Saving on Kid’s College Costs by Retiring Early

As a parent of 2 small children I consider helping to cover their college expenses as one of the largest barriers to being able to retire early and achieve financial independence. I started my career saddled with roughly $70,000 of student loan debt so I fully understand the stress that being in that position creates. I also appreciate that being responsible for your own education and the costs associated with the choices you make on what school to attend, can be a good springboard into being a responsible and accountable adult. Based on both of these points, I’ve decided to strive for a compromise which is to help minimize the college cost liability for my children and then make them accountable for managing these reduced cost options.

Financial Aid Process

Anyone who researches “college costs” or “financial aid” will immediately become familiar with the Free Application for Federal Student Aid (FAFSA). The FAFSA is the form used by the US Government that takes financial information from the prospective or current college student and their parents to determine their need for financial aid. This aid can be made up of loans, grants and/or work study depending on the calculations. Once a family completes the FAFSA, they will be provided a Student Aid Report (SAR) which contains an overview of the types of aid available to the student as well as the family’s Expected Family Contribution (EFC).

1st Strategy

The Expected Family Contribution is, as it sounds, the amount that a family is expect to contribute to the costs of college. The lower the EFC is, the lower amount the family will have to pay for college. The way the EFC is calculated changes slightly from year to year, but it looks at family income and assets to determine their ability to pay. Any assets or income which are in the student’s name are considered at a much higher rate than those in the parent’s name. This is the basis for the most prevalent strategy to reduce the EFC which is to minimize any assets in the student’s name. By shifting or keeping assets in the parent’s name these assets will have a lower expected contribution rate.

2nd Strategy

The 2nd most used strategy to reduce the Expected Family Contribution is to strategically allocate assets held by the parents. This strategy is effective because the FAFSA only includes certain types of assets and others are completely excluded from consideration. The two biggest asset classes which are excluded from the calculation are the value of the primary residence of the family as well as any retirement accounts the parents have. Since these are excluded, a family could contribute more to retirement accounts or pay down the mortgage on their house to decrease the assets which will be considered when calculating the EFC. This can be especially effective if the family has a significant amount of cash sitting in savings or checking accounts as all of these funds would be considered as available assets in the calculation.

3rd Strategy

The last generally recommended strategy is to try to minimize any large one time increases in parent income during the years when requesting financial aid. This is obvious because that jump in income will increase the Expected Family Contribution. However, I wanted to investigate what would happen if the opposite were true. What would happen to my EFC if my income dropped significantly because I retired early before my children entered college? **One quick note before we get into the details of the comparison. The income considered on the FAFSA is from previous years so if you plan to employ this strategy please ensure that you account for these timeline details as you execute the plan.**

Scenarios

To investigate this strategy I compared the Expected Family Contribution between maintaining working during my children’s college years and retiring early before they enter college. I used my current income/expense numbers for the “Working” scenario and used some lifestyle cost assumptions when building the “Retire Early” scenario. All of the details of the scenarios are listed below.

Working
Adjusted Gross Income: $100,000 (From $125,000 income)
Savings/Checking/Brokerage Accounts: $100,000
Retirement Accounts: $500,000 (Not Considered on FAFSA)
Primary Home Equity: $200,000 (Not Considered on FAFSA)
Remaining Mortgage: $100,000

Retire Early
Adjusted Gross Income: $30,000 (From investments and savings)
Savings/Checking/Brokerage Accounts: $200,000
Retirement Accounts: $600,000 (Not Considered on FAFSA)
Primary Home Equity: $200,000 (Not Considered on FAFSA)
Remaining Mortgage: $100,000

Running the Numbers

In order to evaluate these scenarios I used a very handy EFC Calculator from The College Board that gives a good estimate to the actual calculation. The calculator can be found at the following link.

Expected Family Contribution Calculator

When I plugged both of the scenarios into the EFC Calculator I got the following results for the Expected Family Contribution:

Working: $19,685 (Ouch)
Retire Early: $5,121 (Much Better)

Analysis

That is a reduction of $14,564 or 74%. The most impressive part is that difference represents the savings for only one year. Depending on how many years my two children are in college this could add up to almost $100,000 in total EFC savings. The main reason for this drastic reduction is due to the difference in how income and asset are considered. When determining the Expected Family Contribution the government runs each family’s income and assets through a calculation which generates the Adjusted Available Income (AAI). The silver bullet is that this calculation only uses 12% of considered assets (again this doesn’t include primary home equity or retirement accounts) in the Adjusted Available Income. However, 100% of Total Income is included in the AAI. So even included assets are calculated much more favorably than current year income. This discrepancy is the key to why retiring early has such a positive impact.

Closing Thoughts

Now some will notice that the “Retire Early” scenario has $200,000 in additional savings compared to the “Working” scenario. I added this into the “Retire Early” assumption because I estimate I will need assets of that size if I use the 4% rule to support my lifestyle costs while being retired. Since I have 15 years until my first child enter college this would mean I would have to save an additional $600 per month assuming a 7% rate of return. This is a significant amount of money, but it also comes with $100,000 in college expense savings. So looking at this another way, if I was going to plan on paying for the full amount of the larger Expected Family Contribution I would have had to save half the amount anyway. Also, in the “Retire Early” scenario I get to keep all of this additional savings and use it to retire years earlier. To me this is one more extremely compelling reason to aggressively continue down the road toward Financial Independence.

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