Have a child to educate? Start putting money in a 529 plan. At least that’s the conventional wisdom, and there’s nothing wrong with it.
Of course, there are a lot of other ways for clients to finance their children’s college education. Some of them involve saving and spending in ways that don’t use a 529 account. Others incorporate strategies to help reduce the total cost. By tugging on both the savings and cost-reduction ends of the rope, clients can bring college costs within reach.
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ROTHS A GOOD CHOICE
“It’s not a good idea to max out a 529 plan if there are other options that offer more flexibility,” says Robert Schmansky, founder and financial advisor at Clear Financial Advisors in Livonia, Mich.
“A Roth IRA, for instance, can be a great choice,” he says.” If you don’t need the money for college, it’s great for retirement, and you don’t have to pay the 10% penalty to use the money for noneducational purposes.”
Money that has been put to work in a 529 plan has other limitations as well. It can’t be used for income tax credits, for instance, and may not have all the investment options available to other types of accounts. “I see a tendency in 529 plans to drive accounts toward riskier investments and a lack of diversification,” Schmansky says.
In addition to Roths, he says, clients should consider education savings accounts, which “give you more control over your investment mix.”
Series I bonds are another option for someone who is more conservative. “They’re not the best tool for long-term growth,” Schmansky concedes, “but you have the option of not recognizing the bond income until they’re cashed in, and if the money is used for qualified educational expenses, then the return is tax-free.”
A client who hasn’t saved very much toward a child’s college may be able to cover at least part of the bill by tapping into cash flow, according to Daniel Lash, a partner at VLP Financial Advisors in Vienna, Va. “Some people pay off their mortgages and then have more money for college expenses,” he says.
Financing college by using current cash flow can be especially attractive for a family in which one parent was the primary caregiver while the children were quite young, but who went back to work once the children entered high school or college.
“There may be a boost in household income when one parent goes back to work,” Schmansky notes. But if the family plans on using it to help meet their kids’ college expenses, he warns, they need to avoid temptation and not “suck up that money.”
SHARING IS CARING
Letting college students pay some tuition can be an excellent idea.
“Last week, I had an amazing conversation with my clients and their twin boys who will head off to college in the fall,” says Howard Pressman, a planner at Egan, Berger & Weiner in Vienna, Va. “The family decided that the boys would go to public in-state schools, and the parents would pay for half, using a 529 account and a bit of other savings. The boys will cover the other half themselves with loans of about $10,000 a year each.”
That will mean paying off $40,000 in college loans, which might bring protests from some teenagers. Not this pair. “I was really impressed with the boys and their attitudes toward this,” Pressman says. “They were immediately open to cost-sharing with the parents, without any complaint.”
START WITH COMMUNITY COLLEGE
A family might also consider having the student attend community college and live at home during the first two years.
“It can make sense to have a child attend two years of junior or community college, then transfer to a larger, more prestigious college or university after that,” Lash says. A community college might cost between $3,000 and $5,000 a year, much less than even in-state tuition at a public college.
Better yet, some community colleges have guaranteed-admittance arrangements with certain state colleges and universities. “In northern Virginia, the community college has agreements with many of the state colleges and universities,” Lash explains. “So if a student finishes a two-year associate’s degree, then admission to the state college or university is guaranteed.”
The student can get their basic classes out of the way at community college, and then go on to get a degree from the University of Virginia, for instance. “No one cares where you started,” Lash observes.
“Some colleges are more generous with aid to middle- and upper-middle-class families than others,” says Melissa Sotudeh, a wealth advisor at Halpern Financial in Rockville, Md. “Seek them out and put them in the pool of schools to which the kid is applying.”
Net cost calculators are a good way of identifying those schools, Sotudeh says. Federal law requires that universities must provide these calculators on their websites, and they must show how much aid the university might provide.
Remember, too, that a public school isn’t necessarily the least-expensive option. For a student with exceptional credentials, “a private school that has a large endowment and offers merit-based aid can end up being cheaper than an out-of-state public school,” Sotudeh contends, although she acknowledges that this is less frequently the case with in-state public schools.
Top private schools provide aid for some families that have surprisingly high income levels. Families earning between $90,000 to $150,000 may very well receive a discount based on their income, making an Ivy League college cost competitive with a public state university.
And if a student receives a generous offer of financial aid from one institution, it may be possible to parlay that into offers from other schools. “It never hurts to politely request a review to see if a school can match the deal offered by another school,” Sotudeh says.
GET THE FAFSA IN EARLY
Clients who hope for financial aid should get the Free Application for Federal Student Aid in as early as possible, on Jan. 1 for courses that start later that year. “Using estimated numbers gets you your place in line; later you can update it with the correct information,” advises Andrea Blackwelder, founder and president of Wisdom Wealth Strategies in Denver.
“Federal grant programs can run out of money, and so can schools,” Blackwelder says. “They don’t wait for the entire pool of applicants to file to start making decisions. If you know you’re going to file the FAFSA, don’t be the last guy in line.”
Virtually every school uses the FAFSA, although some private schools also ask for the CSS/Financial Aid Profile to determine their grants. By understanding how these applications work, an advisor can help clients make financial decisions with their requirements in mind.
More than 70% of aid is need based, so showing greater need is the name of the game,” says Christopher Ordway, a Certified College Planning Specialist and an owner of San Tan Financial in Phoenix. “In general, when the feds are looking at someone’s finances, they look at parents’ income and assets and the student’s income and assets. They assess those at different rates.”
Under the FAFSA’s rules, both students and parents receive an income allowance, Ordway says. “Anything over that, they assess at 50 cents on the dollar and add it to your expected contribution,” he notes.
The FAFSA also expects that within a year of study, families will spend between 20% and 35% of the student’s savings, as well as 50% of any income from those savings. That means the family must spend most or all of the assets in a Uniform Transfers to Minors Act account.
“If a kid has an UTMA, there are two things you can do,” Blackwelder says. “You can spend it. If the child needs a car at 16, that can be an awesome
place to use that money, potentially freeing up other assets that the parent has.”
The other option, she notes, is to move the money to the parents’ 529 plan. “You have to maintain the designation for the child’s benefit, but by moving it, you get better FAFSA treatment,” she says. “It can make the difference between qualifying and not qualifying for aid, depending on the size of the UTMA.”
Parents are assessed for 22% of everything over their FAFSA income allowance, although this goes up as they age. On this side of the equation, the goal is to minimize adjusted gross income.
“Max out your contribution to retirement, including any catch-up provisions, and you can turn a family that earns $100,000 a year to a family that earns $50,000, from the FAFSA’s point of view,” Blackwelder says.
Clients can also tap investments for living expenses, thereby reducing another item that the FAFSA assesses. To reduce their income further, clients who own a business can strategically time and write off their business expenses.
Blackwelder also suggests recognizing losses, contributing to health savings and flex accounts, and deferring income wherever possible. “You want anything that will reduce that bottom line the year before the kid goes to college,” she says.
The FAFSA also gives parents an asset allowance, which depends on the age of the older parent. Funds that are in a retirement account and assets that are owned by a family business are considered off limits. Otherwise, Ordway says, parents are expected to contribute 5.6% of any assets over their allowance.
WHERE TO PUT ASSETS
Clearly, it’s better to keep assets in the parents’ name than in the child’s name, and better still to put money in a retirement account or business.
But a better solution, from the standpoint of maximizing aid under FAFSA rules, may be to put assets in the name of a trusted family member or friend. “A grandparent can own the 529 plan, which puts it outside the financial aid equation,” Ordway says. The rules allow you to name a successor owner, which would keep it out of probate if a grandparent dies, though it would again become a parental asset.
Equity in an investment property counts toward the expected family contribution. However, Ordway points out, “you could refinance and put the extra money into retirement accounts, or in assets that belong to people outside the nuclear family. Or you could take equity out of an investment property and pay off your home, which the FAFSA doesn’t consider.” All of this, he adds, is perfectly legal.
In the end, Schmansky observes, “Everything has pros and cons, and there is no magic way to pay for college.”
But by understanding options, planners can help clients maximize their children’s educational opportunities while minimizing the financial sting.
Ingrid Case, a Financial Planning contributing writer in Minneapolis, is a former editor at Bloomberg News.
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