Student Loans
If you have a child in college or one in high school planning to go to college, it behooves you to investigate financing options.
I have seen some clients wanting to avoid the college debt trap by setting up automatic deposits to investment accounts. They try to choose investments that could beat the rate of increase in college costs. As the children entered junior high, they start transferring assets to the kids’ accounts as gifts. Any gains, when sold, were taxed as the child’s rate.
Many people have used 529 Plans. Others steer away from 529 Plans due to the high fees. The ultra conservative investment returns in these plans do not often equal college cost increases.
Most college websites devote some space on how to pay tuition, including loans and scholarships. The colleges in their best interest want to make sure every student can pay their own way. Be wary of the college steering you to a specific lender. Recent scandals show college student loan officials being fired for taking payoffs.
What are some options?
- Subsidized federal guaranteed (Stafford) loans require filing a FAFSA form by early spring of college bound year. See www.fafsa.ed.gov . The government picks up the interest costs while your child is in school.
- There are unsubsidized federally guaranteed loans (Parent Plus) which are NOT based on need. These loans generate interest charges from the first day of disbursement until payment in full. Interest can be paid monthly or allowed to be added to the principal amount.
- Private loans are available from banks and finance companies. The U.S. Department of Education has a great resource under the National Student Loan Data System, www.NSLDS.ed.gov .
- Another site that can help with the confusion is www.simpletuition.com .
- Other Federal Loans…Ford and Perkins Programs.
- Look at http://mapping-your-future.org . This site offers early awareness, preparation, and career planning. See their online Student Loan Counseling.
- Once a student graduates, you may want to consolidate the school loans. See www.consolidatecomparision.com for insight.
- 529 Plans. Although the plans grow tax free many of the fees and conservative returns make these programs marginal at best. A lot of people think that distributions are tax free if spent on higher education, but that is not necessarily so.
The tax free withdrawals are limited to your adjusted qualified higher education expenses. (See IRS publication #970). Adjustments which are deducted from gross higher education spending include money from grants, scholarships, federal work study programs, Perkins Loans, Stafford Loans, and Lifetime Learning credits.
For example, suppose Mr. Smith sends his son Bill to college where the official costs are $32,000 a year. Bill gets a $10,000 merit scholarship, so Mr. Smith only pays $22,000 this year. Mr. Smith pulls $22,000 from the 529 plan to pay these costs. Bill’s adjusted qualified expenses are only $12,000!! That is $22,000 minus $10,000. By taking $22,000, Mr. Smith would be $10,000 over the limit. Now assume that $10,000 of the $22,000 withdrawal was growth. Then, $12,000 qualified ÷ $22,000 withdrawal × $10,000 growth = $5,455 tax free. The remainder $4,545 would be taxable and penalized. This taxable amount could impact the expected family contribution, and, college aid the next year.
- Another alternative is using an IRA. If the child is working they can fund their own IRA. Say the child is earning $8,000. Subtract the $4,000 IRA contribution and the standard deduction and voila…no tax for the child. This IRA is a retirement account that doesn’t count on the federal financial aid form.
- Consider using a non qualified retirement plan. The parents can fund it with after tax dollars; it grows tax free, can be withdrawn tax free in any amounts, and does not count on the financial aid form. (See previous articles on the Missed Fortune ideas by Doug Andrews).
Okay, you are feeling stressed and confused. Take a step back. Your plan should be communicated at a young age to your children. Maybe, you can only fund a certain portion of their college needs. Maybe the kids will need to work and save during their high school years (it won’t hurt and they will not be emotionally traumatized) and they will pay for part of their college costs. They may have to work during the college summers and vacation. You may have to cut a deal with them. That is, they may apply for student loans. Tell them if they get A’s and B’s, you will pay X% of the loan after they graduate. If they get B’s and C’s, then the kids pay the whole loan off.
Above all, start early. The best time to start saving is when you hear two sounds-… “Whack and WAAUGH” … “Mr. and Mrs. X, you have a healthy baby.” Hmmm!
Say you want to fully fund for a child born today, going to college in 18 years at a state school. Assume you are getting a 10% return on investment. Then, you need to start saving $640/mo starting the first day they are born. Whoa!
Discipline or Regret?