As college students end their winter break and head back for spring semester, I thought it would be a good time to review some college planning basics.
I tell clients there’s no “magic bullet” for accomplishing the college savings goal. Paying for college for your children usually incorporates several strategies including:
- Saving money in a college fund
- Scholarships and Grants
- Loans by parents and/or students
- Re-directing current income from parents or students during the college years.
In most cases, the best vehicle to save for college is 529 savings accounts. 529 refers to the section of the Internal Revenue Service code which allows for tax preferential treatment of college savings accounts. 529 plans are typically owned by the parent with the child as beneficiary.
There are many benefits to investing in a 529 account. The main benefit is that money saved for college is money that will not have to be borrowed for college. Compound interest doesn’t care if you’re earning it or paying it. You are much better earning compound interest in a 529 account than paying compound interest on a student loan. According to the College Board, 60% of all college Bachelor degree recipients have borrowed to pay for their education. While the average loan amount is $28,400, I have seen students graduate with loan amounts in excess of $100,000. That’s like having the mortgage without owning the house.
There are tax benefits to investing in 529 plans. While contributions are not federally tax-deductible, some states like Connecticut can offer a deduction or tax credit for contributions made to state sponsored 529 plans. The compound earnings discussed above grow tax-free. Withdrawals for qualified higher education expenses (QHEE) are tax-free. The new 2018 tax law allows for distributions of $10,000 per year to cover the cost of K-12 expenses. The ability for families to pay for private or religious primary and secondary school expenses is just another reason that families should be using 529 savings plans for all types of educational funding.
In order to have the distributions to qualify as tax-free, they must be used for QHEE at an eligible institution. Qualified higher education expenses include:
- Tuition
- Mandatory fees
- Required textbooks, supplies and equipment
- If used primarily by the beneficiary during the time the beneficiary is enrolled at an eligible educational institution, the following are included:
- Computer or peripheral equipment
- Computer software
- Internet access and related services
- Room and Board during any academic period which the student is enrolled at least half-time in a degree, certificate or other program that leads to a recognized educational credential awarded by an eligible educational institution. If the student lives off campus, the amount of this expense is considered a QHEE, but is limited to the cost of on-campus housing.
- Special needs services for student with special needs
Two common pitfalls I’ve seen with 529 distributions that can cause them to be taxable. First, paying a student loan is not considered a qualified higher educational expense. Second, is not matching the year the distribution is taken with the year the QHEE is used. If the college bill for the spring semester is due in January, take the distribution in January, not December of the previous year.
The tax penalty for non-qualified distributions are taxes and penalties due for earnings or growth, but not on your contributions (which were made after tax).
529 plans where the parent is the owner and the student is the beneficiary, are viewed more favorably for potential financial aid than money held in an account in the student’s name only. FAFSA (Free Application for Federal Student Aid) generally counts 20% of any student owned assets as being available to pay for college. FAFSA counts 5.64% of parent owned assets as available for paying for college. For example, if your child has $10,000 in a bank account in their name, 20% or $2000 would be deemed available to pay for school. This means $2000 less in potential financial aid. If the same $10,000 is in a parent owned 529, the reduction in financial aid would only be $564.
I would like to make one final important and personal appeal. Prior to sending your children off to college, understand that they are now young adults. As young adults over the age of 18, they gain certain legal rights which excludes your ability to access or assist in certain aspects of your child’s life. If you want to be continued to be involved in your child’s educational life, the Family Educational Rights and Privacy Act (FERPA) requires that students age 18 or older provide written consent before educational records such as grades, transcripts and disciplinary records can be shared with parents. Colleges typically provide FERPA consent forms for students to sign.
A financial power of attorney allows the parents to help manage the child’s finances. If, for instance, a student has a car accident or illness, leaving them either temporarily or permanently unable to make financial decisions, this document allows the parents to avoid an expensive court process of being appointed the guardian for the student.
Finally and more importantly, parents should also have a health care power of attorney and HIPPA authorization on behalf of their children. As some of you know, our youngest son Michael contracted viral meningitis one week prior to final exams last April. Abby and I flew to North Carolina and spent a week in the hospital with Michael in Greensboro while Michael was diagnosed, treated and started his recovery from this awful disease. (Thank you Bob and Donna in Greensboro for all your guidance and support during this very difficult time). The health care power of attorney gives parents the ability to make health care decisions for their children. Luckily, Mike never lost consciousness and allowed us this ability. Had he been unconscious or in a coma, this would not have been the case! HIPPA authorization allows doctors to speak to parents about a child’s medical condition. While the child may be concerned with privacy, I recommend full parental access to the student’s health records which could be especially valuable in situations that can’t be anticipated.
Mike has fully recovered and was able to complete his classes and finish his final exams when he returned to High Point University last fall. I wanted to share this very difficult ordeal because of the lesson it provided to Abby and I, and the opportunity to share that lesson with all of you. Whether you’re sending them off to preschool or sending them to grad-school, a little planning can save you time, money and grief!
