How to Pay College Bills Not Covered by Financial Aid

January 18, 2017

Worried about paying college bills? Considering that the average balance in a 529 college savings plan is only $21,000, it’s no surprise that one of the most frequently asked questions we get at Financial Finesse is, “How should I pay for my kids’ college?” Here are some ideas, along with the benefits and pitfalls of each.

529 College Savings Plans

529 plans have become the most popular way for parents to save for future college expenses due to the tax advantages of both tax-free growth (as long as funds are used for qualified expenses) and in some cases, state income tax deductions for contributions.

Pros: They offer tax advantages, ease of saving, and have less of an effect on financial aid than savings in the child’s name.

Cons: They must be used for qualified education expenses to avoid a 10% penalty plus taxation of withdrawals. Funds held in a grandparent’s or other non-parent’s name are treated as income in the year distributed, which can affect future years’ applications for aid.

UTMA/UGMA Custodial Accounts or Other Savings in Your Child’s Name

Any account in your child’s name, even their own savings from summer jobs, will have the greatest impact on the availability of aid. If these assets are intended to be spent on college anyway, consider transferring them into a 529 plan to reduce the impact. Otherwise, spend what you’re going to spend from these accounts first to lower that impact.

Pros: Any capital gains from the sale of investments are treated as income to your child instead of you (beware kiddie tax rules though) and funds can also be used for things like a new laptop for school or eventually, your child’s first home or wedding.

Cons: 20% of the value is counted in aid formulas, potentially reducing the amount offered to your child. Once your child reaches the age of majority in the state where they are going to school, they’ll have unfettered access to the funds.

Taxable Investment Accounts

Any investments you own outside of retirement accounts are included in the financial aid formula and should be spent before dipping into retirement savings. If you have to sell investments for a gain, consider gifting them to your child first so that they could potentially pay a lower capital gains rate than you would. Doing this right before your child enters college, but after you’ve counted it as your asset on the FAFSA, nets the best benefit in terms of how it affects financial aid as the income won’t come into play until your child’s junior year package. However, if your investments are at a loss, keep them in your name to reap the benefit of up to $3,000 per year of capital losses.

Pros: There are possible tax benefits but no early withdrawal penalty.

Cons: Taxable gains could affect future aid offerings.

Home Equity

As long as interest rates stay low and you are able to deduct any interest paid on a home equity loan or line of credit, you may consider tapping this source if it’s available rather than having your child take out higher rate student loans. Of course you’ll be on the hook to pay it off even if your kid drops out mid-semester, but that’s a different kind of planning conversation to have with your child.

Pros: They have relatively low interest rates and there’s a potential income tax deduction for interest.

Cons: Your home is now collateral for your child’s education whether they graduate or not.

401(k) Loan

Rather than requesting a hardship withdrawal from your 401(k), which would incur income taxes and possibly an early withdrawal penalty if you’re under age 59 ½, borrowing from your 401(k) may be an option worth considering.

Pros: There’s no credit check, you pay yourself back the interest, and they generally have lower interest rates than student loans.

Cons: Your plan most likely limits the amount you can borrow to the lesser of $50,000 or 50% of your vested account value and you typically have to pay it back in 5 years or less. If you leave your job, you may also be on the hook for any balance due or risk negative tax consequences.

IRAs

Traditional and Roth IRAs allow penalty-free early withdrawals for qualified education expenses, although you’d still have to pay taxes on any traditional IRA withdrawals and any growth in your Roth IRA.

Pros: You don’t have to pay it back and there are no penalties for early withdrawal. Roth IRAs also let you withdraw up to the total amount of contributions without any tax consequences, so you could leave any growth in the account to continue growing for your retirement.

Cons: You can’t pay the money back as you’re still limited to annual contribution limits and most likely, you will have to pay income taxes on withdrawals unless you’re just using your Roth IRA contributions.

Student Loans

At the end of the day, you may need to ask yourself if you should even be contributing much at all, particularly if doing so would compromise your ability to retire at a reasonable age. As our CEO Liz Davidson likes to say, they don’t give out loans for retirement and you can’t “work through” it either. I also like to remind parents that sacrificing retirement so that your child can graduate debt-free may be a great way to negate the possibility that they’ll end up back at home sleeping on your couch, but it could mean that one day you’ll find yourself sleeping on THEIR couch.

Student loans are there for a reason (and no, they’re not “financial aid,”) and have provisions in place to account for the fact that your child may not be earning a ton of money right out of school or they may face difficulty in finding a job after graduation. Help your child reduce these chances by helping them choose a lucrative major. Then consider this college funding plan that many of my friends are choosing for their own children: they plan to fund about half of their kids’ educations on a semester-by-semester basis and expect their child to fund the other half either through working, loans, work-study programs or whatever means work for their student. This method worked to keep them motivated to do well and graduate on time and the hope is that it will serve the same purpose for their children.

 

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How Can You Maximize Financial Aid Eligibility?

October 13, 2016

As children apply to colleges this fall, many parents are wondering how they will afford to pay those upcoming bills for tuition, room and board, and books and other supplies. While a lot of what determines your child’s eligibility for aid is out of your control, there are some things you can do to maximize how much aid they can get. Let’s take a look at some of the factors affecting eligibility:

Student Income: The biggest factor is student income which reduces aid by about 50% (over a $6,250 allowance). Most students don’t have much income to report, but be careful of taking money out of 529 plans that are not in the name of you or your child because withdrawals from plans owned by grandparents or other friends or relatives are counted as income to the child. Instead, they may want to wait and use that money for the last year of school after the aid has already been awarded.

Parental Income: Your eligible income reduces aid by 22-47%, with higher reductions typically for household incomes above $50k. It’s based largely on AGI so contributions to pre-tax retirement accounts and HSAs can reduce the eligible income. Many people don’t realize that this income also includes asset sales and withdrawals from retirement accounts. Try to take capital gains before your child’s sophomore year of high school or after their junior year of college or look for investments you can sell at a loss. If you want to use an IRA for education expenses, use it for the last year like a non-parental 529 plan.

Student Assets: Assets in your child’s name can reduce financial aid by about 20%. This is a downside of UGMA/UTMA accounts. One exception is for money in a custodial 529 or a Coverdell Education Savings account so consider moving the child’s money into one of those accounts (plus the earnings are tax-free if used for qualified education expenses). Otherwise, try to spend it as early as possible so it will count against fewer years.

Parental Assets: This only reduces aid by about 5-6%. Retirement accounts don’t count against you and debt won’t reduce your countable assets so it’s one more reason to contribute to retirement accounts and pay off debt.

Your child’s financial aid eligibility isn’t necessarily set in stone. The financial aid impact of your decisions can matter as much or even more than the tax impact. If you’re unsure how to do this, you may want to consider consulting with a qualified and unbiased financial planner.

 

 

Celebrate 529 Day this Thursday, 5/29

May 27, 2014

This Thursday is 529 College Savings Day, a day to raise awareness about the value of planning ahead for college expenses with 529 plans. The general theme is: Don’t panic, plan. Any amount saved in advance can lower amounts that may need to be borrowed for college, trade or technical school down the road.  Continue reading “Celebrate 529 Day this Thursday, 5/29”

Common Myths About 529 Plans

April 22, 2014

For my grandson’s upcoming first birthday, I mentioned to my daughter-in-law that we might invest in a Pennsylvania 529 college savings plan as our gift. She was a bit concerned since my stepson and his family are Maryland residents, not Pennsylvanians, and would that mean that he’d have to go to a PA school? The reality is that the 529 funds can be used at any college across the country and even accredited schools abroad so her fear was unfounded. My grandson will have the ability to use the money for any college of his choosing and by opening the PA 529 plan, we get the benefit of up to a $14,000 state income tax deduction and the advantage of Vanguard investment options. Continue reading “Common Myths About 529 Plans”

The Cost of Raising My Colt

April 30, 2013

As a little girl, I dreamed of owning my own horse. My favorite book was Misty of Chincoteague and I even subscribed to Horse of Course magazine. I would beg my parents to get me a colt or pony but since they knew the ongoing expense, I would never get my wish.  According to petplace.com, it can cost about $10,000 a year to keep a horse, including boarding, vet bills, feed, etc.  The average lifespan of a horse is around 25 years so you can do the math and see that it would be VERY expensive. Continue reading “The Cost of Raising My Colt”

Tax Planning for 2013 Begins Now

April 24, 2013

Just because tax season is over doesn’t mean your tax planning is done.  Whether you owed the IRS money or got money back, tax planning is something you can do all year.  Consider these tax tips: Continue reading “Tax Planning for 2013 Begins Now”

How Risky are Prepaid College Plans?

July 11, 2012

With soaring tuition rates and the increasing importance of a college degree in our economy, prepaid college plans have become popular over the last two decades.  However,  declining returns from the stock market, compounded by the recent financial crisis, have caused a large gap between the funds in these state-administered programs and the escalating costs of state schools.  So what exactly are prepaid college plans and how risky are they? Continue reading “How Risky are Prepaid College Plans?”

Pros & Cons of a 529 College Savings Plan for Your Kids

May 16, 2012

Figuring out how to pay for your child’s college education can be overwhelming. The cost for one year of school at a public university is over $17,000 and is nearly $40,000 at a private school – and that doesn’t even include the price of room and board. Counting on scholarships to cover college costs is foolhardy and the availability of student loans (especially a loan with a good rate) is not guaranteed. Continue reading “Pros & Cons of a 529 College Savings Plan for Your Kids”

Getting Smart About College Costs: Part 3

May 02, 2012

By May, the “long wait” is over for most high school seniors. They’ve heard from the colleges or universities they applied to and have made their final choice. With a September destination locked in, there’s not a whole lot of learning going on in those last weeks of high school. Usually it’s a time for just showing up, having fun and saying goodbye to teachers and friends. Let Senior Week begin! Continue reading “Getting Smart About College Costs: Part 3”

GUEST BLOG POST: Back to School

September 01, 2011

Clipping coupons and watching out for store sales and promotions will be important, but elementary strategies, for keeping back-to-school spending in line. This year, however, parents of college-age kids may need some higher grade ideas for keeping their back-to-school expenses affordable.

  • For college kids with 529 plans, be aware of a potentially expensive pitfall as a result of 2011 tax legislation. Formerly, withdrawals for computers, electronics and internet services were considered as qualified educational expenses, and were therefore tax-free. Now, however, a 10% penalty may be imposed if money from the 529 plan is used for these purchases, unless they are required by the college, university or technical school. Be sure to check with your child’s school on their policy on this. If their college or university does not have a policy requiring computer equipment, it is best for you to purchase those outside your 529 plan.
  • Also, going forward, you may want to require your child use summer earnings to purchase any new technology needed for college or to fund other college expenses. Since college students will be responsible for their expenses after college, it’s a good strategy to start giving them some responsibility for expenses before they graduate to make the transition into the real world a little easier. Budgeting and saving are the most important financial skills for young adults, so any opportunity you can give your child to practice budgeting and saving will pay off in the long run. Some of the most financially responsible and successful people I’ve met had to pay for at least a portion of their college expenses out of money they earned themselves.
  • If your child has a custodial UGMA or UTMA account, and has not yet reached your state’s age of majority, it’s okay for parents who are custodians on these accounts to use the funds for college expenses, including computers and equipment.
  • Get educated on the rules for taking educational deductions and credits on your tax return for your child’s college expenses. Talk to a financial planner with tax expertise for a planning strategy to coordinate and maximize these tax benefits now, so that you don’t discover you missed opportunities when you file your tax return.