before your child begins college. Such items may include a car, furniture, or the like for parents and a car (second-hand, of course), computer, or the like for students. Remember, the idea is not to go out and spend the money on anything; the purchase should have been previously planned.

Increase home equity The federal methodology does not count home equity as an asset in determining your child's financial aid eligibility. So using assessable assets to pay down the mortgage on your home is one way to reduce these assets and benefit yourself at the same time.

Caution: Although the federal government does not include home equity in determining a family's total assets, most private colleges do include home equity in deciding which students are most deserving of campus-based aid. In addition, some colleges may expect parents to borrow against the equity in their homes to help finance their child's college education.

Leverage parents' asset protection allowance Once the parents' assessable assets are totaled, the federal methodology grants parents an asset protection allowance, which enables them to exclude a certain portion of their assets from consideration. The amount of the asset protection allowance varies depending on the age of the older parent at the time the child applies for aid (the idea being the closer the parents are to retirement age, the larger the asset protection allowance).

Once parents determine what their asset protection allowance will be, one strategy is to consider saving an equal amount of money in assets that are counted under the federal methodology. Then, any savings above this amount can be shifted to assets that are excluded by the federal methodology, such as home equity, retirement plans, cash value life insurance, and annuities.

Use student's assets for the first year Under the federal methodology for financial aid, the federal government expects a child to contribute 20 percent of his or her assets each year to college costs, whereas parents are expected to contribute a maximum of 5.6 percent of their assets. If assets have been accumulated in a child's name, parents may want to consider using these assets to pay for the first year of college. By reducing the child's assets in the first year, the family will likely increase its chances to qualify for more financial aid in subsequent years.

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Financial Aid: Loans What is a financial aid loan?

A financial aid loan, commonly referred to as a student loan, is money given to a student to help the student pay for college or graduate school. Loans eventually have to be repaid by you or your child. By contrast, scholarships and grants do not. Nearly 45 percent of all undergraduate students finance part of their education with student loans. Not surprisingly, the percentage is even higher for those students pursuing advanced degrees--more than 50 percent of all graduate students and 75 percent of all professional students borrow money to attend school.

Most student loans are guaranteed by the federal government, which means that the government will reimburse your lender if you default on your loans. Since the 1970s, the amount of student loans guaranteed by the federal government has been increasing steadily.

Are there different types of student loans?

Yes. The world of student loans is often complex because of the variety of loan types and lenders on the scene.

The system of student loans depends on a network of money-lending institutions (banks) and other unique institutions such as guarantee agencies, student loan servicers, colleges, state agencies, and, of course, the federal government.

Federal student loans The federal government is the largest provider of student loans. Under the William D. Ford Federal Direct Loan program, the federal government began issuing federal student loans along with financial institutions. Before 1994, all federal student loans were issued only by private financial institutions. The result is that today your federal student loan may be a direct loan (issued by the federal government) or an institutional loan (issued by a financial institution under the Federal Family Education Loan Program). It is expected that the federal government will eventually make 60 percent of all federal student loans.

Despite a strong foothold in the student loan arena, the federal government's loan programs change often, depending on the overall health of the economy and other social and fiscal policies. If what is black and white today may be gray tomorrow, it is important to keep informed of such changes, especially when your child is at or near college age. To apply for any of the federal student loans, you will need to fill out the federal government's financial aid form, the FAFSA (Free Application for Federal Student Aid).

Private student loans Private lenders are the second-largest providers of student loans after the federal government. Private student loans are made by financial institutions directly to students without any involvement by the federal government.

Private student loans differ from the institutional loans discussed above in that they are not guaranteed by the federal government: The bank gets stuck with the loan if you don't repay it. However, private student loans are closely linked to federal student loans. For example, many graduate students (and some undergraduates) can use one application package to apply for both federal student loans and private student loans. To apply for private student loans, you will need to complete the appropriate lender application (if any) and perhaps the federal government's FAFSA. Check with your lender.

State student loans Every state has its own agency dedicated to higher education, and most states offer a variety of student loan programs.

To apply for state student loans, you must complete the appropriate state application. Also, you'll likely be

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required to submit the federal government's FAFSA. College student loans Like the states, many schools have their own loan programs. As you might expect, college loan programs (if your college even offers one) vary regarding the interest rate, borrowing limits, repayment terms, and other provisions.

To apply for college student loans, check with the particular college to learn what forms are required. Most colleges use the PROFILE form, a standard financial aid application put out by the College Scholarship Service.

Others use an individualized institutional form. In addition, it is likely you will be required to submit the federal government's FAFSA.

How do I know who holds my student loans?

The institution that lent you the money may not be the same institution that now holds your student loans. Loans are frequently passed from one institution to another. Such a system may be frustrating when it's time to repay your student loans because you must keep track of where to send your payments.

Your student loans may be held by one of the four following entities: Lenders Assuming your student loans are not in default, they may be held by one of four types of lenders: 1. Private lender (bank, savings and loan association, credit union) 2. Federal government (most likely the Department of Education but sometimes the Department of Health and Human Services) 3. Colleges 4. State student loan agency If your loan is in default, chances are the lender will pass it on to either a collection agency or a guarantee agency (discussed below).

Companies on the secondary market The secondary market consists of financial companies. The secondary market is where lenders sell loans that are not in default if, for business reasons, they don't want to collect the loans themselves. It is not required for a lender to get your permission before selling your loan on the secondary market; however, the lender should notify you so you will know where to send your payments.

Nearly 30 different companies exist on the secondary market to buy student loans. One of the biggest is the Student Loan Marketing Association, commonly known as Sallie Mae. Loan servicers A loan servicer is a company hired either by your lender or a company on the secondary market to collect your loan (assuming you have not defaulted). The loan servicer receives and processes your loan payments, examines deferment or cancellation requests, and otherwise handles all correspondence. The Student Loan Servicing Center is an example of a loan servicer.

Guarantee agencies Federal student loans are mostly administered through state or private nonprofit agencies called guarantee agencies. A guarantee agency is like an insurance company--it insures your loans and pays off the holder of the loans if you don't pay. Most loans are sold to a guarantee agency by the original lender or by the secondary

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market company that bought the loan.

One of the guarantee agency's primary purposes is to collect student loans that are in default. Consequently, most--though not all--student loans that are in default are with guarantee agencies. All 50 states have a guarantee agency, but some do not collect student loans. In these states, collection activities are usually handled by a different state's guarantee agency or a private guarantee agency.

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Financial Aid: Grants What is a grant?

A grant is a type of financial aid that, like a scholarship, does not have to be repaid. For this reason, a grant is referred to as gift aid. By contrast, a loan must be repaid by you or your child.

Grants may be offered by a variety of sources: the federal government, state governments, colleges, and virtually thousands of private institutions. They may be available on both a financial-need basis and on a merit basis.

Though a small percentage of financial aid comes in the form of grants (compared to loans), it is financially worthwhile to research and apply for any grants for which your child may be eligible. Grant information is available free of charge at your local library, or you can visit your child's high school guidance counselor or college career office.

How do grants fit into the financial aid picture?

If your child receives a grant based on financial need, he or she may have additional need, some or all of which will be met with other grants, scholarships, or loans. If your child receives a merit grant (one given without regard to financial need), he or she may also have additional financial need.

Your child receives a merit grant and has financial need When your child receives a merit grant, the cost of college is reduced by the amount of the award. The grant can eliminate: (1) part of your child's need, (2) all of your child's need, or (3) all of your child's need and part of your expected family contribution (EFC). Federal regulations prohibit colleges from using non-need (merit) money to replace your EFC unless all of your child's financial need has been met first.

For the following examples, let's assume that the cost of college for one year is $15,000 and that your EFC is $10,000, making your child's need $5,000.

Example(s): Your child receives a merit grant of $1,000. You have reduced your child's need from $5,000 to $4,000, and your EFC remains the same at $10,000.

Example(s): Your child receives a merit grant of $5,000. All of your child's need is eliminated, and your EFC remains the same at $10,000.

Example(s): Your child receives a merit grant of $7,000. All of your child's need is eliminated, and you can apply the extra $2,000 to help cover your EFC. In the first two examples above, you can try to convince the financial aid administrator to reduce or replace a loan portion of the financial aid package rather than a scholarship or grant portion.

Your child receives a merit grant and does not have financial need In this situation, your child's financial aid package is not affected. The grant simply replaces your own money when you write a check for tuition. But your child's merit award cannot exceed the cost of attendance.

Example(s): Assume the cost of college for one year is $15,000. Your child receives a merit grant of $18,000. You can only receive $15,000; you can't pocket the additional $3,000.

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Tax implications The federal government taxes as ordinary income the portion of a grant that exceeds tuition, fees, books, and equipment. This means that room-and-board grants may be taxed. So, if your child receives a large grant, use it to pay the tax-free items first.

Federal grants Pell Grant The Pell Grant program is Uncle Sam's largest financial aid gift program. Pell Grants are available to undergraduate students with exceptional need, and are the foundation of every undergraduate student's financial aid package (those who qualify). Graduate students are not eligible for Pell Grants.

For the 2009/2010 academic year (July 1, 2009 to June 30, 2010), the maximum Pell Grant is $5,350. The amount you receive depends on your EFC. To estimate your Pell Grant, subtract your EFC from the maximum grant award for the year. For instance, for a full-time student, an EFC of $3,000 translates into a $2,350 Pell Grant ($5,350 maximum grant award minus $3,000 EFC).

If your child is a part-time, half-time, or three-quarter-time student, your child will receive 25 percent, 50 percent, or 75 percent of the award, respectively. Your child can apply for a Pell Grant by completing the federal government's aid application, the FAFSA (Free Application for Federal Student Aid). Your child should apply even if you believe you are not eligible, because colleges and states will not consider your child for other awards until they know your child's Pell status. If your child is awarded a Pell Grant, the school can pay you directly, credit the grant to your account, or combine these two methods.

Supplemental Educational Opportunity Grant (SEOG) The Supplemental Educational Opportunity Grant (SEOG) is the federal government's second-largest grant program. A SEOG is available to undergraduate students who demonstrate exceptional financial need (i.e., those students with the lowest EFCs). Priority is given to Pell Grant recipients. As with the Pell Grant, graduate students are not eligible to receive a SEOG. The SEOG is a campus-based program, which means that the financial aid administrator (FAA) at each individual college administers it. Each school receives a certain amount of SEOG funding from the federal government, and when the funds are awarded, there are no more until the following year. Even though your child might be eligible for a SEOG based on his or her financial need, your child might not receive one because the funds may have already been awarded to students who applied earlier. The FAA at each school decides who will receive a SEOG. The maximum grant amount is $4,000 per academic year ($4,400 for students who study abroad), and the awards range from $100 to $4,000. The amount your child obtains will depend on the date he or she applies, the amount of your child's financial need, the financial aid policies of your child's school, and the total funds available at the school.

Academic Competitiveness Grant and National Science and Mathematics Access to Retain Talent (SMART) Grant Two federal grant programs are available to full-time undergraduate students who qualify for a Pell Grant and meet other specific requirements. These programs are intended to supplement the Pell Grant and will sunset at the end of fiscal year 2010.

The Academic Competitiveness Grant will provide up to $750 to first-year students and up to $1,300 to second-year students. The National Science and Mathematics Access to Retain Talent (SMART) Grant will provide up to $4,000 to third- or fourth-year students majoring in math, science, technology, computer science, engineering, or a foreign language critical to national security.

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State grants Most states provide grants to students pursuing higher education. Often, these grants are need-based and awarded solely to undergraduate students, although merit-based grants are increasing because states do not want to lose their best students to other states. Each state has its own award amounts, eligibility requirements, and application procedures.

In the past, the federally sponsored State Student Incentive Grant (SSIG) program helped states provide grants to students by providing federal matching funds. This program has been renamed the Leveraging Educational Assistance Partnership (LEAP) program. A specific breakdown of state grant programs is beyond the scope of this discussion. For more information on what state grant programs are available, contact your state's higher education agency.

College grants Colleges may offer grants to students based on achievement or financial need. These funds may come from the college's own endowment funds or from a tuition discount. Generally, college grants are available to both undergraduate and graduate students. For graduate students, this aid comes in the form of fellowships (either from the college or from a foundation, government agency, or corporation) or stipends for living expenses.

Contact the school you are interested in for more information.

Other grant sources In addition to governments and colleges, there are thousands of other potential grant sources from foundations, corporations, and associations of all kinds. Your child's background, employment history, membership in clubs, nationality, or chosen field of study may make your child eligible for certain grants. Ask your local reference librarian or your child's high school guidance counselor to get you started on a grant search.

Caution: Be wary of anyone who offers to conduct a grant search for a fee, because grant information is available free of charge to anyone. A good place to start is your local library, bookstore, guidance office, or the Internet. Also, be wary if anyone tries to guarantee any grant awards in an effort to secure your business.

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Financial Aid: Scholarships What is a scholarship?

A scholarship is a type of financial aid that, like a grant, does not have to be repaid. For this reason, a scholarship is referred to as gift aid. By contrast, you or your child must repay a loan.

Scholarships may be offered by several sources: the federal government, state governments, colleges, and a variety of private organizations. Scholarships can be either need-based (awarded on the basis of some achievement and your financial need), or non-need-based or merit (awarded solely on the basis of some achievement).

Though only a small percentage of financial aid generally comes in the form of scholarships (compared to loans), it is financially worthwhile to research and apply for any scholarships your child may be eligible for. At one time, need-based scholarships were the most common; in recent years, however, merit scholarships have been increasing as colleges seek to lure the brightest students to their campuses.

How do scholarships fit into the financial aid picture?

If your child receives a need-based scholarship, he or she may have additional need, some or all of which will be met with other scholarships, grants, or loans. If your child receives a merit scholarship, he or she may also have additional financial need.

Your child receives a merit scholarship and has financial need When your child receives a merit scholarship, the cost of college is reduced by the amount of your child's award.

The scholarship can eliminate: (1) part of your child's need, (2) all of your child's need, or (3) all of your child's need and part of your expected family contribution (EFC). Federal regulations prohibit colleges from using non-need (merit) money to replace your EFC unless all of your child's financial need has been met first.

For the following examples, let's assume that the cost of college for one year is $15,000 and that your EFC is $10,000, making your child's need $5,000.

Example(s): Your child receives a merit scholarship of $1,000. You have reduced your child's need from $5,000 to $4,000, and your EFC remains the same at $10,000.

Example(s): Your child receives a merit scholarship of $5,000. All of your child's need is eliminated, and your EFC remains the same at $10,000.

Example(s): Your child receives a merit scholarship of $7,000. All of your child's need is eliminated, and you can apply the extra $2,000 to help cover your EFC. Tip: In the first two examples above, you can try to convince the financial aid administrator to reduce or replace a loan portion of the financial aid package rather than a scholarship or grant portion.

Your child receives a merit scholarship and does not have financial need In this situation, your child's financial aid package is not affected. The scholarship simply replaces your own money when you write a check for tuition. But your child's merit award cannot exceed the cost of attendance.

Example(s): Assume the cost of college for one year is $25,000. Your child receives a merit scholarship of $30,000. You can only receive $25,000; you can't pocket the additional $5,000.

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Tax implications The federal government taxes as ordinary income the portion of any scholarship that exceeds tuition, fees, books, and equipment. This means that room-and-board scholarships are taxed. So, if your child receives a scholarship that can be used for any expense, apply it first to the tax-free items (e.g., tuition, fees, and books) before using it for room and board.

Federal scholarships There are two main federal scholarship programs: the Robert C. Byrd Scholarship Program and the AmeriCorps Program.

Robert C. Byrd Scholarship Program The Robert C. Byrd Scholarship Program provides scholarships to students who have demonstrated outstanding academic achievement and the promise of continued academic excellence. Generally, the scholarship is $1,500 for the academic year. It is a renewable scholarship, which means that it is awarded for each year of a student's first four years at college.

Though the federal government provides the scholarship funds, each state establishes its own criteria and then selects recipients. To find the agency in your state where you can get information on the Robert C. Byrd Scholarship Program, call (202) 502-7777.

AmeriCorps Program The AmeriCorps Program offers educational awards in exchange for community service work before, during, or after college or graduate school. The community service work is in one of four areas: education, the environment, human services, and public safety. The federal government provides the funding, while states and nonprofit agencies do the hiring.

Participants receive a minimum wage stipend and a $4,725 credit per year of full-time service (for up to two years). Students may then use the credit at any college or graduate school or to repay student loans. In addition, a living allowance of approximately $10,000 per year is paid during the community service work. If necessary, another allowance is available for health-care and child-care costs.

Tip: Money earned in the AmeriCorps Program does not affect a student's eligibility for other federal student aid.

Interested students should apply directly to a funded AmeriCorps Program. For a list, contact the AmeriCorps at (202) 606-5000, or visit its website at www.americorps.org.

State scholarships Many states offer their own scholarship programs (along with free scholarship searches). To learn more about possible scholarships in your state, contact your state's higher education agency.

College scholarships Colleges are the main source of merit scholarships. Most are academic scholarships based on academic achievement; others are based on a specific talent, such as athletics or music. Contact the colleges you are interested in to learn more about the scholarships they offer.

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Other scholarship sources In addition to colleges and federal and state governments, there are literally thousands of associations and foundations of all kinds that offer scholarships. Some organizations favor student leaders or students who perform community service. Other groups look for students who have exceptional talents--writers, scientists, musicians, or athletes. Ask the reference librarian at your local library or your child's guidance counselor to help you get started on a scholarship search. The Internet can also be a valuable resource because the scholarship information is continually updated.

Each scholarship likely has a different application procedure and deadline, so it is important to be organized.

Most scholarships require an essay, a transcript of grades, a description of extracurricular activities, and recommendation letters. Obviously, the more scholarships your child applies for, the better his or her chances of winning one (or more). However, because each organization defines its own selection criteria, it is critical that your child customize his or her materials to fit these criteria.

Tip: Your child does not have to inform most scholarship organizations that he or she has applied to other groups and has been awarded money. However, it may be in your child's interest to do so, because winning other scholarships enhances your child's credibility.

Caution: Do not pay anyone to help you search for scholarships, since this information is available free of charge at your local library or your child's guidance counselor's office. There are several scholarship "sham" organizations that attempt to guarantee your child an award if you sign up for a fee.

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Financial Aid: Work-Study What is work-study?

Work-study is a type of financial aid program that allows students to work and earn money as a way to supplement higher education costs. The most established program is the federal work-study program, although some states may have work-study programs of their own.

The federal work-study program The federal work-study program is a federally sponsored financial aid program that subsidizes jobs for both undergraduate and graduate students. It is based on a student's financial need.

The federal work-study program encourages jobs that are related to your child's course of study and/or the community (employment may not involve political or religious activity). These jobs can be either on- or off-campus, and they pay at least minimum wage (but can pay higher). Money earned in a work-study job is paid directly to the student at least once per month (undergraduate students are paid by the hour; graduate students either by the hour or on a salary basis). The student can then spend the money in any way he or she wishes. The federal work-study program is a campus-based program. This means that the financial aid administrator at each individual college administers it. Each school receives a certain amount of money for the federal work-study program, and once the money is awarded, there is no more until the following year.

Tip: Because federal work-study is a first-come, first-served program, it is in your child's best interest to apply as early as possible. In any case, make sure your child applies before the college's application deadline.

If your child qualifies for a work-study job, the amount of the total work-study award will depend on your child's level of financial need, the time your child applies, and the total funds available at your child's college or university.

Caution: You cannot earn more money than your award stipulates. For example, if you receive a $2,000 work-study award, your employment lasts until you earn $2,000, and then it is over for that academic year.

Caution: You may decide to turn down a work-study position if you are able to get a job on your own that provides better pay and hours.

To apply for federal work-study, your child should contact the financial aid office of the college he or she will attend.

State work-study programs States may have work-study programs of their own. To find out if your state offers such a program, contact your state's higher education agency.

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Financial Aid Considerations for Graduate School What are the special financial aid considerations for graduate school?

When it comes to graduate school and financial aid, there are a few differences compared to undergraduate college and financial aid. Though most of the established financial aid programs are available to all students, a select few are not available to graduate students. "Financial aid" refers to loans, grants, scholarships, and work-study.

Loans Over 50 percent of all graduate students borrow money to attend school. Remember, to be eligible for federal student loans, you must be enrolled in graduate school on at least a half-time basis.

Currently, all of the federal student loan programs that are available to undergraduates are also available to graduate students. The terms of the loans are identical for each group, except that the borrowing limits for graduate students are generally higher. Also, graduate students are eligible for PLUS Loans, which were previously reserved for parents of dependent undergraduate students. Under the GradPLUS program, creditworthy graduate students can borrow up to the full cost of their graduate education, minus any aid received.

Regarding private student loans, only a few are restricted to undergraduates. In fact, most private student loans are specifically targeted to graduate students, such as MBA students, law students, or medical students.

Colleges vary in the graduate loan programs they offer. Consequently, the type and amount of graduate aid that colleges offer can differ substantially. Contact the financial aid office of the graduate schools you are considering to learn more about any potential loan programs.

States, like colleges, also vary in the scope of their loan programs. While most states have a student loan program available for undergraduates, they may restrict the availability of funds for graduate students. Contact your state's higher education agency and inquire about any special loan programs for graduate students.

Grants Perhaps the biggest difference between graduate school and undergraduate education is the availability of grants. The two biggest federal grant programs--the Pell Grant and the Supplemental Educational Opportunity Grant (SEOG)--are not available to graduate students. Similarly, most state grants are available only to undergraduate students. To find out if your state offers any grants specifically for graduate students, contact the appropriate state agency.

As for other grant sources, there are virtually thousands of foundations, associations, and corporations that offer grants. These are the places where hopeful graduate students will likely have the most success. Ask your local reference librarian or the financial aid administrator at your college for help in getting started on a search.

Scholarships Like grants, scholarships are offered by a wide range of institutions. The Robert C. Byrd Scholarship Program (a federal scholarship) is limited to undergraduate students only. However, the AmeriCorps Program is available to both undergraduate and graduate students.

Start your scholarship search with the graduate schools you are interested in to learn about any scholarships they offer. Then check your local library or college career placement office for a broader listing of possible scholarship sources from professional organizations, unions, clubs, foundations, etc. You can also use the Internet to research possible scholarship sources. In addition, your state's higher education agency may offer scholarships for particular graduate fields of study.

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Work-study The federal work-study program is available to graduate students as well as undergraduates. This means that graduate students can work in a federally subsidized job while they attend school to earn money for tuition or related expenses. States may also offer special work-study programs for graduate students.

Are there any other funding considerations that graduate students should be aware of?

Many graduate students utilize their employer's tuition reimbursement benefits to help fund graduate school (each year the first $5,250 is excluded from your income). Although tuition reimbursement is a nice benefit when offered, it usually means the student is working at least half-time and attending graduate school on less than a half-time basis--a situation that makes the student ineligible for federal student loans and possibly other loans as well.

Another consideration is that graduate students are usually independent. Consequently, any loans they apply for (financial aid loans or personal loans) do not consider the parents' income or assets. Some of the options that undergraduate students may be able to take advantage of to lower college costs may not be available to graduate students. These options include such things as attending a community college for two years then transferring to private school or special academic exams that allow undergraduates to place out of certain course requirements. However, on the flip side, some options may indeed be available to graduate students. For example, graduate students may be able to attend school in an accelerated program, attend a co-op graduate program, or have their parents buy housing near the school.

Does the deduction for student loan interest apply to graduate loans?

Yes. The deduction for student loan interest does not distinguish between undergraduate loans and graduate loans. Rather, any loans obtained in the pursuit of higher education qualify for the student loan interest deduction.

However, certain income limits must be met to take the deduction.

Does the Lifetime Learning credit apply to graduate studies?

Yes. As the name implies, the Lifetime Learning credit applies to courses that are taken throughout your life. The credit is worth up to $2,000 (in 2009) for the graduate expenses of you, your spouse, or your child. However, you must meet certain income limits.

By contrast, the Hope credit (renamed the American Opportunity tax credit for 2009 and 2010) does not apply to graduate students; only undergraduates in their first four years of college are eligible.

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Implementing Other Creative Solutions to Cover Higher Education Costs What are creative solutions to help pay for college?

Saving money, borrowing money, and financial aid are the most obvious ways to pay for college. But none of these methods attempt to lower the actual cost of college. Yet as college costs continue to grow, it is imperative for many families to find ways to lower the actual cost of college. There are several creative ways to lower the cost of college, which, in turn, will lower your own costs. In some cases, these solutions may mean the difference between your child being able to attend college and not being able to attend at all.

What are the specific creative solutions I can implement to lower the cost of college?

Deferred enrollment plans Many colleges will accept your child for admission in the future--maybe in a year or two. Instead of heading straight to college after his or her high school graduation, your child can work full-time to earn money to apply to the future college bill.

Consider accelerated programs If the college allows it, your child may be able to obtain a bachelor's degree in three years instead of four or a five year bachelor's-master's degree. This way, you'll save a year's worth of expenses. The drawback is that your child will have to take a heavier course load each semester and may have to forgo summer breaks.

Enroll in a community college, then transfer to a four-year institution Many students live at home to attend a local two-year community college for basic level courses and then transfer to a four-year school for their final two years. In nearly all cases, the community college will be less expensive than the four-year college and can save you money for two years. The benefit is that your child receives a diploma from the four-year college that does not announce that your child spent the first two years at a community college. Of course, you should make sure that the four-year college will accept for credit the community college courses.

Take special academic exams Your child may be able to earn college credits for basic courses before he or she even gets to college. This is accomplished by taking courses or tests designated as advanced placement (AP) or as college level exam program (CLEP). This saves money by cutting down on the required college course load. Make sure the college accepts the test before your child takes it.

Consider a co-op education Some 900 colleges now allow students to alternate semesters of education with semesters of full-time work in a field related to their majors. A co-op degree usually takes about five years, a full year longer than the typical college education. However, not only will your child have a history of relevant work experience to present to potential employers after graduation, but also he or she will earn a paycheck while working. For a listing of such programs, go to www.co-op.edu.

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Find part-time work Part-time work can help your child defray some costs while in college, reducing the amount necessary to borrow.

However, working during school can be both a physical and an emotional strain. One option might be for your child to focus on school for the freshman and sophomore years and to find a part-time job for the remaining years.

Live at home This may not be every child's dream of the college experience, but living at home, even for a year or two, can save a significant amount of money on room and board expenses. However, depending on how far you live from the college, commuting costs may become a factor.

Buy real estate for child's housing Rather than pay room and board to a college for four years, some parents may decide to purchase a condominium or small house for their child's living quarters during the college years (and possibly for graduate school). If the property has more than one bedroom and the parents and child are comfortable with the idea, they may consider renting out the spare bedroom(s) and applying the rents to the monthly mortgage payment.

Of course, parents need extra cash up front to purchase such a property. In addition, they may be confronted with a sagging real estate market when and if they try to sell the property. Yet, oftentimes parents are able to recoup their purchase price, and some lucky parents may even be able to turn a profit. Moreover, while the property is held, parents may be eligible for certain tax deductions.

Enroll in government military programs There are three different options for the military route: • Your child can attend a service academy (e.g., Air Force Academy, Naval Academy). Not only is the education free, but your child will also earn a salary each year he or she is in school. Admissions standards at these service academies are among the most competitive in the country. Upon graduation your child must serve a minimum of five years of active duty. • Your child can serve in the military first and then attend college under the Government Issue (GI) Bill.

The GI Bill is a program designed for people who choose to enlist in one of the branches of the armed forces first and pursue a college degree later. To qualify for these educational benefits, your child must serve at least three continuous years of active duty or two years of active duty followed by four years in the reserves. • Your child can train for the military while in school under the Reserve Officers' Training Corps (ROTC).

This is a scholarship program that lets students go to college full-time and participate in a part-time or summer officer-training program. ROTC scholarships offer recipients free tuition, fees, and books in exchange for up to four years of active duty following graduation. Students also receive a salary in the last two years of school, a travel allowance, and paid summer training. Your child can apply for a ROTC scholarship at a military recruiting office during his or her junior or senior year of high school.

Have grandparents pay tuition directly to college or university Another option for lowering the cost of college is for grandparents (or any other generous relative, for that matter) to pay college tuition directly to an educational institution. Such payments are not considered gifts for federal gift tax purposes. To qualify for this tax exclusion, however, the payment must be for tuition only and made directly to the college; grandparents cannot give the money directly to the student or to a trust on behalf of the student.

Consider a Canadian college Families after deals might want to look in Canada. The best schools in Canada often equate to just under the Ivy League schools in the United States, but come at a fraction of the price (e.g., McGill University in Montreal costs

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less than half of New York University). The cultural difference can make life interesting for four years and may reap other rewards as well. With the age of the global economy, prospective employers in the United States tend to look with favor on graduates of Canadian schools.

Strengths Reduce your out-of-pocket costs for college When you attempt to cut college costs by implementing various creative solutions, you have the potential to lower the amount of savings or borrowings you will need to apply to college costs.

Possibly enjoy other incidental benefits Some creative solutions can offer nonfinancial benefits that were unforeseeable at the time they were implemented. For example, your child may pursue a co-op education strictly for the monetary savings but then discover that working in his or her chosen field was not the experience he or she expected. Similarly, your child may choose part-time work solely for the income and then realize it gives him or her a welcome break from daily studies and dorm life.

Tradeoffs Your child may not receive the typical four-year college experience Many of the creative solutions to lower college costs put a spin on the typical four-year college experience. For example, by living at home, your daughter may find herself left out of many dorm-related events. Similarly, if your son participates in an accelerated program and graduates in three years, he may feel he's missed out on his senior year of college.

Your child may experience other unforeseen problems Perhaps you encouraged your daughter to live at home, and now you can't stand it when she's out all night.

Perhaps your son thought he could deal with a part-time job, but now he's too exhausted to study. Maybe your child started off at a local community college, planning to transfer, but the transfer application was just rejected by the college of his or her choice. In sum, simply selecting a creative solution doesn't mean it will work out to your liking.

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Saving for College and Retirement What is it?

These days it's not uncommon for parents to postpone starting a family until both spouses are settled in their marriage and careers, often well into their 30s and 40s. Though this financial security can be an advantage, it can also present a dilemma--the need to save for college and retirement at the same time.

The prevailing wisdom has parents saving for both goals at the same time. The reason is that older parents can't afford to put off saving for retirement until the college years are over, because to do so means missing out on years of tax-deferred growth. Moreover, because generous corporate pensions (and lifetime job security) are now the exception rather than the rule, employees must take greater responsibility for funding their own retirements.

First, determine your monetary needs The first step is to determine your projected monetary needs, both for retirement and college. This analysis will reveal whether you are on a savings course to meet both goals, or whether some modifications will be necessary.

For information on figuring your income needs in retirement, see Determining Your Retirement Income Needs: Pre-Retirement.

For information on estimating college expenses, see Estimating College Costs.

You've come up short: what are your options?

You've run the numbers on both your anticipated retirement and college expenses, and you've come up short.

The numbers say you won't be able to afford to educate your children and retire with the lifestyle you expected based on your current earnings. Now what? It's time to sit down and make some tough decisions about your expectations and, ultimately, how to compromise.

The following options can help you in that effort. Some parents may need to combine more than one strategy to meet their goals.

Defer retirement Staying in the workforce longer is one way of meeting your retirement and education goals. The longer you wait to dip into your retirement funds, the longer the money will last. For more information, see Delayed Retirement Considerations.

Reduce standard of living now or in retirement You may be able to adjust your spending habits now in order to have more money later. Consider making a written budget to track your monthly income and expenses (see Budgeting for more information). If your monetary needs have fallen far short of the mark, you will need to make a bigger spending adjustment than you would with a lesser shortfall. The following are some suggested changes: • Move to a less-expensive home or apartment • Sell your second car and carpool whenever possible • Reduce your entertainment budget (e.g., bring your lunch to work, eat out once a month instead of every week, rent movies instead of going to the cinema)

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• Get books and magazines from the library instead of the bookstore • Cancel any club memberships (e.g., golf club, health club) • Set a limit on birthday and holiday gifts for family members • Forgo expensive vacations • Shop for clothes in the off-season, when they're likely to be on sale • Buy used furniture and used big-ticket items • Limit your child's extracurricular activities, like music lessons or hockey camp If you're unable or unwilling to lower your standard of living now, perhaps you can lower it in retirement. This may mean revising your expectations about a luxurious, vacation-filled retirement. The key is to recognize the difference between the things you want and the things you need. The following are a few suggestions to help reduce your standard of living in retirement: • Reduce your housing expectations • Cut back on travel plans • Own a less-expensive automobile • Lower household expenses Note: There's a difference between reducing your standard of living in retirement and drastically reducing your standard of living in retirement. Most professionals discourage the use of retirement funds for your child's education if paying college bills will leave you high and dry in your retirement years.

Work part-time during retirement About 25 percent of retirees work part-time. You may find that the extra income enables you to enjoy the kind of retirement you had anticipated.

Increase earnings (i.e., spouse returns to work) Increasing earnings may be another way to meet both your education and retirement goals. The usual scenario is that a stay-at-home spouse returns to the workforce. This has the benefit of increasing the family's earnings so there's more money available to save for education and/or retirement. However, there are drawbacks. The additional income may push the family into a higher tax bracket (see Second-Income Analysis), and incidental expenses like day care and commuting costs may eat into your overall take-home pay. For more information on the pros and cons of a spouse returning to work, see Spouse Returns to or Increases Hours at Work.

In addition to a spouse returning to work, one spouse may decide to increase his or her hours at work, take another job with better compensation, or moonlight at a second job. Factors to consider here include the expectation of increased job pressure, less availability for child rearing and household management, the amount of extra income, the opportunity for advancement, and job security. Another way to create extra income is for a spouse to turn a hobby into a business.

Be more aggressive in investments Your analysis has shown that your current savings (and the accompanying investment vehicles) will leave you short of your education and retirement goals. One option is to try to earn a greater rate of return on your savings.

This may mean choosing more aggressive investments (e.g., growth stocks) over more conservative investments (e.g., bonds, certificates of deposit, savings accounts). This strategy works best the more years you have until retirement.

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Caution: The more aggressive the investment, the greater the risk of loss of your principal. This strategy isn't for people who shudder at the slightest downturn in the stock market. If you'll have trouble sleeping at night, you probably shouldn't take on greater risk in your investment portfolio.

Reduce education goal One of the realities parents may have to face is that they can't afford to fund 100 percent (or 75 percent, or 50 percent, as the case may be) of their child's college education. This is often an emotional issue. Parents naturally want the best for their children. For many parents, this translates into sending them to (and paying for) college (especially in cases where one or both parents didn't have such an opportunity).

You may have dreamed that your child would go to a prestigious Ivy League school. Well, with a year's cost at such a school hovering at the $40,000 mark, maybe you need to lower your expectations. That small liberal arts college or the big state school may challenge your child just as much and at a far lower cost. Remember, there are loans available for college, but none for retirement.

Children pay more and/or assume more responsibility for loans With college costs continuing to increase at a rate faster than most family incomes (see Estimating College Costs), and with perhaps more than one child in the family picture, chances are that more responsibility will fall on your child to help fund college costs. This money can come from part-time jobs or gifts, though the majority of your child's contribution is likely to come from student loans. For more information on student loans, see Financial Aid: Loans.

Though student loans can be a financial burden in the early years, when graduates are just starting out in their careers, many loan providers offer flexible repayment options in anticipation of this common situation (see Repaying Student Loans). In addition, if your child meets certain income limits, he or she can deduct the interest paid on qualified student loans (see Student Loan Interest Deduction for more information).

When children take out student loans, parents can always decide to help financially rather than mortgaging their house before college. Students who take out student loans to pay for college may have a more vested interest in their education than students who receive help from their parents.

Other ways to lower cost of college In addition to reducing your education goal and having your child pay a portion of college costs, there are other ways to lower the cost of college. For example, your child can choose a college with an accelerated program that allows students to graduate in three years instead of four. Likewise, your child may choose to attend a community college for two years and then transfer to a four-year private institution. The diploma will reflect the four-year college, but your pocketbook won't. For more ideas on ways to lower the cost of college, see Implementing Other Creative Solutions to Cover Higher Education Costs.

How do you decide what strategy is best for you?

This decision must be made on a case-by-case basis. What works for one family may not work for another family.

In some cases, more than one strategy will be necessary to deal with the demands of educating children and retiring successfully. Factors influencing your decision may include the following: • The amount of your financial need • Your current income and assets and any expectation of significant future income (e.g., a bonus at work, exercise of stock options, an inheritance) • The number of years you have until retirement • Your willingness to reduce your standard of living (now or in the future) for the sake of your children • The number of children in your family who plan on attending college

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• The academic, athletic, or other notable skills of your child that may raise the possibility of a college scholarship

Can retirement accounts be used to save for college?

Yes. But should you? Probably not. Many financial advisors recommend against dipping into your retirement account to pay college expenses as a preferred strategy. But if you must, there are some tax breaks available.

It's now possible to withdraw money from either a traditional IRA or Roth IRA before age 59½ to pay college expenses without incurring the 10 percent early withdrawal penalty that normally applies to such withdrawals.

However, any distributions of earnings and deductible contributions from a traditional IRA and any nonqualified distributions of earnings from a Roth IRA may be included in your income for the year, which may push you into a higher tax bracket. For more information, see Traditional IRAs and Roth IRAs. Tip: This college exception to the 10 percent early withdrawal penalty is a good reason to funnel your child's income from a part-time job into an IRA. Unfortunately, there's no similar college exception for employer-sponsored retirement plans, such as a 401(k) plan. So, if you're under age 59½, you'll pay a 10 percent early withdrawal penalty on any withdrawals. As with an IRA, any withdrawals are added into your income for the year, which may push you into a higher tax bracket.

Nevertheless, saving in a 401(k) plan can be an attractive option for some parents because the company may match employee contributions and because most employer plans allow you to borrow against your contributions (and possibly earnings) before age 59½ without penalty. For more information, see Employer-Sponsored Retirement Plans for Education Savings.

Tip: Some parents who have built a college fund within their 401(k) accounts, but who are not yet 59½ when the kids are in college, take out what's called a bridge loan (such as a home equity loan) to pay their child's college bills. A bridge loan is a source of funds that tides you over until it's more economical to tap your retirement account. Although you pay interest on a bridge loan, it may still cost less than what your 401(k) funds can earn. Then, when you turn 59½, you can start tapping your 401(k) plan to pay off the bridge loan with no early withdrawal penalty.

A benefit of using retirement accounts to save for college is that the federal government doesn't consider the value of your retirement accounts in awarding financial aid (the federal formula also excludes annuities, cash value life insurance, and home equity from consideration). However, most private colleges do consider the value of your retirement accounts in deciding which students are the most deserving of campus-based aid. See Applying for Financial Aid for more information.

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Education Tax Credits and Deductions What are the tax credits and deductions relating to higher education?

There are two education tax credits--the Hope credit (renamed the American Opportunity credit for 2009 and 2010) and the Lifetime Learning credit--that provide some relief to families in the midst of financing their children's college education. There is also a federal income tax deduction for certain taxpayers who pay qualified higher education expenses, as well as a deduction for certain individuals who pay student loans. As a general rule, a tax credit is a dollar-for-dollar reduction against taxes owed, and it is therefore more valuable than a tax deduction of the same dollar amount.

Hope credit (American Opportunity credit) The Hope credit (American Opportunity credit) is worth a maximum $2,500 per student in tax savings for the first four years of your child's post-secondary education. The credit is calculated as 100 percent of the first $2,000 of qualified tuition and related expenses, plus 25 percent of the next $2,000 of expenses.

There are eligibility restrictions. First, the credit applies only to undergraduate students who are enrolled in college on at least a half-time basis. Second, the ability of parents to take the credit depends on their modified adjusted gross income (MAGI). The full credit is limited to single filers with a MAGI below $80,000 and joint filers with a MAGI below $160,000. A partial credit is available for single filers with a MAGI between $80,000 and $90,000 and joint filers with a MAGI between $160,000 and $180,000.

One distinct advantage of the Hope credit is that there is no limit on the number of credits that may be claimed on a single tax return in a given year (provided each person qualifies independently). For example, if Mom and Dad have triplets who are in their freshman year of college, then Mom and Dad can claim a total of $5,400 ($1,800 x 3) in Hope credits for that year. However, the Hope credit and Lifetime Learning credit are mutually exclusive; they cannot be taken in the same year.

Lifetime Learning credit The second tax credit is called the Lifetime Learning credit This credit is worth a maximum yearly tax savings of $2,000. The credit is calculated as 20 percent of the first $10,000 of qualified tuition and related expenses.

As the name implies, the Lifetime Learning credit is intended to apply to higher education courses taken throughout your lifetime, whether to acquire or improve job skills. As such, it is less restrictive on the type and level of enrollment than the Hope credit. For example, the Lifetime Learning credit is available to graduate students as well as to undergraduate students. It is also available to students enrolled on less than a half-time basis. So, a single word processing course taken by a lawyer at his or her local community college will qualify for the credit.

As with the Hope credit, there are restrictions on the Lifetime Learning credit. The full credit is limited to single filers with a modified adjusted gross income (MAGI) below $50,000 and joint filers with a MAGI below $100,000.

A partial credit is available for single filers with a MAGI between $50,000 and $60,000 and joint filers with a MAGI between $100,000 and $120,000. One particular disadvantage of the Lifetime Learning credit is that it is limited to a total of $2,000 per tax return per year, regardless of the number of people who qualify in a family in a given year. So, in the example with the triplets, Mom and Dad would be able to take a total credit of $2,000, not $6,000.

Yet on the plus side, the Lifetime Learning credit is available for an unlimited number of years, whereas the Hope credit is limited to the first two years of a child's post-secondary education.

Deduction for qualified higher education expenses You may also be able to deduct qualified higher education expenses you paid during the tax year. In 2009, single

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filers with a MAGI of $65,000 or less and joint filers with a MAGI of $130,000 or less are entitled to a $4,000 deduction; single filers with a MAGI between $65,000 and $80,000 and joint filers with a MAGI between $130,000 and $160,000 are entitled to a $2,000 deduction. These expenses include the tuition and fees you've paid for enrollment in a degree or certificate program at an accredited post-secondary educational institution. This deduction is not available in 2010.

Student loan interest deduction You can deduct up to $2,500 of the interest you pay on qualified student loans, provided you meet the income limits. For single filers, a full student loan interest deduction is available with a modified adjusted gross income (MAGI) up to $60,000; a partial deduction is available for a MAGI between $60,000 and $75,000. For joint filers, a full deduction is available with a MAGI up to $120,000; a partial deduction is available with a MAGI between $120,000 and $150,000.

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Comparison of Federal Higher Education Loans Unsubsidized Stafford Loan

Subsidized Stafford Loan

Perkins Loan

PLUS Loan

Description

A low-interest, federally deferred student loan

A low-interest, federally deferred student loan

A low-interest, federally deferred student loan available to students with the greatest financial need

A federal education loan made to borrowers with good credit histories; borrowers may borrow the full cost of higher education, less any financial aid received

Available to

Undergraduate and graduate students enrolled at least half-time

Undergraduate and graduate students enrolled at least half-time

Undergraduate and graduate students (can be less than half-time)

Parents of undergraduate students enrolled at least half-time, and independent graduate and professional students

Lender

Federal government or private financial institution, depending on which federal education loan program the college participates in

Federal government or private financial institution, depending on which federal education loan program the college participates in

College

Federal government or private financial institution, depending on which federal education loan program the college participates in

Borrower

Student

Student

Student

Parent or graduate/professio nal student

Based on financial need

No

Yes

Yes

No

Interest rate

6.8% fixed for loans disbursed after June 30, 20061

6.8% fixed for loans disbursed after June 30, 2006--this interest rate will gradually be reduced to 3.4% by 20122

5%

8.5% fixed for loans disbursed after June 30, 20061

Interest subsidized

No

Yes3

Yes3

No

Grace period

6 months

6 months

generally 9 months

6 months

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Page 47 of 96 Undergraduate students: $4,000/year $20,000 limit

Loan limits 2009/2010

Dependent undergraduates:

1st year:

$5,500 ($3,500 subsidized)

2nd year:

$6,500 ($4,500 subsidized)

3rd - 5th year:

$7,500/year ($5,500/year subsidized)

Maximum:

$31,000

Graduate students: $6,000/year $40,000 limit (including undergraduate loans)

Student's total cost of education, less any other financial aid received by either the student or parent

Independent undergraduates and dependent undergraduates whose parents don't qualify for PLUS loans: 1st year:

$9,500 ($3,500 subsidized)

2nd year:

$10,500 ($4,500 subsidized)

3rd - 5th year:

$12,500/year ($5,500/year subsidized)

Maximum:

$57,500

Graduate students: Any year:

$20,500/year ($8,500 subsidized)

Maximum:

$138,500, including undergraduate loans ($65,500 subsidized)

Notes 1 The interest rate for Stafford and PLUS Loans disbursed on or after July 1, 1998 through June 30, 2006 is variable. For the period July 1, 2009 through June 30, 2010, the interest rate on Stafford Loans in repayment is 2.48% (down from 4.21%), the interest rate on in-school, grace, or deferment status Stafford Loans is 1.88% (down from 3.61%), and the interest rate on PLUS Loans is 3.28% (down from 5.01%).

2 For subsidized Stafford Loans, the interest rate will be fixed at 6.0% for loans first disbursed on or after July 1, 2008 and before July 1, 2009; 5.6% for loans first disbursed on or after July 1, 2009 and before July 1, 2010; 4.5% for loans first disbursed on or after July 1, 2010 and before July 1, 2011; and 3.4% for loans first disbursed on or after July 1, 2011 and before July 1, 2012.

3 The federal government pays the interest on the loan when the student is in school at least half-time, in a grace period, or in a deferment period.

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Comparison of Education Tax Credits and Deductions

Hope credit1

Lifetime Learning credit

Student loan interest deduction

Deduction for qualified higher education expenses

Credit/deduction applies to

Qualified tuition and related expenses for first four years of undergraduate education

Qualified tuition and related expenses for courses taken throughout lifetime to improve or acquire job skills

Interest paid on a qualified student loan

Not available in 2010

Qualified education expenses include room and board?

No

No

Yes

N/A

Amount of credit/deduction in 2010

$2,500 maximum

$2,000 maximum

$2,500 maximum

N/A

Single filers:full credit available if modified adjusted gross income (MAGI) $80,000 or less (same in 2009)

Single filers:full credit available if modified adjusted gross income (MAGI) $50,000 or less (same in 2009)

Single filers:full deduction available if modified adjusted gross income (MAGI) $60,000 or less (same in 2009)

Partial credit available if MAGI between $80,000 and $90,000 (same in 2009)

Partial credit available if MAGI between $50,000 and $60,000 (same in 2009)

Partial deduction available if MAGI between $60,000 and $75,000 (same in 2009)

Joint filers:full credit available if MAGI $160,000 or less (same in 2009)

Joint filers:full credit available if MAGI $100,000 or less (same in 2009)

Joint filers:full deduction available if MAGI $120,000 or less (same in 2009)

Partial credit available if MAGI between $160,000 and $180,000 (same in 2009)

Partial credit available if MAGI between $100,000 and $120,000 (same in 2009)

Partial deduction available if MAGI between $120,000 and $150,000 (same in 2009)

No

Yes

Less than half-time--no; graduate students--yes

Income limits on who is eligible to take credit/deduction in 2010

Less than half-time students or graduate students eligible?

N/A

N/A

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Limit on number of students in family for whom credit/deduction can be taken in same year?

No

No, but the annual credit is limited to $2,000 per tax return

No; if applicable, parents can claim the deduction for more than one child in the same year

N/A

Credit/deduction available in same year as tax-free distribution from a Coverdell education savings account?

Yes

Yes

Yes

N/A

Must student be enrolled for a degree or in other program leading to an educational credential?

Yes

No

Yes

N/A

Allowed if student has a controlled substance conviction?

No

Yes

Yes

N/A

Notes: 1

For 2009 and 2010, the Hope credit is renamed the American Opportunity tax credit.

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Financial Aid Calendar If your child will be applying for financial aid for college, here's a calendar highlighting the important tasks to be done during the senior year of high school.

September Create a timetable of financial aid deadlines for both federal government and individual college programs

December Obtain the federal government's Free Application for Federal Student Aid (FAFSA)

October Explore potential private scholarship sources at the library or on-line

January Compile income tax information to help in completing the FAFSA

November Request application materials from private scholarship and grant sources

February Verify that all required financial aid forms have been submitted

Complete, photocopy, and submit the FAFSA as soon as possible after January 1 Complete college and private source financial aid forms

Obtain any other financial aid forms required by selected colleges March Watch mail for Student Aid Report from the federal government showing your family's expected family contribution (EFC) to college costs

April Receive financial aid awards from various colleges

May Contact financial aid office to check status of aid

Compare financial aid awards Sign and return financial aid forms

Watch for reports from college and private financial aid applications Notify financial aid administrator of changes in circumstances that affect family's ability to pay EFC (e.g., job loss, divorce, etc.)

June

Summer

Off to College!

Sign student loan promissory notes Receive federal student loan counseling

HIGH SCHOOL GRADUATION

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Finding the Funds to Pay for a College Education Finding the funds to pay for your child's college education is like filling a test tube.

The length of the tube represents the cost of education at any one school--tuition, fees, books, room and board, transportation, and personal expenses.

The first ingredient is what you'll have to contribute from your own pocket: the expected family contribution (EFC), which is determined by the federal government's financial aid formula.

Your EFC is the same regardless of the college your child chooses. The difference between your EFC and the cost of a particular college equals your child's financial need, which is a variable.

To meet this financial need, your child might be eligible for financial aid in the form of loans, grants, scholarships, and/or work-study funds from the federal government, the college itself, and/or independent organizations. (In some cases, a family's EFC may be enough to satisfy all college costs.)

Your child may not receive all the financial aid he or she needs. If so, you'll have to top off the tube with more of your own funds, which are in addition to the EFC.

This illustration represents one possible financial situation. Actual percentages vary from student to student.

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College Application and Financial Aid Calendar Activities for high school student's senior year Many parents begin planning their child's education at birth. Whether you've been saving and planning for the past 18 years or you just recently started discussing college plans with your child, senior year is quickly approaching, and decisions need to be made.

The summer before your child's senior year is a good time to narrow down college choices. You and your child may base these decisions on various factors (e.g., cost, location, curriculum, or extracurricular activities). If you haven't done so already, now is the time to request catalogs, attend college fairs, and visit campuses to help narrow the list of schools.

Be sure to jot down specific school deadlines for applications, scholarships, and financial aid forms. Post this calendar on your refrigerator so that you and your child can plan together.

Fall

Winter

Spring

Summer

Attend college fairs.

Gather financial aid information--attend financial aid nights.

Compare financial aid packages offered by various colleges.

Buy supplies.

Visit college campuses before making the final cut.

Apply for financial aid (annually). Complete FAFSA (Free Application for Federal Student Aid).

Make final decision--which school will it be?

Work to earn spending money.

Decide which schools to apply to, and mail the applications.

Obtain and review student aid report--make necessary revisions.

Pay deposit to college.

Prepare to move if you're going away to school.

Early decision applications are typically due in November--check with each school.

Complete other financial aid forms. (college,state)

General admissions process begins.

Get settled in your dorm/apartment. If you'll be living at home, set up a special study area.

Learn about employment and extracurricular activities on campus and the nearby area.

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Finding Money to Pay College Bills Out of Pocket You've saved for your child's college education through the years, helped your child research schools, and supervised the application process. Now, thankfully, your child is in college. But you probably can't disappear just yet--there are still bills to pay. Maybe you underestimated exactly how much financial aid would cover. Or perhaps you knew all along that you'd have to use some of your own resources or take out more loans. In any case, you'll need to come up with some money soon. So where should you look?

Your paycheck If you can afford it, applying part of your paycheck to your child's college bills is probably the easiest route. You won't have any paperwork to fill out or messy calculations at tax time, and you can leave your retirement accounts and life insurance intact.

Most colleges bill once each semester. To have enough money saved to meet each semester's bill, you'll need to set aside an amount from each paycheck as soon as you get it, rather than save whatever is left at the end of the month. As you accumulate money, you should put it somewhere safe (e.g., a savings account, money market account, or certificate of deposit) because of your short time frame. Some colleges, however, offer quarterly or monthly bills in an effort to make payment easier for you. Colleges may even offer you a tuition discount if you allow them to debit your account directly. In addition, some private companies now offer a 10-month payment plan coordinated with individual colleges.

The main drawback to using your paycheck as a source of cash for college bills is that this consistent outflow of cash over a period of months or years may leave you financially strapped to invest for other goals. To determine how much of a contribution you can manage (if any), you'll need to prepare a detailed budget of your household income and expenses.

Your savings and investments The next logical place to look for spare funds is your savings and investments. This category encompasses everything from savings accounts and money market accounts to stocks, mutual funds, and real estate holdings.

Not surprisingly, it can be difficult to figure out which source to use. Generally speaking, withdrawing from your savings accounts is the easier route. Again, no applications or independent approvals are necessary (except perhaps from your spouse!). Also, no tax penalties are associated with such withdrawals. And the fact that savings accounts generally earn the lowest rates of return means that you don't have to worry about missing out on high returns. However, try to keep at least three to six months' worth of savings on hand for emergencies.

The process is a bit more complicated with investments. Though most investments are easily liquidated (i.e., converted to cash), it's not always easy to know which ones to liquidate. The answer depends in part on each investment's rate of return, future prospects, and potential capital gain (or loss) if sold and the tax consequences.

If you're unsure which investments to liquidate, a professional financial planner can help you sort through the possibilities.

If you have a 529 college savings plan or a 529 prepaid tuition plan, you'll need to notify the plan administrator before you make a withdrawal. Check the specific rules of your plan for more information. If you have a Coverdell education savings account, keep in mind that all withdrawals must be made before the beneficiary reaches age 30 (unless the beneficiary has special needs).

Your home If you're one of the lucky ones whose home has increased in value over the years, you can usually tap this equity for college bills by taking out a home equity loan. The loan can be structured as either a revolving line of credit (you're approved for a certain amount and you tap the funds periodically as you need them) or a second mortgage (you receive one lump sum). The main advantage of a home equity loan is that interest payments are

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usually tax deductible. And because your home serves as collateral for the loan, the interest rate is likely to be lower than on an unsecured loan. However, because the loan is now tied to your house, your lender can foreclose on your home if you default.

Your life insurance If you have a cash value life insurance policy, you might decide to use part of the cash value that has built up inside the policy by making a withdrawal or taking out a loan, or using some combination of the two. For withdrawals, the amount that you withdraw is generally limited to a percentage of your cash value and varies by policy and company. The main drawback is that such withdrawals decrease your death benefit (i.e., the sum of cash that the insurance company pays at your death). For policy loans, you are likewise allowed to borrow up to a specified percentage of your cash value. However, if you die with an outstanding loan against your policy, your death benefit is reduced by the amount of the outstanding loan and interest. For more information, contact your insurance agent.

Private loan/PLUS Loan If the idea of putting your home at risk with a home equity loan scares you, then you might consider obtaining a personal (unsecured) loan from a private financial institution. To get approved, you'll likely need a good credit history.

If you're looking for a loan that's college-specific, the federal government's Parent PLUS Loan may be a good option. Under this program, parents can borrow up to the full cost of their child's college education, less any financial aid received. The loan can be obtained either directly from the federal government or from participating private lenders. Importantly, PLUS Loans aren't based on your child's financial need. However, you'll need to pass a credit check.

Your retirement plans By the time your child's in college, it's likely that you'll have at least some money saved in one or more retirement accounts, such as an IRA or an employer-sponsored plan like a 401(k). Should you tap these funds? As a general rule, most planners don't recommend using your retirement funds to pay college bills. You'll need the money in retirement, and you'll miss out on the growth that would have occurred had you not withdrawn the money.

However, there may be instances where you need (or want) to use your retirement funds. With IRAs (traditional IRAs and Roth IRAs), you can withdraw funds at any age, penalty free, to pay your child's college bills ("qualified higher education expenses," as the IRS likes to call them). However, you may owe income tax on your withdrawals; consult the appropriate IRS publication on your type of IRA, or speak with a tax professional. Be aware that once you withdraw the money, it can't be paid back like a loan.

Unfortunately, if you withdraw funds from an employer-sponsored retirement plan like a 401(k) or 403(b) and you're under age 59½, you'll pay a 10 percent early withdrawal penalty. Keep in mind, too, that all withdrawals will be added to your taxable income for the year. Instead of withdrawing funds, another option is to borrow the money, assuming your company's plan allows it (check with your human resources manager). By borrowing instead of withdrawing, you avoid taxes and penalties. However, most plans require you to pay back the entire loan within five years (you can start to repay right away through a payroll deduction) or immediately if you leave the company.

Your child's piggy bank In finding spare change for college bills, leave no stone unturned. Does your child have any income or assets that could be used? What about that vintage lunch box collection collecting dust in your child's closet, or those $100 savings bonds that your child received from Aunt Agnes every year? In addition, your child could get a summer job or part-time job during the school year to help pay the bills.

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ABCs of Financial Aid These days, it's hard to talk about college without mentioning financial aid. Yet this pairing isn't a marriage of love, but one of necessity. In many cases, financial aid may be the deciding factor in whether your child attends the college of his or her choice or even attends college at all. That's why it's important to develop a basic understanding of financial aid before your child applies to college. Without such knowledge, you may have trouble understanding the process of aid determination, filling out the proper aid applications, and comparing the financial aid awards that your child receives.

But let's face it. Financial aid information is probably not on anyone's top ten list of bedtime reading material. It can be an intimidating and confusing topic. There are different types, different sources, and different formulas for evaluating your child's eligibility. Here are some of the basics to help you get started.

What is financial aid?

Financial aid is money distributed primarily by the federal government and colleges in the form of loans, grants, scholarships, or work-study jobs. A student can receive both federal and college aid.

Grants and scholarships are more favorable than loans because they don't have to be repaid--they're free money.

In a work-study program, your child works for a certain number of hours per week (either on or off campus) to earn money for college expenses. Obviously, an ideal financial aid package will contain more grants and scholarships than loans.

Need-based aid vs. merit aid Financial aid can be further broken down into two categories--need-based aid, which is based on your child's financial need; and merit aid, which is awarded according to your child's academic, athletic, musical, or artistic merit.

The majority of financial aid is need-based aid. However, in recent years, merit aid has been making a comeback as colleges (particularly private colleges) use favorable merit aid packages to lure the best and brightest students to their campuses, regardless of their financial need. However, the availability of merit aid tends to fluctuate from year to year as colleges decide how much of their endowments to spend, as well as which specific academic and extracurricular programs they want to target.

Sources of merit aid The best place to look for merit aid is at the colleges that your child is applying to. Does the college offer any grants or scholarships for academic, athletic, musical, or other abilities? If so, what is the application procedure?

College guidebooks can give you an idea of how much merit aid (as a percentage of a general student's overall aid package) each college has provided in past years.

Besides colleges, a wide variety of private and public companies, associations, and foundations offer merit scholarships and grants. Many have specific eligibility criteria. In the past, sifting through the possibilities could be a daunting task. Now, with the Internet, there are websites where your child can input his or her background, abilities, and interests and receive (free of charge) a matching list of potential scholarships. Then it's up to your child to meet the various application deadlines. However, though this avenue is certainly worth exploring, such research (and subsequent work to complete any applications) shouldn't come at the expense of researching and applying for the more common need-based financial aid.

Sources of need-based aid The main provider of need-based financial aid is the federal government, followed by colleges. States come in at

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a distant third. The amount of federal aid available in any given year depends on the amount that the federal budget appropriates, and this aid is spread over several different financial aid programs. For colleges, need-based aid comes from a college's endowment, and policies may differ from year to year, resulting in an uneven availability of funds. States, like the federal government, must appropriate the money in their budgets.

The federal government's aid application is known as the FAFSA, which stands for Free Application for Federal Student Aid. The federal government and colleges use the FAFSA when federal funds are being distributed (colleges are responsible for administering certain federal financial aid programs). When colleges distribute their own financial aid, they use one of two forms. The majority of colleges use the PROFILE application, created by the College Scholarship Service of Princeton, New Jersey. A minority of colleges use their own institutional applications. The states may use the FAFSA or may require their own application. Contact your state's higher education authority to learn about the state aid programs available and the applications that you'll need to complete.

The FAFSA is filed as soon after January 1 as possible in the year your child will be attending college. You must wait until after January 1 because the FAFSA relies on your tax information from the previous year. The PROFILE (or individual college application) can usually be filed earlier than the FAFSA. The specific deadline is left up to the individual college, and you'll need to keep track of it.

How is my child's financial need determined?

The way your child's financial need is determined depends on which aid application you're filling out. The FAFSA uses a formula known as the federal methodology; the PROFILE (or a college's own application) uses a formula known as the institutional methodology. The general process of aid assessment is called needs analysis.

Under the FAFSA, your current income and assets and your child's current income and assets are run through a formula. You are allowed certain deductions and allowances against your income, and you're able to exclude certain assets from consideration. The result is a figure known as the expected family contribution, or EFC. It's the amount of money that you'll be expected to contribute to college costs before you are eligible for aid.

Your EFC remains constant, no matter which college your child applies to. An important point: Your EFC is not the same as your child's financial need. To calculate your child's financial need, subtract your EFC from the cost of attendance at your child's college. Because colleges aren't all the same price, your child's financial need will fluctuate with the cost of a particular college.

For example, you fill out the FAFSA, and your EFC is calculated to be $5,000. Assuming that the cost of attendance at College A is $18,000 per year and the cost at College B is $25,000, your child's financial need is $13,000 at College A and $20,000 at College B. The PROFILE application (or the college's own application) basically works the same way. However, the PROFILE generally takes a more thorough look at your income and assets to determine what you can really afford to pay (for example, the PROFILE looks at your home equity and retirement assets). In this way, colleges attempt to target those students with the greatest financial need.

What factors the most in needs analysis? Your current income is the most important factor, but other criteria play a role, such as your total assets, how many family members are in college at the same time, and how close you are to retirement age.

How does financial need relate to my child's financial aid award?

When your child is accepted at a particular college, the college's financial aid administrator will attempt to create a financial aid package to meet your child's financial need. Sometime in early spring, your child will receive these financial aid award letters that detail the specific amount and type of financial aid that each college is offering.

When comparing awards, first check to see if each college is meeting all of your child's need (colleges aren't obligated to meet all of it). In fact, it's not uncommon for colleges to meet only a portion of a student's need, a phenomenon known as getting "gapped." If this happens to you, you'll have to make up the shortfall, in addition to

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paying your EFC. College guidebooks can give you an idea of how well individual colleges meet their students' financial need under the entry "average percentage of need met" or something similar. Next, look at the loan component of each award and compare actual out-of-pocket costs. Remember, grants and scholarships don't have to be repaid and so don't count toward out-of-pocket costs. Again, you would like your child's need met with the highest percentage of grants, scholarships, and work-study jobs and the least amount of loans.

If you'd like to lobby a particular school for more aid, tread carefully. A polite letter to the financial aid administrator followed up by a telephone call is appropriate. Your chances for getting more aid are best if you can document a change in circumstances that affects your ability to pay, such as a recent job loss, unusually high medical bills, or some other unforeseen event. Also, your chances improve if your child has been offered more aid from a direct competitor college, because colleges generally don't like to lose a prospective student to a direct competitor.

How much should our family rely on financial aid?

With all this talk of financial aid, it's easy to assume that it will do most of the heavy lifting when it comes time to pay the college bills. But the reality is you shouldn't rely too heavily on financial aid. Although aid can certainly help cover your child's college costs, student loans make up the largest percentage of the typical aid package, not grants and scholarships. As a general rule of thumb, plan on student loans covering up to 50 percent of college expenses, grants and scholarships covering up to 15 percent, and work-study jobs covering a variable amount. But remember, parents and students who rely mainly on loans to finance college can end up with a considerable debt burden.

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529 Plans and Financial Aid Eligibility If you're thinking about joining a 529 plan, or if you've already opened an account, you might be concerned about how 529 funds will affect your child's chances of receiving financial aid. Of all the areas related to 529 plans, financial aid is perhaps the most uncertain, and the one most likely to change in the future. But here's where things stand now.

First, why should you be concerned?

The financial aid process is all about assessing what a family can afford to pay for college and trying to fill the gap. To do this, the institutions that offer financial aid examine a family's income and assets to determine how much a family should be expected to contribute before receiving financial aid. Financial aid formulas weigh assets differently, depending on whether they are owned by the parent or the child. So, it's important to know how your college savings plan account or your prepaid tuition plan account will be classified, because this will affect the amount of your child's financial aid award.

A general word about financial aid Financial aid is money given to a student to help that student pay for college or graduate school. This money can consist of one or more of the following: • A loan (which must be repaid in the future) • A grant (which doesn't need to be repaid) • A scholarship • A work-study job (where the student gets a part-time job either on campus or in the community and earns money for tuition) The typical financial aid package contains all of these types of aid. Obviously, grants are more favorable than loans because they don't need to be repaid. However, over the past few decades, the percentage of loans in the average aid package has been steadily increasing, while the percentage of grants has been steadily decreasing.

This trend puts into perspective what qualifying for more financial aid can mean. There are no guarantees that a larger financial aid award will consist of favorable grants and scholarships--your child may simply get (and have to pay back) more loans.

The two main sources of financial aid are the federal government and colleges. In determining a student's financial need, the federal government uses a formula known as the federal methodology, while colleges use a formula known as the institutional methodology. The treatment of your 529 plan may differ, depending on the formula used.

How is your child's financial need determined?

Though the federal government and colleges use different formulas to assess financial need, the basic process is the same. You and your child fill out a financial aid application by listing your current assets and income (exactly what assets must be listed will depend on the formula used). The federal application is known as the FAFSA (Free Application for Federal Student Aid); colleges generally use an application known as the PROFILE. Your family's asset and income information is run through a specific formula to determine your expected family contribution (EFC). The EFC represents the amount of money that your family is considered to have available to put toward college costs for that year. The federal government uses its EFC figure in distributing federal aid; a college uses its EFC figure in distributing its own private aid. The difference between your EFC and the cost of attendance (COA) at your child's college equals your child's financial need. The COA generally includes tuition,

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fees, room and board, books, supplies, transportation, and personal expenses. It's important to remember that the amount of your child's financial need will vary, depending on the cost of a particular school.

The results of your FAFSA are sent to every college that your child applies to. Every college that accepts a student will then attempt to craft a financial aid package to meet that student's financial need. In addition to the federal EFC figure, the college has its own EFC figure to work with. Eventually, the financial aid administrator will create an aid package made up of loans, grants, scholarships, and work-study jobs. Some of the aid will be from federal programs (e.g., Stafford Loan, Perkins Loan, Pell Grant), and the rest will be from the college's own endowment funds. Keep in mind that colleges aren't obligated to meet all of your child's financial need. If they don't, you're responsible for the shortfall.

The federal methodology and 529 plans Now let's see how a 529 account will affect federal financial aid. Under the federal methodology, 529 plans--both college savings plans and prepaid tuition plans--are considered an asset of the parent, if the parent is the account owner.

So, if you're the parent and the account owner of a 529 plan, you must list the value of the account as an asset on the FAFSA. Under the federal formula, a parent's assets are assessed (or counted) at a rate of no more than 5.6 percent. This means that every year, the federal government treats 5.6 percent of a parent's assets as available to help pay college costs. By contrast, student assets are currently assessed at a rate of 20 percent.

There are two points to keep in mind regarding the classification of 529 plans as a parental asset: • A parent is required to list a 529 plan as an asset only if he or she is the account owner of the plan. If a grandparent, other relative, or friend is the account owner, then the 529 plan doesn't need to be listed on the FAFSA. Similarly, if the student is considered the account owner (as may be the case with a "custodial 529 account," which results when UGMA/UTMA assets are transferred to an existing 529 account), then the 529 plan doesn't need to be listed on the FAFSA. • If your adjusted gross income is less than $50,000 and you meet a few other requirements, the federal government doesn't count any of your assets in determining your EFC. So, your 529 plan wouldn't affect financial aid eligibility at all.

Distributions (withdrawals) from a 529 plan that are used to pay the beneficiary's qualified education expenses aren't classified as either parent or student income on the FAFSA.

The federal methodology and other college savings options How do other college savings options fare under the federal system? Coverdell education savings accounts, mutual funds, and U.S. savings bonds (e.g., Series EE and Series I) owned by a parent are considered parental assets and counted at a rate of 5.6 percent. However, UGMA/UTMA custodial accounts and trusts are considered student assets. Under the federal methodology, student assets are assessed at a rate of 20 percent in calculating the EFC. Also, distributions (withdrawals) from a Coverdell ESA that are used to pay qualified education expenses are treated the same as distributions from a 529 plan--they aren't counted as either parent or student income on the FAFSA, so they don't reduce financial aid eligibility.

One final point to note is that the federal government excludes some assets entirely from consideration in the financial aid process. These assets include all retirement accounts (e.g., traditional IRAs, Roth IRAs, employer-sponsored retirement plans), cash value life insurance, home equity, and annuities.

The institutional methodology and 529 plans When distributing aid from their own endowment funds, colleges aren't required to use the federal methodology.

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As noted, most colleges use the PROFILE application (a few colleges use their own individual application).

Generally speaking, the PROFILE digs a bit deeper into your family finances than the FAFSA. Regarding 529 plans, the PROFILE treats both college savings plans and prepaid tuition plans as a parental asset. And once funds are withdrawn, colleges generally treat the entire amount (contributions plus earnings) from either type of plan as student income.

Note:Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in the issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

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Student Loan Basics You vaguely remember signing a piece of paper every year at college registration time. Now that you've graduated, it's all become painfully clear--those pieces of paper were promissory notes detailing your student loan obligations. Your loans aren't going to go away, and you'll want to repay them as quickly and easily as possible. So whether you have a small sum or a small fortune to pay off, you'll want to brush up on some student loan basics.

First, remember the grace period After you graduate, you'll probably have a lot to think about--choosing where to live, finding a job, renting an apartment. Luckily, you don't have to add student loans to your list, too, at least not for now. Thanks to the grace period built into most student loans, you'll likely get anywhere from six to nine months before you need to begin repaying your loans. This time can allow you to get financially settled (at least partially!) and examine your repayment options before the drudgery begins.

Understand your repayment options Gone are the days when your only repayment option consisted of fixed, equal payments spread over a 10-year term. Though this is certainly one option, it's not the only one. Because of the increasing number of students who require student loans to finance their education, as well as the increasing amount of their debt, many lenders offer flexible repayment plans to help students manage this large financial responsibility.

• Standard repayment plan: This is the original repayment plan. With a standard plan, you generally pay a fixed amount each month for up to 10 years.

• Graduated repayment plan: With a graduated plan, your payments start out low in the early years of the loan but increase in later years (the term is still 10 years). This plan is tailored to individuals with relatively low current incomes (e.g., recent college graduates) who expect their incomes to increase in the future. However, you'll ultimately pay more for your loan than you would under the standard plan, because more interest accumulates in the early years of the plan when your outstanding loan balance is higher.

• Extended repayment plan: With an extended plan, you extend the time you have to repay your loan, usually from 12 to 30 years, depending on the loan amount. Your fixed monthly payment is lower than it would be under the standard plan, but again, you'll ultimately pay more for your loan because of the interest that accumulates under the longer repayment period. Note: Many lenders allow you to combine an extended plan with a graduated plan.

• Income-based repayment plan: With an income-based plan, your monthly loan payment is based on your annual income. As your income increases or decreases, so do your payments.

• Loan consolidation: Loan consolidation is technically not a repayment option, but it does overlap. With loan consolidation, you combine several student loans into one loan, sometimes at a lower interest rate. Thus, you can write one check each month. You need to apply for loan consolidation, and different lenders have different rules about which loans qualify for consolidation. However, with most loan consolidations, you can choose an extended repayment and/or a graduated repayment plan in addition to a standard repayment plan.

To pick the best repayment option, you'll need to determine the amount of discretionary income that you have to put toward your student loan each month. This, in turn, requires you to make a budget and track your monthly income and expenses.

In addition to inquiring about repayment options, ask whether your lender offers any special discounts for prompt

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loan repayment. For example, some lenders may shave a percentage point off your interest rate if you allow them to directly debit your checking account each month. Or, they may waive some monthly payments after receiving on-time payments for a certain length of time.

Consider a deferment, forbearance, or loan cancellation if you can't pay At times, you may find it financially difficult or impossible to repay your student loan. The worst thing that you can do is bury your head in the sand and ignore your payments (and your lender) completely. The best thing that you can do is contact your lender and apply for a deferment, forbearance, or cancellation of your loan. • Deferment: With a deferment, your lender grants you a temporary reprieve from repaying your student loan based on a specific condition, such as unemployment, temporary disability, military service, or a return to graduate school on a full-time basis. For federal loans, the federal government pays the interest that accrues during the deferment period, so your loan balance won't increase. A deferment usually lasts six months, and you are limited in the total number of deferments you can take over the life of the loan. • Forbearance: With a forbearance, your lender grants you permission to reduce or stop your loan payments for a certain period of time at its discretion (one common reason is economic hardship).

However, interest continues to accrue, even on federal loans. Like a deferment, a forbearance usually lasts six months, and the total number allowed over the life of the loan is limited. • Cancellation: With a cancellation, your loan is permanently wiped off your list of financial obligations.

It's not easy to qualify for a cancellation, though. Situations when this may be allowed are the death or permanent total disability of the borrower, or if the borrower takes a job teaching needy populations in certain geographic areas. Typically, student loans can't be discharged in bankruptcy.

Remember, these things are never automatic. You'll need to fill out the appropriate application from your lender, attach any supporting documentation, and follow up to make sure that your application has been processed correctly.

Keep track of your paperwork If your idea of organization is stuffing your random assortment of student loan papers into your sock drawer, think again. Repaying your student loans is a serious matter, and you'll need to stay on top of it. It's important to keep accurate, accessible records. Open a file folder for each loan, and file any accompanying paperwork there, such as copies of promissory notes, coupon booklets, correspondence from your lender, deferment and/or forbearance paperwork, and notes of any phone calls.

Investigate the student loan interest deduction On the bright side, you might be able to deduct on your federal tax return some of the student loan interest that you pay. In 2010, if you're a single filer with a modified adjusted gross income (MAGI) under $60,000 or a joint filer with a MAGI under $120,000, you can deduct up to $2,500 of student loan interest that you pay during the year. (A partial deduction is available to single filers with a MAGI between $60,000 and $75,000 and joint filers with a MAGI between $120,000 and $150,000.) There are a couple of hurdles, though. For example, you must have incurred the loans when you were at least a half-time student, and you can't take the deduction if you're claimed as a dependent on someone else's tax return.

If you paid $600 or more of interest to a single lender on a qualified student loan during the year, you should receive Form 1098-E at tax time from your lender, showing the amount of student loan interest you've paid for the year. For more information, see IRS Publication 970.

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Sticker Shock: Creative Ways to Lower the Cost of College Even with all of your savvy college shopping and research about financial aid, college costs may still be prohibitive. At these prices, you expect you'll need to make substantial financial sacrifices to send your child to college. Or maybe your child won't be able to attend the college of his or her choice at all. Before you throw in the towel, though, you and your child should consider steps that can actually lower college costs. Although some of these ideas deviate from the typical four-year college experience, they just might be your child's ticket to college--and your ticket to financial sanity.

Ask about tuition discounts and flexible repayment programs Before you rule out a college completely, ask whether it offers any tuition discounts or flexible repayment programs. For example, the school may offer a discount if you pay the entire semester's bill up front, or if you allow the money to be directly debited from your bank account. The college may also allow you to spread your payments over 12 months or extend them for a period after your child graduates. And if it's your alma mater, don't forget to inquire about any discounts for the children of alumni. Finally, ask if some charges are optional (e.g., full meal plan versus limited meal plan).

Graduate in three years instead of four Some colleges offer accelerated programs that allow your child to graduate in three years instead of four. This can save you a whole year's worth of tuition and related expenses. Some colleges offer a similar program that combines an undergraduate/graduate degree in five years. The main drawback is that your child will have to take a heavier course load each semester and may have to forgo summer breaks to meet his or her academic obligations. Also, some educators believe that students need four years of college to develop to their fullest potential--intellectually, emotionally, and occupationally.

Earn college credit while still in high school By taking advanced placement courses or special academic exams, your child may be able to earn college credits while still in high school. This means that your child may be able to take fewer classes in college, saving you money.

Think about cooperative education Cooperative (co-op) education is a type of education where semesters of course work alternate with semesters of paid work at internships that your child helps select. Although a co-op degree usually takes five years to obtain, your child will be earning money during these years that can be used for tuition costs. In addition, your child gains valuable job experience.

Enroll in a community college, then transfer to a four-year college One surefire way to cut college costs is to have your child enroll in a local community college for a couple of years, where costs are often substantially less than four-year institutions. Then, after two years, your child can transfer to a four-year institution. Your child's diploma will be from the four-year institution, but your expenses won't. Before choosing this route, though, make sure that any credits your child earns at the community college will be transferable to another institution.

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Defer enrollment for a year Your child might be aching to get to college, but taking a year off can give you both some financial breathing room and allow your child to work and save money for a full year before starting college. Your child will apply under the college's normal application deadline with the rest of his or her classmates and, once accepted, can ask for a one-year deferment. But make sure the college offers deferred enrollment before your child goes through the time and expense of applying.

Live at home It's not every child's dream, but attending a nearby college and living at home, even for a year or two, can substantially reduce costs by eliminating room-and-board expenses (though your child will incur commuting costs). This arrangement may work out best at a college that has a student commuter population, because the college is likely to try to meet these students' needs. If your child does live at home, you'll both need to sit down beforehand and discuss mutual expectations. For example, now that your child's in college, it's not realistic to expect him or her to adhere to a rigid weekend curfew.

Consider distance learning Taking courses on-line is a trend that's here to stay, and many colleges are in the process of creating or expanding their opportunities for distance learning. Your child might be able to take a year's worth of classes from home and then attend the same school in person for the remaining years.

Work part-time throughout the college years Part-time work during college can help your child defray some costs, though working during school can be both a physical and emotional strain. To make sure that your child's academic work doesn't suffer, one option might be for your child to focus on school for the first two years and then obtain a part-time job in the remaining years.

Join the military There are several options here. Under the Reserve Officers' Training Corps (ROTC) scholarship program, your child can receive a free college education in exchange for a required period of active duty following graduation.

Your child can apply for an ROTC scholarship at a military recruiting office during his or her junior or senior year of high school. Or, your child can serve in the military and then attend college under the GI Bill. Your child can also attend a service academy, like the U.S. Military Academy at West Point, for free. Be aware, though, that these schools are among the most competitive in the country, and your child must serve a minimum number of years of active duty upon graduation. For more information, visit your local military recruiting office, or speak to your child's high school guidance counselor.

Go to school in Canada Canadian schools generally offer an excellent education at a price comparable to that of an average four-year public college in the United States. And in the global economy, many employers tend to look favorably on studying abroad. Your child will even be eligible for need-based federal student loans (but not grants), as well as the two federal education tax credits--the Hope credit (renamed the American Opportunity credit for 2009 and 2010) and the Lifetime Learning credit.

Check to see if your employer offers any educational assistance Does your employer offer any educational benefits for the children of its employees, like partial tuition reimbursement or company scholarships? Check with your human resources manager.

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Have grandparents pay tuition directly to the college Payments that grandparents (or others) make directly to a college aren't considered gifts for purposes of the federal gift tax rules. So, grandparents can be as generous as they want without having to worry about the tax implications for themselves. Keep in mind, though, that any payments must go directly to the college. They can't be delivered to your child with instructions to apply them to the college bills.

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Education Tax Credits It's tax time, and your kitchen table is littered with papers and forms. As if this isn't bad enough, you recently paid your child's college semester bill, and you don't know where you'll find the money to pay the taxes that you expect to owe. Well, you might finally catch a break. Now that your child is in college, you might qualify for one of two education tax credits--the Hope credit (renamed the American Opportunity credit for 2009 and 2010) and the Lifetime Learning credit. And because a tax credit is a dollar-for-dollar reduction against taxes owed, it's more favorable than a tax deduction, which simply reduces the total income on which your tax is based.

These education tax credits depend on the amount of qualified tuition and related expenses that you pay in a given year, as well as your modified adjusted gross income (MAGI). In 2010, to qualify for the maximum American Opportunity credit, your MAGI must be below $80,000 if you're a single filer and $160,000 if you're a joint filer. A partial credit is available for single filers with an MAGI between $80,000 and $90,000 and joint filers with an MAGI between $160,000 and $180,000. To qualify for the maximum Lifetime Learning credit in 2010, your MAGI must be below $50,000 if you're a single filer and $100,000 if you're a joint filer. A partial credit is available for single filers with an MAGI between $50,000 and $60,000 and joint filers with an MAGI between $100,000 and $120,000.

Hope credit (American Opportunity credit) can help with college expenses The Hope credit (American Opportunity credit) is a tax credit that covers the first four years of your, your spouse's or your child's undergraduate education. Graduate and professional-level courses aren't eligible. The credit is worth a maximum of $2,500 in 2010. It's calculated as 100 percent of the first $2,000 of tuition and related expenses that you've paid for the year, plus 25 percent of the next $2,000 of such expenses.

To take the credit, both you and your child must clear some hurdles: • Your child must attend an eligible educational institution as defined by the IRS (generally, any post-secondary school that offers a degree program and is eligible to participate in federal aid programs qualifies).

• Your child must attend college on at least a half-time basis.

• Your child can't have a felony conviction.

• You must claim your child as a dependent on your tax return. If your child has paid the tuition expenses, you can still take the credit as long as you claim your child as a dependent on your return.

But if your child has paid the tuition expenses and isn't claimed as a dependent on your return, your child can take the credit on his or her own return.

The American Opportunity credit can be taken for more than one student in the same year, provided each student qualifies independently. So, if you have twins who are in their freshman year of college (and you otherwise meet the requirements), your credit would be worth $5,000. However, there are other restrictions. You can't take both the American Opportunity credit and the Lifetime Learning credit in the same year for the same student. And whatever education expenses you cover with a tax-free distribution from your 529 plan or Coverdell education savings account cannot be the same expenses you use to qualify for the American Opportunity credit.

Lifetime Learning credit can help with college, graduate school, and individual course expenses The Lifetime Learning credit is a tax credit for the qualified education expenses that you, your spouse, or your child incur for courses taken to improve or acquire job skills (even courses related to sports, games, or hobbies qualify if they meet this requirement!). The Lifetime Learning credit is much less restrictive than the American Opportunity credit. In addition to college expenses, the Lifetime Learning credit covers the tuition expenses of

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graduate students and students enrolled less than half-time.

The Lifetime Learning credit is generally worth a maximum of $2,000. It's calculated as 20 percent of the first $10,000 of tuition and related expenses that you've paid for the year.

One major difference between the American Opportunity credit and the Lifetime Learning credit is that the Lifetime Learning credit is generally limited to a total of $2,000 per tax return, regardless of the number of students in a family who may qualify in a given year. So if you have twins who are in their senior year of college, your Lifetime Learning credit would be worth $2,000, not $4,000.

As with the American Opportunity credit, if you withdraw money from your 529 plan or Coverdell ESA in the same year that you claim the Lifetime Learning credit, your withdrawal cannot cover the same expenses that you use to qualify for the Lifetime Learning credit.

My child is in college--how do I know which credit to take?

The American Opportunity credit and the Lifetime Learning credit cannot be claimed in the same year for the same student, so you'll need to pick one. Because the American Opportunity tax credit is available for all four years of undergraduate education, is worth more, and the income limits to qualify are higher, that credit will probably be your first choice. But if your child is attending school less than half-time, the Lifetime Learning credit will be your only option (assuming you meet the income limits).

How do I claim either credit on my tax return?

You should receive Form 1098-T from the college, showing the tuition expenses you've paid for the year. Then, at tax time, you must file Form 8863 to take either credit. If you are married, you must file a joint return to take either credit. For more information, see IRS Publication 970 or consult a tax professional.

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Now that my child is in college, am I entitled to any education tax credits?

Answer: You may be. There are two education tax credits--the Hope credit (renamed the American Opportunity credit for 2009 and 2010) and the Lifetime Learning credit. To claim either credit in a given year (you cannot claim both in the same year), you must list your child as a dependent on your tax return. In addition, you must meet income limits. For 2010, a full American Opportunity credit is available to single filers with a modified adjusted gross income (MAGI) below $80,000 and joint filers with an MAGI below $160,000. A partial credit is available to single filers with an MAGI between $80,000 and $90,000 and joint filers with an MAGI between $160,000 and $180,000.

For 2010, a full Lifetime Learning credit is available to single filers with a MAGI below $50,000 and joint filers with an MAGI below $100,000. A partial credit is available to single filers with an MAGI between $50,000 and $60,000 and joint filers with an MAGI between $100,000 and $120,000.

Now, what credit might you be eligible for? The American Opportunity credit applies to the first four years of undergraduate education. In 2010, it is worth a maximum of $2,500. It is calculated as 100 percent of the first $2,000 of your child's annual tuition and related expenses, plus 25 percent of the next $2,000 of such expenses.

One final point: To qualify for the credit, your child must be attending college on at least a half-time basis.

The Lifetime Learning credit is worth a maximum of $2,000 per year. It is calculated as 20 percent of the first $10,000 of your child's annual tuition and related expenses. Unlike the American Opportunity credit, the Lifetime Learning credit is available even if your child is enrolled on less than a half-time basis.

If you are eligible to take the credits, remember that you cannot claim both credits in the same year. As a result, you will need to determine which credit offers you the most benefit in a given year. In this analysis, you must consider an important distinction between the two credits. The American Opportunity credit can be taken for more than one child in a given year, provided each child qualifies independently. For example, if you have two children in college, one a freshman and the other a sophomore, you can take a $5,000 credit on your tax return. By contrast, the Lifetime Learning credit is limited to $2,000 per tax return, even if you have multiple children who would qualify independently in the same year.

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How do I know if I'm eligible for federal financial aid?

Question: How do I know if I'm eligible for federal financial aid?

Answer: The answer is you don't, until you apply. For most parents, even two-income parents, it's difficult to predict who will qualify for financial aid. Some families with incomes of $100,000 or more may qualify for financial aid, while those with lesser incomes may not.

Your current income is the main factor that determines whether your child will qualify for aid, but it's not the only factor. Other important considerations include your assets, the number of children you have in college at the same time, and how many years you have until retirement.

Regarding assets, a common misconception is that all your hard work saving for retirement will count against you come financial aid time. However, the federal government's formula for determining aid eligibility specifically excludes retirement assets from consideration. The federal formula also excludes home equity (in your primary residence only), cash value life insurance, and annuities. Be aware, however, that a college's own institutional aid application may include one or more of these assets.

The rule is "When in doubt, apply." The federal government's aid application, known as the FAFSA, is free, so all that you will lose if you discover your child is ineligible for aid is just a few hours of your time.

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How can my child find scholarships for college?

Question: How can my child find scholarships for college?

Answer: Scholarships are definitely a preferred type of financial aid because they do not have to be repaid. Consequently, they reduce your out-of-pocket costs for college.

There are basically two types of scholarships--those awarded solely on the basis of talent (often called merit scholarships) and those awarded on the basis of talent and financial need. These scholarships can come from two sources--the colleges you are interested in and everywhere else.

First, the easy part. Have your child check with the admissions office at each college he or she is interested in to find out what scholarships it offers. Recently, colleges have tended to offer more merit scholarships, without consideration of financial need, as a way of attracting the best and brightest students. The admissions office may then direct your child to a specific department or contact person, depending on whether his or her talent is musical, athletic, or academic.

Besides the colleges your child is interested in, the scholarship world is wide open. Virtually thousands of scholarships are offered each year by the federal government, individual states, and a wide variety of local, state, and national organizations. Although it is impossible to research them all, a tailored search is possible.

Have your child ask his or her high school guidance counselor or the reference librarian at your local library to recommend an up-to-date scholarship handbook. Better yet, go on-line to one of a number of websites that perform scholarship searches for free. Such websites can save you a tremendous amount of time because they automatically exclude scholarships that don't match your qualifications, background, and interests.

If your child finds a handful of appropriate scholarships, the next step is to follow each one's instructions and apply by the required deadlines. Most scholarships require an essay, a grade transcript, a description of extracurricular activities, and recommendation letters.

Finally, a word of caution. Only a small percentage of the average student's overall financial aid package consists of scholarships. So, while scholarships are certainly worth researching, such research should not be at the expense of filling out the federal government's financial aid form (the FAFSA) or any applicable college or state financial aid forms.

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How do I apply for financial aid?

Question: How do I apply for financial aid?

Answer: You should start by filling out the federal government's aid application--the FAFSA. This application is used by both the federal government and colleges when federal money is being dispersed.

You can obtain a paper FAFSA at your child's high school guidance office, or an on-line version at the Department of Education's website (see below). The earliest date you can file the FAFSA is January 1 of the year your child will be attending college. This is because the FAFSA relies on your family's tax information from the previous year.

To complete the application, follow the instructions in the FAFSA carefully. You may need to gather several documents to complete the FAFSA, similar to preparing your tax return.

Once the information is filled in, a FAFSA can be filed in one of four ways • Mailing it to the regional processing center listed on the paper FAFSA • Filing it electronically through the college your child will be attending (not all colleges have this capability) • Filing it electronically using the U.S. Department of Education's FAFSA Express software, which can be downloaded from the Department of Education's website (www.ed.gov) • Filing it electronically by filling out the FAFSA directly on the Department of Education's website (www.fafsa.ed.gov) Paper FAFSAs take approximately four to six weeks to process; electronic FAFSAs take one week.

Regarding college financial aid, colleges use either their own institutional application or a common type of application known as the PROFILE application. The PROFILE application may duplicate some of the questions on the FAFSA. You will need to find out which application your child's college requires and then submit it by the deadline.

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How does the federal financial aid process work?

Question: How does the federal financial aid process work?

Answer: For the federal government to determine your child's financial aid eligibility, you must first complete its aid application known as the Free Application for Federal Student Aid, or FAFSA. The FAFSA requires specific income and asset information from both you and your child. Independent students do not need to list their parents' information.

A specific formula is then applied that results in a figure known as the expected family contribution, or EFC. This figure is the amount of money your family must contribute to college costs for the year before the federal government awards any financial aid. The difference between the cost of attendance at your child's college and your EFC is your child's financial need.

The federal government notifies you of the amount of your EFC in a document known as the Student Aid Report, or SAR. The SAR is also sent to the colleges that your child has applied to. When your child is accepted at a college, the financial aid administrator at that school attempts to create a financial aid package that will meet your child's financial need. The package will include various combinations of loans, grants, scholarships, and work-study programs. If appropriate, you will be given further information on where to apply for various loan programs.

If you're lucky, your child's financial aid package will meet all of his or her financial need. However, colleges aren't obligated to do so. If a college doesn't meet 100 percent of your child's financial need, you are responsible for meeting this shortfall. In some cases, you may be able to present special personal or financial circumstances to the financial aid administrator in an attempt to increase your child's aid award.

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Are my student loan payments tax deductible?

Answer: The interest portion might be, thanks to the student loan interest deduction. The maximum deduction is $2,500 in 2010. You don't need to itemize to claim this deduction.

To qualify, you must meet two requirements: First, the student loan on which you're paying interest must be one that you incurred to pay college expenses when you were at least a half-time student. This requirement excludes part-time adult learners or other nontraditional students.

Second, you must meet income limits. In 2010, to take the full student loan interest deduction, single filers must have a modified adjusted gross income (MAGI) below $60,000 (below $120,000 for married filing jointly). A partial deduction is available for single filers with an MAGI between $60,000 and $75,000 (between $120,000 and $150,000 for married filing jointly). These income limits are adjusted annually for inflation.

If you paid over $600 of interest to a single lender on a qualified student loan during the year, you should receive Form 1098-E from your lender, showing the total amount of interest you paid for the year. If not, contact your lender to request this information.

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Should I use my 401(k) to fund my child's college education?

Question: Should I use my 401(k) to fund my child's college education?

Answer: You can, but it isn't your best option. Your 401(k) plan should be dedicated primarily to your retirement.

There are two primary drawbacks to using your 401(k) for college funding. First, if you withdraw funds from your 401(k) before you are 59½, you may owe a 10 percent premature distribution penalty on the withdrawal. This penalty is in addition to income taxes you will owe on the withdrawal. Second, frequent dips into your 401(k) reduce the amount of money you ultimately have available to reap the benefits of compounding and tax deferral.

This, in turn, reduces the overall funds for your retirement.

If you really need to use your 401(k) to pay for college, a better option might be to borrow from it if your plan allows loans. Plan loans are not taxed or penalized, as long as you repay the funds within a specified time period.

But make sure you compare the cost of borrowing college funds from your plan with other finance options.

Although interest rates on plan loans may be favorable, the amount you can borrow is limited, and you generally must repay the loan within five years. In addition, some plans require you to repay the loan immediately if you leave your job. Your retirement earnings will also suffer as a result of removing funds from a tax-deferred investment.

If you want to save for college in a retirement vehicle, consider using a traditional IRA or Roth IRA instead. With these IRAs, you will not owe the 10 percent premature distribution penalty on withdrawals you make before age 59½, as long as the money is used to pay your child's qualified college expenses. If you have some time to plan your child's college fund, you might consider a Coverdell education savings account or a 529 plan established and maintained by a state or eligible educational institution. Each of these vehicles is specifically geared to college investors and offers numerous tax advantages.

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What happens if our child's college does not give us all the financial aid we need?

Question: What happens if our child's college does not give us all the financial aid we need?

Answer: You must make up the difference. A common misconception is that if your child qualifies for financial aid, he or she will receive 100 percent of the aid he or she needs. In creating financial aid packages, colleges aren't obligated to meet all of a student's financial need. Colleges have limited financial aid budgets and tend to offer the most aid to those students who meet their specific enrollment goals.

If the college doesn't meet 100 percent of your child's financial need with a combination of loans, grants, scholarships, and work-study programs, you have been "gapped" by the college. You're responsible for meeting this shortfall.

Options to bridge this financial gap include drawing on your own assets (e.g., withdrawing from a retirement account or liquidating stock holdings), applying more of your current income to college costs, or taking out private loans (e.g., a home equity loan) or financial aid loans (e.g., a PLUS loan). In many cases, a combination of these options is used.

If, despite your planning, you have simply no way of meeting the shortfall, you might consider contacting the financial aid administrator at your child's school to discuss an increase in your child's aid package. Follow the specific instructions in your child's financial aid award letter. Generally, your chances of success are best if you can document a specific circumstance that prevents you from meeting the shortfall. Examples of such circumstances may include a recent job loss or prolonged unemployment, unusually high medical bills, or bills incurred while caring for an elderly relative. A general plea of an inability to pay is unlikely to bring results.

Note: In an effort to avoid this problem, make it a priority in your college selection process to research the costs of specific colleges and the amount of financial aid that various schools award. This information can be found in college guidebooks. Then choose only those schools that consistently meet all, or a high percentage, of their students' financial need.

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Can we negotiate our child's financial aid award?

Question: Can we negotiate our child's financial aid award?

Answer: In some cases, yes. If you decide to appeal all or part of the award, follow the instructions in the award letter. In most cases, this will involve a polite business letter to the financial aid administrator (FAA) and a follow-up telephone call or meeting. Because the FAA may handle a number of similar requests, it's important to clearly label your correspondence. You should also be persistent in following up on your request, but not to the point of being a pest.

The FAA has authority to exercise "professional judgment" to reduce the loan component of your child's aid package and/or increase the scholarship, grant, or work-study component. Your chances of successfully renegotiating your child's aid package are best in two situations.

The first situation is if you have any special circumstances that affect your ability to pay your expected family contribution (what the federal government's financial aid form says you can afford) or any additional shortfall (the difference between your child's financial need and what the college offers in its aid package). Examples of special circumstances include the disability of you or your spouse, a recent job loss or prolonged unemployment, unusually high medical expenses, long-term care costs for an elderly relative, or some other situation that puts above-average constraints on your current income and savings. By contrast, a general plea of an inability to pay will likely fall on deaf ears--most parents make financial sacrifices to send their kids to college. If you have a special circumstance, you should provide written documentation to the FAA. The second situation is if your child has been accepted at two direct competitor colleges, and one has offered a more generous financial aid package than the other. This strategy works best with direct competitors. Although many colleges don't care if they lose an applicant to a more (or less) selective college, they generally don't like to lose an applicant to a direct competitor. In this case, you might contact College A and inquire if it could possibly match the amount of grants, scholarships, and/or work-study that College B offers. Of course, your child must have the qualities that College A is looking for.

Underlying your success in either situation will be the principle of supply and demand. Your chances will be best in the years when colleges are vying for limited applicants, as opposed to the years when applicants outnumber the available college slots. Your child's high school guidance counselor should be able to give you an idea of the competitiveness of any particular college year.

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Are there any assets that are not counted for financial aid purposes?

Question: Are there any assets that are not counted for financial aid purposes?

Answer: Yes, assuming you are talking about federal financial aid. Under the federal government's financial aid formula, four main types of assets are excluded from consideration when determining your child's financial need: • All retirement accounts (e.g., IRAs, 401(k)s, 403(b)s) • Home equity in a primary residence • Annuities • Cash value life insurance These assets are known as nonassessable assets. All other assets that belong to you and your child are known as assessable assets and include items like checking and savings accounts, stocks, bonds, mutual funds, 529 plans, Coverdell education savings accounts, custodial accounts, trusts, and investment property. The more assessable assets you have, the more money you will be expected to contribute to college costs before any financial aid is forthcoming.

For example, Mr. and Mrs. Green have a Roth IRA worth $50,000, home equity of $75,000, cash value life insurance of $100,000, and a mutual fund worth $25,000. Under the federal financial aid formula, the Greens are considered to have only $25,000 worth of assets (i.e., the mutual fund).

By contrast, Mr. and Mrs. White have stock holdings worth $50,000, a 529 plan worth $35,000, a Coverdell account worth $15,000, and home equity of $100,000. Under the federal financial aid formula, the Whites are deemed to have $100,000 worth of assets (i.e., stock holdings, 529 plan, and Coverdell account).

Keep in mind that financial aid programs that are funded by individual colleges may use a formula that differs from the one used by the federal government to determine financial need. Specifically, the formula may take into account the value of your retirement accounts and/or home equity, and may even expect you to borrow against these assets.

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Do colleges offer financial aid?

Question: Do colleges offer financial aid?

Answer: Yes, most do. Next to the federal government, colleges are the second-largest provider of financial aid. Such aid can be one of two types: need-based aid and non-need-based aid (also known as merit aid). Though aid based on financial need is more prevalent, a trend in recent years has been for colleges, especially private colleges, to offer more merit aid. This trend stems in part from the flight of top students to less expensive public colleges.

College financial aid most often comes in the form of grants, scholarships, and work-study programs. Grants and scholarships are preferred types of financial aid because they don't need to be repaid. Generally speaking, private colleges have greater endowment funds than public colleges from which to provide financial aid. They're also not as restricted in the manner they choose to spend it. Though private schools are generally more expensive than public schools, an especially generous aid package from a private school can translate into lower out-of-pocket costs compared to a public school.

To determine which students are the most deserving of financial aid, colleges can use either a standard aid application known as the PROFILE or their own institutional application. Most colleges use the PROFILE form.

The main difference between the PROFILE form and the federal government's aid application is that the PROFILE digs deeper into your family's financial background. For example, the PROFILE application may require you to note the value of your retirement accounts and home equity, whereas the federal government's application does not. This is because colleges want to insure that their aid is awarded to the most financially deserving students.

On a side note, colleges also receive money from the federal government that is then distributed as financial aid.

For example, the Perkins Loan program is a federally funded loan program that is administered by individual colleges. Each college receives a certain amount of money for this program and awards the funds on a first-come, first-served basis. Once the funds are dispersed, no more are available until the following year's appropriation. The federal Supplemental Educational Opportunity Grant, known as SEOG, is also administered this way. This should serve as an incentive to submit your application for financial aid as early as possible.

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What are the major federal financial aid loan programs?

Question: What are the major federal financial aid loan programs?

Answer: The three major federal financial aid programs are the Stafford, Perkins, and PLUS Loan programs.

Stafford Loans are available to both undergraduate and graduate students. These loans come in two forms, subsidized and unsubsidized. Interest starts to accumulate immediately after the funds are disbursed, but with a subsidized loan, the federal government pays the interest on the loan while you are in school, during any deferment periods, and for six months after you graduate, leave school, or reduce your course load to half-time.

To qualify for the subsidized loan, you must demonstrate financial need. The unsubsidized version requires no such determination.

For either type of loan, there is a six-month grace period before loan repayment must begin. The interest rate on Stafford Loans issued before July 1, 2006 is variable (adjusted each July) and is capped at 8.25 percent. The interest rate on unsubsidized Stafford Loans issued on or after July 1, 2006 is fixed at 8.25 percent, and the interest rate on subsidized Stafford Loans issued on or after July 1, 2006 is fixed as follows: 6.8 percent for loans first disbursed on or after July 1, 2006 and before July 1, 2008 6.0 percent for loans first disbursed on or after July 1, 2008 and before July 1, 2009 5.6 percent for loans first disbursed on or after July 1, 2009 and before July 1, 2010 4.5 percent for loans first disbursed on or after July 1, 2010 and before July 1, 2011 3.4 percent for loans first disbursed on or after July 1, 2011 and before July 1, 2012 The Perkins Loan is a low-interest, federally guaranteed, and subsidized loan that is available to both undergraduate and graduate students with the lowest expected family contributions. Perkins Loans differ from Stafford Loans in that the school, not the federal government, distributes the money to the students. Each school is given a finite amount of money to distribute among its students. These loans are awarded on a first-come, first-served basis and are based strictly on financial need. Similar to a Stafford Loan, there is a grace period for the repayment of a Perkins Loan.

PLUS Loans are federally guaranteed, unsubsidized loans made to parents with good credit histories who want to help pay for their dependent child's undergraduate education. Graduate and professional students can also borrow under the PLUS Loan program (called GradPLUS Loans). Like the unsubsidized Stafford Loans, PLUS Loans are not based on financial need. Borrowers need only pass a credit check. The interest rate on PLUS Loans issued before July 1, 2006 is variable (adjusted each July) and is capped at 9 percent. The interest rate on PLUS Loans issued on or after July 1, 2006 is fixed at 8.5 percent. PLUS Loans obtained by parents have no grace period; once the funds are dispersed, parents must begin to repay within 60 days of the last disbursement for that academic year. However, graduate borrowers who obtain GradPLUS Loans after July 1, 2008 have a six-month grace period before repayment of such loans must begin.

If you want to be considered for any of the federal financial aid programs, you'll need to fill out a Free Application for Federal Student Aid, or FAFSA. FAFSA forms can be obtained on-line at the Department of Education's website, www.ed.gov. Or, you can contact your local high school, college, or public library for more information.

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Are any financial aid programs tailored especially to parents of post-secondary students?

Question: Are any financial aid programs tailored especially to parents of post-secondary students?

Answer: Although the bulk of financial aid is awarded directly to students, one major federal financial aid program is available to assist parents with their share of post-secondary (beyond the high school level) educational expenses. This program is known as the Parent PLUS Loan.

PLUS Loans are available to any creditworthy parent of a student matriculated at least half-time in an undergraduate degree or certificate program offered by an accredited post-secondary educational institution.

Graduate and professional students can borrow under the PLUS Loan program too (these loans are called GradPLUS Loans). PLUS Loans are not limited for use only at colleges; they may also be used for post-secondary vocational or trade program expenses. These loans may be granted by a private lender or directly by the federal government. Completed loan applications are forwarded by the parent to the financial aid administrator of the student's school for certification and further processing.

The limit that a parent may borrow for any single academic year is the cost of education (which may include tuition, fees, room and board, books, and supplies), minus any other financial aid received. Thus, if the cost of education were $30,000 and the student received aid totaling $10,000, a parent would be eligible to take out a $20,000 PLUS Loan.

The interest rate on PLUS Loans issued before July 1, 2006 is variable (adjusted each July) and is capped at 9 percent. The interest rate on PLUS Loans issued on or after July 1, 2006 is fixed at 8.5 percent. Interest begins accruing upon the first loan disbursement. Disbursements are made directly to the school, usually in two equal installments. Repayment of the loan must begin within 60 days of the last disbursement for that academic year. In some cases, PLUS Loan repayment may be deferred or forgiven; such consideration is usually given only in cases of the parent's death, total disability, or return to school.

Parents would also be well advised to investigate other alternatives, such as employer reimbursement programs.

Some such programs pay reimbursement costs for the educational expenses of the children of the employee.

State employees may find that their family members are eligible for free or reduced tuition at state educational institutions.

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Is there anything I can do now so that my child can obtain more financial aid later?

Question: Is there anything I can do now so that my child can obtain more financial aid later?

Answer: Yes, there are steps you can take now that may help your child obtain more financial aid later. All federally funded financial aid programs use a formula known as the federal methodology to determine how much money a family must contribute toward a child's educational costs before becoming eligible for financial aid. This figure is known as the expected family contribution (EFC). The difference between your EFC and the cost of your child's college equals your child's financial need. The greater your EFC, the lower your child's financial need and the less aid your child will be eligible for.

To determine your EFC, the federal methodology considers the value of your family's income and assets in the calendar year before the year that your child applies for aid. This year is known as the base year. Thus, lowering your income and assets in the base year can lower your EFC and increase your child's financial aid eligibility. It's important to note that these strategies aren't meant to subvert the financial aid rules in any way. Instead, they simply take advantage of the rules regarding what is counted.

To lower your income and assets in the base year, you might try to: • Defer employment bonuses until after December 31 • Sell investments that can be taken as a loss (if they're not expected to recover) • Avoid selling investments that will incur capital gains or interest • Avoid pension plan and IRA distributions • Pay all federal and state income taxes due during the base year (this reduces your available cash--a countable asset--and you're allowed to deduct taxes you paid during the base year on the financial aid application) • Use available cash to reduce outstanding consumer debt or to make large planned purchases In addition to taking steps during the base year to lower your available income and assets, you can take steps several years before the time your child applies for aid. Generally, such strategies work best with your assets.

Specifically, the federal methodology excludes four types of assets from consideration when determining how much your family is expected to contribute to college costs. These assets are home equity (in a primary residence only), all types of retirement plans, annuities, and cash value life insurance. So, all other things being equal, you might consider putting more of your cash in one or more of these vehicles because they aren't counted for financial aid purposes.

One final note: Just because your child is eligible for more financial aid doesn't necessarily mean that more of the aid will be in the form of favorable grants or scholarships. Your child may simply end up with more loans that will need to be repaid at some future date.

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Help! My child is only two years away from college and we haven't saved much. What should we do?

Question: Help! My child is only two years away from college and we haven't saved much. What should we do?

Answer: Your late start means you've missed most of the best opportunities to grow the money you have. With only two years until your child starts college, you'll need to refine the college selection process, accumulate enough of a down payment for the early college bills, and establish a savings plan for the later college years. Here are some constructive steps you can take.

First, help your child investigate schools that provide a good value. Some less expensive state universities and second-tier private colleges may offer better programs than their more expensive private counterparts. Think creatively. Your child could attend a nearby school and live at home for a year or two to save money on room and board. He or she could attend a community college for two years and then transfer to a private four-year college.

Or, your child could consider cooperative education, where semesters of academic work alternate with semesters of paid work. If your finances are severely limited, your child might consider taking a year off before starting college.

Second, learn all you can about financial aid. Do a dry run through the federal government's financial aid application to determine whether your child is likely to qualify for financial aid, and, if so, for how much. For financial aid references, ask a librarian or your child's high school guidance counselor, or conduct a search on the Internet. When you've zeroed in on a few colleges, examine their financial aid statistics. For example, what percentage of students receive financial aid? What percentage of the average package consists of loans? What percentage of a student's financial need is generally met--100 percent? 75 percent? Does the college offer merit scholarships?

Third, start investigating potential scholarships. There are a number of websites where your child can type in his or her interests, abilities, and goals to obtain a list of relevant scholarships. However, outside scholarships generally make up only a small portion of a student's overall aid package, so it's very important that this search be made in addition to, not in place of, the quest for federal and college-sponsored financial aid.

Fourth, examine any current financial resources that you can draw on for the early college bills. Do you have savings accounts, stocks, mutual funds, or cash value life insurance? Can you pay a portion of the tuition bills from current income? Can you increase the family income by getting a second job or having a previously stay-at-home spouse return to the work force? If you're still short, you'll need to investigate a personal loan, a home equity loan, or the federally sponsored PLUS loan, which is tailored especially to parents. In other cases, you may need to tap your retirement accounts, though this is generally recommended only as a last resort.

Finally, you'll need to start earmarking a portion of your current income for college bills that won't come due until four or five years, when your child is a junior or senior in college. Because you'll need the money relatively soon, you should avoid high-risk investments. Instead, choose a low-risk, stable investment, such as a certificate of deposit that is timed to mature when you need it, or a money market mutual fund.

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What is a Stafford Loan?

Question: What is a Stafford Loan?

Answer: Stafford Loans are among the most popular and available of education loans. If you're a graduate or undergraduate student enrolled in an eligible program of study on at least a half-time basis, you can apply for a Stafford Loan. Two types of Stafford Loans are available--subsidized and unsubsidized.

With a subsidized Stafford Loan, the federal government pays the interest on the loan while you're in school, for six months after graduation, and during any approved deferment periods. To qualify for a subsidized Stafford Loan, you must demonstrate financial need. Therefore, not everyone is eligible. Your financial need is based on the income and asset information you supply on the federal government's financial aid application, known as the FAFSA. With an unsubsidized Stafford Loan, you are responsible for paying the interest that accrues during the school year, in the six-month period after graduation, and during any deferment periods. Unsubsidized Stafford Loans are not based on financial need, so they can be obtained by students at all income levels.

Each loan has specific annual borrowing limits. The interest rate issued on Stafford Loans issued before July 1, 2006 is variable (adjusted each July) and is capped at 8.25 percent. The interest rate on unsubsidized Stafford Loans issued on or after July 1, 2006 is fixed at 8.25 percent, and the interest rate on subsidized Stafford Loans issued on or after July 1, 2006 is fixed as follows: 6.8 percent for loans first disbursed on or after July 1, 2006 and before July 1, 2008 6.0 percent for loans first disbursed on or after July 1, 2008 and before July 1, 2009 5.6 percent for loans first disbursed on or after July 1, 2009 and before July 1, 2010 4.5 percent for loans first disbursed on or after July 1, 2010 and before July 1, 2011 3.4 percent for loans first disbursed on or after July 1, 2011 and before July 1, 2012 If you're interested in applying for a Stafford Loan, talk to a financial aid counselor.

One final note: Your lender for a Stafford Loan (subsidized or unsubsidized) can be either the federal government (through the Direct Loan Program) or a private lender (through the Federal Family Education Loan Program). In most cases, you don't choose your lender. Instead, the college will tell you which lender it prefers.

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Can anyone get a Pell Grant?

Answer: No, the Pell Grant is an educational grant that the federal government offers only to those students who demonstrate exceptional financial need. The determination of exceptional financial need is based on the income and asset information you supply on the federal government's financial aid application, known as the FAFSA. The main benefit of a Pell Grant is that it does not have to be repaid. For the academic year 2009/2010, the Pell Grant can range from $976 to $5,350, depending on your financial need. Pell Grants are available only for undergraduates; graduate students are ineligible.

Even if you think that your financial situation may make you ineligible for a Pell Grant, you should apply anyway because many institutions will not consider you for other awards until they know your Pell status.

If you are eligible for a Pell Grant, the school can credit the funds to your account, write you a check, or combine these methods. The school is required to notify you in writing how much you will be receiving.

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Should I withdraw money from my IRA to pay for my child's college tuition?

Question: Should I withdraw money from my IRA to pay for my child's college tuition?

Answer: Assuming that you have a traditional IRA or Roth IRA, you'll want to consider the financial consequences before making a decision. You'll want to evaluate any fund withdrawals based on several factors: • How far away from retirement you are • The size of your retirement fund • The amount of money you intend to withdraw • Whether or not you have other sources of cash available • The tax consequences of a withdrawal Both the traditional IRA and Roth IRA allow you to withdraw money for qualified higher education expenses before age 59½ without incurring the federal 10 percent early withdrawal penalty that normally applies to such withdrawals. However, you'll need to carefully consider the income tax consequences if your contributions to a traditional IRA were deductible. The amount you withdraw will be added to your taxable income for the year you withdraw it. This could be enough to put you in a higher tax bracket. Even if your retirement is years away, you'll need to consider the impact of the withdrawal on your retirement plans. However, you may have time to reconcile the loss and perhaps even compensate for it by increasing your payback after any withdrawal (subject to annual contribution limits).

If your retirement is close, you'll need to look carefully at the impact of any withdrawal on your retirement plans.

Consider the size of the withdrawal, potential tax concerns (your withdrawal may be subject to taxes), and your ability to recover from the loss through other retirement assets, if any. If the IRA is your sole retirement fund, you'll want to investigate alternatives (e.g., financial aid such as grants and federal loans, personal loans) before withdrawing money. After all, a large withdrawal close to your retirement could cripple your plans.

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Can a grandparent pay a grandchild's tuition directly to the college without any gift tax problems?

Answer: Yes. The general rule is that any gifts over the $13,000 (in 2010) annual gift tax exclusion from one person to another are subject to federal gift tax and generation-skipping transfer tax (GSTT). However, an exception to this rule exists for certain tuition payments. Specifically, any tuition payments made by a grandparent (or anyone else) directly to a qualifying educational organization (e.g., a college) to cover a student's tuition expenses are exempt from federal gift tax and GSTT, even if such payments exceed the annual gift tax exclusion. The key is that such payments must be made directly to the qualifying educational institution. You will not qualify for the exemption if you gift the money directly to the student with instructions to apply it to tuition expenses. The unlimited exclusion does not cover books, supplies, or room and board expenses.

This type of gift may still be subject to state gift tax and/or GSTT. Call a tax attorney in your state for more information.

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I'm having trouble paying my student loans. What should I do?

Question: I'm having trouble paying my student loans. What should I do?

Answer: The first thing you need to do is to make your lender aware of your situation. Other options are available to you, but confronting the problem is probably the most beneficial thing you can do.

You can temporarily postpone your loan repayment by requesting either a deferment or forbearance from your lender. Although they are often seen as the same, deferment and forbearance are different options.

With a deferment, your lender grants you a reprieve from your loan payments based on a specific condition such as unemployment, a temporary disability, a return to school, or a similar situation. Your lender can tell you which conditions qualify for deferment. In most cases, the government pays the interest on your loan so the balance does not increase during the deferred period.

With a forbearance, your lender grants you--at its discretion--permission to reduce or stop your loan payment for a period of time. Interest continues to accrue on your loan, and you'll still have to pay off both the accrued interest and the loan when you resume your payments. Although a deferment is preferable, a forbearance is often easier to get because it's not governed by the type of your loan or the date you obtained it.

Deferments and forbearances are usually granted for a six-month period. There is usually a limit to the number of times they are granted during the course of your loan. You'll need to apply for them with the appropriate paperwork from your lender. You may also need to reapply periodically to maintain your eligibility.

You can also try to have your student loan permanently canceled. This means that you don't have to repay it at all because of a specified condition. The loan is permanently removed from your financial obligations. Like a deferment, a cancellation is based on the type and time of the loan in question. However, cancellations don't come easily. They usually involve the borrower's death or permanent disability, or periods of public service such as teaching in needy areas.

If you can't negotiate for a reprieve with your lender, you'll be in default on your student loans. It is important to note that the government now tracks defaults, and this nonpayment can have a negative impact on your future.

As a final alternative, you might be able to declare bankruptcy. However, not all student loans can be discharged through bankruptcy, so you'll need to find out if yours can be discharged this way. Keep in mind that bankruptcy is a serious matter and should not be entered into lightly. Talk to a financial professional for more information.

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What expenses are included in the annual cost of college?

Question: What expenses are included in the annual cost of college?

Answer: To most parents, the annual cost of college simply refers to tuition and room and board. To the federal government, however, the annual cost of college means the cost of attendance. Twice per year, the federal government calculates the cost of attendance for each college (over 3,000 of them), adjusts the figure for inflation, and, if your child is applying for financial aid, uses this number to determine your child's financial need.

Five categories of expenses are used to determine the cost of attendance at a particular college: • Tuition and fees: Usually the same for all students • Books and supplies: Can vary by student, depending on your child's courses and his or her requirements • Room and board: Can vary by student, depending on the meal plan your child selects and whether he or she lives on or off campus • Transportation: Can vary greatly by student, depending on where your child lives in relation to the school • Personal expenses: Can vary by student (e.g., health insurance, pizzas, telephone bills) In the last four categories, the federal government sets a monetary figure even though the exact expenses incurred will depend on the individual student. Thus, depending on these variables, your child's actual cost may be slightly higher or lower than the cost used for official purposes like financial aid determinations.

If you're interested in obtaining the monetary amount allotted to each category for a particular college, contact that college directly.

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Are there any ways to lower the cost of college?

Question: Are there any ways to lower the cost of college?

Answer: You can lower the cost of college in a number of ways. The deciding factors in achieving your cost goals may be limited only by your flexibility.

The primary way to lower the cost of college is to choose a less expensive school. You may find that excluding prestigious colleges significantly lowers the bill with little or no impact on the quality of your child's education.

Less expensive private schools and state universities often have stronger offerings in certain programs than their more prestigious private counterparts, and may offer smaller class sizes. Local colleges also offer the opportunity to live at home, which can minimize room-and-board expenses. Be aware, however, that this choice might require the purchase of a car in addition to commuting costs.

As a creative alternative, your child could enroll in a less expensive institution (e.g., a state or community college) and then transfer to the college of his or her choice after two years. Your child's degree would be from the preferred college, but the total cost would be reduced by the two years you spent paying lower tuition and fees.

You can also check to see if the schools your child wishes to attend offer accelerated programs or special academic exams. Accelerated programs offer the chance to graduate in three years, allowing you to save a year's worth of college expenses. Special academic exams offer the opportunity to earn college credits even before your child enters college. This can also cut down on the required course load and consequent expenses.

You can also investigate government military programs. Your child's options include attending a service academy, enlisting in the military first and then attending college under the GI Bill, and training for the military while in school under the ROTC program. Although such programs all offer benefits, each has specific service requirements that you should understand thoroughly.

Finally, you should investigate all possible sources of financial aid. Your child might obtain a student loan or enroll in a work-study program. None of these options actually lowers the cost of attendance, but they will diminish the bite college expenses take out of the family budget.

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How will I ever pay off my student loans?

Question: How will I ever pay off my student loans?

Answer: As the cost of post-secondary education continues to increase and you take on further student loan indebtedness to pay for it, you may feel as if you are leaving the ivory tower with a mortgage on your back. You may be surprised to discover that some or all of your indebtedness can be forgiven if you are employed in certain public-service sectors, teach in teacher-shortage areas, or go into the Peace Corps.

If these choices aren't available to you, you must find a way to budget for your student loan payments. Review your household income and expenses. Can you reduce your spending on entertainment, luxuries, and discretionary items? If so, you can divert these saved funds toward monthly principal prepayment of your student loans, thus shortening the overall repayment term and saving on interest charges. You are always permitted to prepay the principal of student loans, partially or in full, without penalty.

Would consolidating your loans or refinancing your loans make the payment schedule easier? Check with your current lender to see what options you might have.

Are you in a position to take on a second, part-time job? The income from this job could be used to reduce your student loan indebtedness. Can you devote a tax refund, gift money, or inheritance to principal prepayment?

Even infrequent payments of this sort will ultimately reduce your loan balance and save you both time (repaying the debt) and money (the interest on the debt).

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Can I refinance my student loan?

Question: Can I refinance my student loan?

Answer: Generally, the standard repayment option for student loans involves a fixed monthly payment for a 5- to 10-year term. With increasing tuition costs, however, it's possible you may graduate with student loan payments that are simply unaffordable. Moreover, if you have multiple student loans, you may be required to make several different monthly payments to different loan servicers. Consolidation of your loans may thus make your debt more manageable.

You can consolidate your federally subsidized student loans through a variety of programs. The process pays off your existing loans with a single new loan. Most consolidation programs offer a variety of repayment options. You can choose an extended payment option, a graduated payment option, or (in some cases) an income-sensitive repayment option.

An extended payment option allows the term for repayment to be as long as 30 years. Although this can dramatically lower your monthly payment, it can also dramatically increase the total cost of the loan. The interest rate may be higher, and interest charged on any unpaid principal will continue to accrue for a longer period of time. However, as with all consolidation programs, you can make prepayments against principal at any time without penalty.

A graduated payment option starts off with lower monthly payments that increase over the term of the loan.

Theoretically, as your income increases, you are better able to afford the higher payments.

An income-sensitive repayment option ties your monthly payments to your income level. The higher your income, the higher the required payment. Conversely, if your income drops, the required monthly payments may be reduced. This option requires you to allow the lender access to your federal tax return information.

Of course, you are always free to explore other refinancing options, such as an equity loan or a loan against a retirement plan. However, you should explore carefully the advantages and disadvantages of these options before pursuing any one of them.

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Should I pay off my student loans early with a home equity loan?

Answer: Generally, the earlier you can pay off your student loans, the better off you'll be. You'll save interest and improve your debt-to-income ratio, a factor lenders consider when deciding whether to offer you credit, and your good payment record will be positively reflected in your credit history and credit score.

If you're a homeowner, you may want to consider paying off your student loans with the proceeds of a home equity loan. There are advantages and disadvantages to this alternative, and you'll need to analyze the financial consequences before you decide.

One advantage is that home equity loans often have longer terms than student loans, which may make your monthly loan payments lower. This can improve your debt-to-income ratio. In addition, if you itemize deductions on your federal income tax return, you may be able to deduct all the interest you pay on your home equity loan.

On the other hand, interest rates for home equity loans are often higher than those for student loans. And whether you itemize or not, you're allowed to deduct from your taxable income a portion of the interest you pay annually on your student loan (up to $2,500 if your modified adjusted gross income is under $60,000 for single filers, or $120,000 for joint filers in 2010).

Finally, keep in mind that student loans are unsecured debts, whereas your residence secures a home equity loan. If you can't meet your student loan payments, you may go into default and undermine your good credit record, but if you default on a home equity loan, you could lose your home to foreclosure.

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Is student loan interest deductible?

Answer: You may be able to deduct all or part of the student loan interest you've paid during the year, assuming you meet the requirements. You may be able to deduct up to $2,500 each year from your gross income if you've paid interest on a qualified education loan for qualified higher education expenses during the year.

To be eligible for the deduction, your modified adjusted gross income (MAGI) must fall below a threshold figure.

The deduction begins to phase out as your MAGI exceeds $60,000 if you're single or $120,000 if you're married and file jointly. It phases out completely when your MAGI exceeds $75,000 ($150,000 for married persons filing jointly). These amounts are indexed for inflation. No deduction is allowed if your filing status is married filing separately.

Generally, a qualified education loan is a debt you incur to pay qualified higher education (undergraduate and graduate) expenses for yourself, your spouse, or a dependent at an eligible educational institution in a program that leads to a degree. The IRS provides specific requirements regarding the definitions of both an eligible educational institution and qualified higher education expenses. To qualify for the deduction, you must have been enrolled in the institution at least half-time at the time of the loan.

If you are claimed as a dependent, you may not take the deduction. If you are a dependent and your parent borrows money to pay for your college tuition, he or she may claim the student loan interest deduction.

For additional details, see IRS Publication 970 and/or consult a tax professional.

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Are scholarships and grants subject to federal income tax?

Question: Are scholarships and grants subject to federal income tax?

Answer: That depends on several factors. If you are a candidate for a degree at an educational institution and receive a qualified scholarship or fellowship that you use for tuition, fees, and required expenses (e.g., books, supplies, and equipment), you need not include the scholarship amount in your taxable income. (Note: the IRS has provided specific guidance regarding the definitions of educational institution and degree candidate.)

However, if your scholarship includes money for room, board, and other incidentals, those dollars are taxable. If you are not a candidate for a degree, your entire scholarship is taxable. If you receive a grant in exchange for performing required services for the school (e.g., working as a teaching assistant), the amount of the grant is generally taxable.

Note: Different rules may apply to tuition reductions and reimbursements.

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What are the Hope credit and the Lifetime Learning credit?

Answer: The Hope credit (renamed the American Opportunity credit for 2009 and 2010) and the Lifetime Learning credit are tax credits for taxpayers who pay certain higher education costs. These credits depend on the amount of qualified tuition and related expenses you paid in a given year, as well as the level of your modified adjusted gross income (MAGI). The credits are available for qualified education expenses that you, your spouse, or your dependent incur at an eligible educational institution. The IRS has provided specific guidance regarding the definitions of eligible educational institution and qualified expenses.

The American Opportunity credit is worth up to $2,500 per student for qualified tuition and related expenses incurred during the first four years of post-secondary education. The credit does not apply to graduate or professional-level courses. To qualify, you must be enrolled in a degree or certificate program at least half-time, and you must not have a felony drug conviction. The credit is available for each eligible student in the household.

The credit is calculated as 100 percent of the first $2,000 of qualified tuition and related expenses, plus 25 percent of the next $2,000 of such expenses. A portion of the credit may be refundable (for 2009 and 2010, you may be able to have a portion of the credit refunded to you if total tax credits exceed total tax liability.)

The Lifetime Learning credit is worth up to $2,000 per year for qualified tuition and related expenses incurred for course work at eligible educational institutions. You need only be enrolled in one or more courses to qualify. The credit is also available for graduate and professional-level courses. Furthermore, courses related to sports, games, or hobbies may qualify if they are part of a course of instruction to acquire or improve job skills. The Lifetime Learning credit is equal to 20 percent of the first $10,000 of your qualified tuition and related expenses, up to a maximum credit of $2,000 per tax return.

The maximum American Opportunity tax credit is available to single filers with a MAGI below $80,000 and to joint filers with a MAGI below $160,000. A partial credit is available to single filers with a MAGI between $80,000 and $90,000 and to joint filers with a MAGI between $160,000 and $180,000. The maximum Lifetime Learning tax credit is available to single filers with a MAGI below $50,000 and to joint filers with a MAGI below $100,000. A partial credit is available to single filers with a MAGI between $50,000 and $60,000 and to joint filers with a MAGI between $100,000 and $120,000. These credits are not available to you if your filing status is married filing separately.

Be aware that you cannot claim both credits for the same student in the same year. For additional information, see IRS Publication 970 or consult a tax professional.

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