As I recently noted, the college class of 2015 is the most indebted ever. There a couple of ways to avoid the student loan trap: choose a cheaper educational route or be lucky enough to have family members that have enough dough that they are able to save money for education, hopefully after they have funded their own retirement accounts! This week, we are celebrating 529 Day (get it? May 29th is 5/29 or 529 Day), when states are trying to boost interest and participation in 529 college savings programs with various incentives. I have long said that the 529 plan is far and away my favorite education-funding vehicle, because it allows for tax-advantaged investing for college. Contributions within the account grow tax-free and are not taxed upon withdrawal, provided they are used for qualified higher education costs. The 529 is like a Roth IRA for education.
529 plans can also be a terrific estate planning tool, because wealthy grandparents can remove assets from their estates either by using the annual gift tax exclusion of $14,000 or by making a lump sum that is far larger (check with your plan to determine the maximum allowable limit). The nice part is that the donor can maintain control over the investments and the ultimate use of the money.
Just remember that while a grandparent’s assets are not included when colleges determine eligibility for financial aid, there is a big downside to using a 529 plan that is in the grandparent’s name: When money is withdrawn to make a payment on behalf of the beneficiary of the plan, students must disclose those amounts as income. For every dollar of income, a student’s aid eligibility may be reduced by as much as 50 cents. In order not to diminish the ability to receive aid, there are a few work-around solutions.
i. Wait to use money in the 529 until the student’s senior year: Tapping the account for the last year of school shouldn't affect eligibility, because the year in which the income will be reported (as income for the previous year) will also be the year in which the student graduates.
ii. Transfer ownership of account: A few years before the first aid application is due, grandparents could transfer ownership of the account to a parent of the beneficiary. Assets in a parent-controlled account get assessed for financial aid purposes, but disbursements do not appear on the income statement of either the parent or the student. Fair warning on this idea: some states, like New York, do not allow changes in account ownership unless there’s a court order or the owner dies.
iii. If the 529 plan ownership seems too complicated, grandparents might considering gifting the money to the parents, who can then deposit the gift into their own 529 accounts that have been established for the kids. It makes sense to wait until after the aid has been determined before making the gift. Alternatively, extended family members may choose to wait until the student has graduated and then help with college loan repayment.
There are some people who could afford to snag money or save for college, but fall prey to a number of misconceptions, which prevent them from acting. Let's dispel some of those myths right now!
1.“I’m not going to complete the Free Application for Federal Student Aid (FAFSA) form, because I make too much money to qualify.”
What’s the number one reason that families don’t qualify for financial aid? According to one college financial aid officer, the answer is obvious: because families do not complete the necessary paperwork. Those with household income below $250,000 and two dependents should spend the time and at least attempt to grab a few bucks. Maybe it will all be for naught, or maybe a few tedious hours of work will be worth a few thousand dollars next semester.
2.“I’m not going to save for college because it will count against me for financial aid.”
Some of your savings can reduce a portion of your need-based aid, but the amount of that reduction may be smaller than you think. The money in retirement plan accounts is not counted, nor is the equity in the family's residence. Additionally, a portion of assets held by the parents is not counted, based on the age of the older parent.
Assets owned by parents for a dependent child are assessed up to 5.64 percent, while assets in the child’s name are assessed at a 20 percent rate, which is why it's preferable to hold accounts in the parents’ names. Let’s say that by the time junior heads off to school, you have saved $100,000 in the kid’s 529 plan, your potential aid may be reduced by $5,640, leaving you with plenty of money to help pay for college.
3. "Rather than save for college, I’m going to count on government grants to cover costs."
Although grants are great, they will not cover the total nut for most colleges. The Pell Grant covers about 10 percent of current private four-year college costs and work study can add up to another 20 percent.
4. "Why save now when I can borrow later?"
Before families start saving for college, I recommend that they get their financial houses in order. That means paying down consumer debt, establishing an emergency reserve fund of six to 12 months worth of expenses and maximizing their retirement savings. But once those big three goals have been accomplished, it makes sense to save today rather than worrying about whether interest rates will rise in the future. Put another way, when you save, you earn interest; while when you borrow, you pay interest.
5. “My kid is a great soccer/basketball/football player, so he/she will get a scholarship.”
As a former varsity NCAA athlete, let me share something with you that few others will tell you: your kid is probably not as good an athlete you think. Of course I thought that I was an awesome soccer player when the collegiate recruiters came calling, but within the first week of practice, I quickly learned that I was a decent player and one who would never have been given a free ride. It is very difficult to earn a scholarship and it is not prudent to count on a future scholarship as the basis of your college funding plan.