How to pay those next college bills


The day has finally come to send Junior to college and let’s face it. You didn’t save much for it. In fact, if you’re like many parents, you might not have saved anything at all.

If you don’t want your child to be struggling with student debt and have extra savings that you don’t need for retirement, where exactly should that money come from? This is a question we get all the time. Here are some considerations.

Does your child have assets?

If so, there are several reasons why you might want to tap into these assets before others. First, they have the greatest impact on eligibility for financial aid since 20% of their value is counted in the aid formulas. (This does not apply to assets in a 529 savings account, which are considered parental assets, nor to Coverdell education savings accounts or any money your child may have in a Roth IRA, which are not included at all.)

Second, once your child reaches the age of majority in your state, he or she can spend that money however they want and their idea of ​​how to use that money well may not be the same as yours. For these reasons, you may want to use that money to purchase personal items like a new computer before you complete the FAFSA and your child’s 18th birthday. (Even if the age of majority in your state is 21, it may be 18 in the state where your child is attending school.)

Do you have money in education savings plans?

If you have been successful in saving money for education, obviously you will want to use that money for this purpose. This way the winnings can be withdrawn tax free. Otherwise, they would be subject to a tax and possibly a 10% penalty if you use the money for other purposes.

However, if a 529 savings account is in someone else’s name (such as a grandparent), you’ll want to wait and use that money for the last year of school if possible. This is because the assets will not be taken into account in the financial assistance formulas until they are withdrawn. At this point, they will have the greatest impact on reducing aid by being counted as income for your child, which can reduce eligibility by 50%! By the time last year’s bills arrive, the last FAFSA will have been filed and you won’t have to worry about financial aid anymore. (Plus, eligible withdrawals from 529 savings plans won’t even count for financial aid eligibility starting in the 2024-2025 school year.)

Do you have taxable assets?

As these do not have the tax advantages of retirement accounts and are accounted for in the financial assistance formulas, taxable assets have priority over withdrawals from retirement accounts. If you have US government savings bonds and meet certain income and other requirements, you may be able to cash them out and use the money tax-free for your child’s education. If you have assets that have lost value since you bought them, you can use the losses to offset other taxes, including up to $ 3,000 a year from your regular income taxes for losses. greater than your earnings. You can carry forward any loss greater than $ 3,000 indefinitely.

What about assets other than savings bonds that have appreciated more than losses? One solution is to give them to your child and ask them to sell them. They will still have to pay capital gains tax, but at a potentially lower rate. For 2021, your child will have the first $ 1,100 of non-taxable investment income and the next $ 1,100 will be taxed at their tax rate (which is also probably zero). However, any amount over $ 2,200 will then be subject to your highest marginal tax rate, which will likely be higher than the capital gains rate you would have paid if it were in your name, you don’t want. therefore not having to earn too much on behalf of your child.

Can you borrow against your house?

If you have equity in your home, it might make more sense to borrow against your home rather than plunder your retirement account or have your child take out student loans. This is because interest rates are still near their historic lows and are likely to be lower than student loan rates and what your investments can generate in your retirement account. That being said, there is an obvious downside. If you can’t afford the payments, your home will be in jeopardy. Ask yourself if the interest savings are worth the risk.

Can you borrow from your pension plan?

The advantage of borrowing as part of your retirement plan is that you can put the money back into your account with the interest you pay. This does not mean that it is free, however. The real cost is the lost income you would have earned if that money had stayed invested. Another downside is that you usually have to pay it back over a relatively short period of 5 years, so you’ll want to make sure you can afford those payments while still putting food on the table and keeping the lights on. Finally, if you quit your job for any reason, the plans often require you to pay off the outstanding loan balance or this will be considered a taxable withdrawal and possibly a 10% penalty if you are under 59. 1/2 years old.

Do you have other retirement accounts?

You can make penalty-free withdrawals from traditional or Roth IRAs for qualifying education expenses. But unlike retirement plan loans, you cannot return that money. You will also have to pay taxes on any untaxed distributions. (This only happens for Roth IRAs after all contributions and converted balances have been withdrawn without tax or penalty.) If you have a retirement plan from a previous employer like a 401 (k) or 403 (b ), you can convert it to an IRA and then use it without penalty for education as well.

If your child has their own Roth IRA, the balance will not count toward financial aid eligibility. However, if they take a withdrawal from it, it could have a negative impact as it would be treated as income and count against them. This is why it generally makes sense to let the child’s Roth IRA continue to grow tax-free and avoid withdrawals (unless it’s for the final year).

Can you take a hardship withdrawal from your pension plan?

Many plans allow you to request a hardship withdrawal, but this should be a last resort. Not only will you have to pay taxes and if you are under 59 1/2 years old possibly a 10% penalty on the withdrawal, but you will not be able to repay that money which will definitely reduce your retirement savings. To add insult to injury, you may also not be able to contribute to your pension plan for a period of time after taking a hardship withdrawal.

Do you want to give or lend money?

Once you have decided where the money is coming from, you still have to decide where exactly it will go and how. Keep in mind that if you give your child money, any amount over $ 15,000 per year (or $ 30,000 if you are married) will require you to complete a gift tax return and reduce your lifetime exemption from unified inheritance and gift tax. You can work around this problem by paying school bills directly, as the donation tax does not apply to direct payments to educational institutions.

Instead of donating, you might want to lend money instead. With interest rates this low, you might be able to earn more on your savings than you would in the bank, even if your child pays you less interest than he would to a loan provider. students. It could be a win / win proposition. Just be aware that you might not get the money back. After all, it’s not exactly FDIC insured.

Should you even provide this money?

Keep in mind that no matter where you take the money out, you can use a retirement calculator to make sure it’s money you won’t need for retirement. After all, if you don’t provide the money, that doesn’t mean you don’t love your child or don’t want them to go to college. It just means that they will have to borrow the difference, as most students do. But if you don’t have enough savings for retirement, good luck finding someone willing to lend you the difference.

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