Saving for College: What I Did Right and What I’d Do Differently

It’s a special time of year for the parents of college students. Our kids are home for winter break! Well, that, and it’s time to take an inventory of our finances so that we can fill out aid applications for next year.

My husband and I are participating in the latter annual event for the second time. As we do, I stopped to reflect on our approach to saving for college up to this point.

What we did right:

• Put our 401(k)s first.
• Took advantage of 529 savings plans second.

What we might have done differently:

• Held on to our low-interest-rate mortgage.
• Scrimped more to save more for college.

Filling Out the FAFSA and the CSS Profile

The Free Application for Federal Student Aid form helps determine a student’s financial aid for the following school year—in other words, filling out FAFSA in late 2023 affects aid granted for the 2024–25 school year. The form is usually available on Oct. 1, but this year it was delayed until December; families were still waiting on it as of midmonth. That’s because the U.S. Department of Education is revising the application. The goal is to both simplify the process and expand aid eligibility for lower-income families.

The changes might mean less aid for some families, however. For example, the formula no longer takes into account the number of siblings in college, and it now considers the value of family farms and small businesses as assets. Although the form is still unavailable, you can use this Department of Education tool to estimate your family’s Student Aid Index for the 2024–25 award year. (The SAI is replacing the Expected Family Contribution calculated in previous years.)

Even if you suspect you aren’t going to come out ahead, you should still fill out the FAFSA. Your student may not be eligible for need-based financial aid but may still qualify for other scholarships—and many schools require the FAFSA for consideration even for merit aid grants.

You may also have to complete the College Board’s College Scholarship Service Profile. This profile is used by many private colleges and universities, and some public ones, to award nonfederal need-based aid. And like the FAFSA, a CSS Profile is often a prerequisite for consideration for merit-based aid as well. (Unlike the FAFSA, the CSS Profile is free only for families who make up to $100,000 a year, and in a few other circumstances.) While each school that uses CSS Profile information applies its own standards, this calculator estimates what your family might be expected to pay.

Retirement Savings First, 529 Plans Second

My husband and I continued maxing out our 401(k) contributions after we had children, even though that sometimes meant saving less in the kids’ college funds. We haven’t regretted that decision. Retirement account balances aren’t factored into FAFSA calculations. And while they are a line item on the CSS Profile, schools that receive this information generally don’t expect these savings to go toward tuition.

“Pay yourself first” is, of course, a financial-planning truism. But it is truer than ever with the retooled FAFSA. While the FAFSA never penalized families for retirement account balances, it did factor that year’s pretax retirement account contributions into a family’s income before calculating the Estimated Family Contribution toward college costs.

The new application will not consider pretax retirement contributions as income available to be used for college in the SAI calculation. This is a boon to middle-class families juggling what may be the two biggest expenses of their lifetime: retirement and college tuition.

After our 401(k)s came 529 plans for each child. One argument against 529s is that there are tax penalties if the money withdrawn is not used for postsecondary education. What if your child, the plan beneficiary, doesn’t go to college? The 529 savings can be used for accredited trade schools instead. Or you can change account beneficiaries to a sibling or another family member, which the IRS defines expansively to include in-laws, cousins, and nieces and nephews. As funds can remain in a 529 account indefinitely, they might even go to your grandchildren someday.

The risk of needing to make unqualified withdrawals from our kids’ 529 plans seemed low. Meanwhile, we live in Illinois, which has a flat income tax rate of 4.95%. Our contributions would be exempt from state taxes. That’s a nice guaranteed return, particularly when interest rates were at historical lows. (In Illinois, you can deduct up to $10,000 a year as a single filer, and $20,000 for married filers.) And while contributions aren’t exempt from federal taxes, earnings are if withdrawn for qualified expenses. That advantage applies even if you live in a low- or no-tax state.

On Second Thought: Our Biggest College Savings Mistake

We paid off our house when interest rates were low. It felt great at the time, but we also gave up a sweet deal when we paid off our sub-4% home loan. We’d likely be better off with more liquid investments on hand today.

Even paying off a higher-rate mortgage might be a mistake if using cash to pay off the home loan means your family ends up taking out more in student or parent loans. These loan rates are almost always higher than fixed-rate mortgage debt because they aren’t secured by an asset. (If you don’t pay, the lender can’t repossess your degree and sell it.)

What’s more, home equity might work against you in the financial aid analysis. While the FAFSA doesn’t ask for this data point, the CSS Profile does. Some schools may leave it out of the equation when calculating aid, but others will count home equity, or a portion of it, as an asset to be tapped. That is, you may be expected to use a percentage of the value of your home equity toward college costs each year.

The catch is that home equity is much less liquid than cash or most other investments. If you are expected to contribute a percentage of your home equity and don’t have liquid assets on hand to cover the amount, you might end up taking out a home equity loan. And that loan might be at a higher rate than your original mortgage.

Don’t Sacrifice the Present, but Do Save for the Future

Our retirement savings were sacrosanct, but we didn’t maximize our college savings come what may. Sometimes we had bigger priorities than saving for college. We don’t regret splurges like our family vacation with cousins and grandparents in Europe the year before COVID-19 hit. That said, we could have done better.

Some will argue that savings work against you when it comes time to apply for financial aid. Sure, it can feel like you’re penalized for frugality. We’ve joked that we should have bought nicer cars over the years and traded for new models more often. But we aren’t really interested in gaming the system—and even if we were, parents are not expected to contribute an inordinate percentage of their savings each year. The FAFSA currently uses a sliding scale capped at 5.64% of parents’ savings each year, which includes 529 plans for dependents. (Students are generally expected to contribute 20% of their own assets each year.)

Current income is what really moves the needle on the financial aid calculation. Even middle-income families are to expected fork over a surprisingly large percentage of that income every year. (The range is currently 22% to 47% of income above a modest adjustment; cost of living is not taken into account.) That means the more you save now, the less your family may need to borrow later.