College Savings

[Rachel]

My husband just got a pay increase we were not expecting. We were just talking last night about how we have 8 years until our oldest starts college. We have not set aside any money for our kids’ college yet.

 

What is the best way to set this money aside for future tuition? I assume our kids will go the college route, but if they wanted to do a trade instead we are ok with that. It is very unlikely our kids will qualify for any need based financial aid.

[regentrude]

I would put it in a 529.

Make sure it remains in the parents'  name, not the student's, so it is considered a parental asset on the FAFSA.

[Arch at Home]

529’s worked well for us.

[Rachel]

Thank you!

[Garga]

I would put it in a 529.

Make sure it remains in the parents'  name, not the student's, so it is considered a parental asset on the FAFSA.

 

 

I was just about to write the same thing.

 

We went the route of Education IRA's (Coverdell accounts) for our kids, but the main thing is to make sure the money stays in your name and not the student's.

 

 

I honestly can't remember whose name our 529 is in.  I'll look it up later.

 

But why is it important to be in the parent's name?  And I wonder if we can change it now or not.  Oldest goes to college in 2.5 years.

[Lori D.]

I honestly can't remember whose name our 529 is in.  I'll look it up later.

 

But why is it important to be in the parent's name?  And I wonder if we can change it now or not.  Oldest goes to college in 2.5 years.

 

The FAFSA EFC number (Estimated Family Contribution) is what is used to determine a student's financial need. The higher the number, the less perceived need. The EFC is calculated by a worksheet/formula (you can look it up in the FAFSA EFC Formula Guide for 2018-19) that more heavily weights student income and student assets than parent income and parent assets

 

student income = 50%

parent income = 47%

student assets = 20%

parent assets = 5.65%

(from the most recent figures I could find)

 

A 529 account is an asset, and is taken into consideration in determining the EFC number, so much less of that asset is counted if it is in the parent's name.

 

And yes, any switches need to happen by 2 years before the student attends college, as the new FAFSA now stretches back that far in looking at family income and assets to determine EFC.

 

(I'm doing a session on Financial Aid this Friday for my homeschool group, so this was a great practice opportunity question, Garga -- thanks!   :laugh: )

 

 

You can get a quick estimate of your FAFSA results at the FAFSA4caster, or an even quicker/rougher estimate from your adjusted gross income off of the Troy Onink color-coded chart way down in his helpful article: "2017 Guide to College Financial Aid: The FAFSA and CSS PROFILE".

 

How'd I do -- am I ready for Friday? LOL!

Edited February 27, 2018 by Lori D.

[RootAnn]

529 accounts have an account owner (which should be the parent, ideally) and a beneficiary which is your kid. If you don't use it all, the beneficiary can be changed to another close family member (sibling, parent, child, even cousin) with no penalty as long as you don't try to change it too often.

Edited to add: some states have tax benefits for 529 contributions for the account owner.

Edited February 27, 2018 by RootAnn

[Garga]

The FAFSA EFC number (Estimated Family Contribution) is what is used to determine a student's financial need. The higher the number, the less perceived need. The EFC is calculated by a worksheet/formula (you can look it up in the FAFSA EFC Formula Guide for 2018-19) that more heavily weights student income and student assets than parent income and parent assets

 

student income = 50%

parent income = 47%

student assets = 20%

parent assets = 5.65%

(from the most recent figures I could find)

 

A 529 account is an asset, and is taken into consideration in determining the EFC number, so much less of that asset is counted if it is in the parent's name.

 

And yes, any switches need to happen by 2 years before the student attends college, as the new FAFSA now stretches back that far in looking at family income and assets to determine EFC.

 

(I'm doing a session on Financial Aid this Friday for my homeschool group, so this was a great practice opportunity question, Garga -- thanks!   :laugh: )

 

 

You can get a quick estimate of your FAFSA results at the FAFSA4caster, or an even quicker/rougher estimate from your adjusted gross income off of the Troy Onink color-coded chart way down in his helpful article: "2017 Guide to College Financial Aid: The FAFSA and CSS PROFILE".

 

How'd I do -- am I ready for Friday? LOL!

 

 

I think you did well!

 

I called our financial guy and it's in my name with my son listed as the beneficiary.  He double checked the numbers while we were on the phone and quoted the same percentages you did (5.65 for parents, 20 for kids), so it sounds like you know what you're talking about.  (As usual!)  :)

 

The article you linked looks good, but I haven't had time to delve into it.  I looked at the little red chart and the number on it didn't knock me off my chair, but I need to read more carefully to be sure I'm understanding everything.

Edited February 27, 2018 by Garga

[Rachel]

We have 3, soon to be 4 children. Do we need one 529 account with our oldest as beneficiary? Or do we need a separate account for each child?

[JanetC]

A 529 account is an asset, and is taken into consideration in determining the EFC number, so much less of that asset is counted if it is in the parent's name.

 

And yes, any switches need to happen by 2 years before the student attends college, as the new FAFSA now stretches back that far in looking at family income and assets to determine EFC.

 

Income is prior-prior year. Assets are your account balances as of the day you file the FAFSA.

[JanetC]

We have 3, soon to be 4 children. Do we need one 529 account with our oldest as beneficiary? Or do we need a separate account for each child?

You can change the benificiary, so any money left over after kid 1 graduates can be given to kid 4. The beneficiary changes who you are allowed to spend the money on, but has no effect on financial aid. $1000 in 529 funds is a $1000 of parent assets for the FAFSA for all your children in college, regardless of who the beneficiary is, in other words, I have to declare kid 2's 529 funds as a parent asset on kid 1's FAFSA (and Profile), not just kid 2.

[RootAnn]

Rach - I think it only matters if you are really going to max out the funds you put into the 529 because of maximum contribution levels. If you are going to put in more than $15,000 from you and $15,000 from your spouse into that 529 this year, then I'd consider opening at least two accounts. If you are going to put in less than $30,000 a year, you can just have one account in eldest's name and decide later how to split it up for the different siblings.

 

We have different accounts for the different kids because we start a new one each time we add another kid to the family. This allows each kid to see how much they have in their "college fund." Some relatives give my kids small monetary gifts for their birthdays or Christmas and those amounts also go into their 529 accounts to grow with time.

[Storygirl]

We have separate 529 accounts for each of our children, because we get a state tax deduction for our annual contribution to each account. If we had only one account, we could take only one deduction. Each state is different, but you should be able to research your state's benefits easily online.

 

ETA: We can transfer money from one account to another. So if the oldest didn't use all of hers, we could move it to the other accounts. We could also move money from their accounts into hers, if we want to move the money so that we can access it sooner to put more toward her expenses (because we will have a little more time to save for the younger ones.)

Edited February 27, 2018 by Storygirl

[Lori D.]

We have 3, soon to be 4 children. Do we need one 529 account with our oldest as beneficiary? Or do we need a separate account for each child?

 

I would talk to a good financial advisor who is knowledgeable with college savings/financial aid, as well as state tax credit laws, as there are a number of factors to consider:

 

one account:

pro: you can switch the beneficiary to a later child

pro: one large account accrues more compound interest than multiple smaller accounts (esp. if started when DC are very young and you adding $3000-5000 or more a year -- more years to accrue interest)

con: removing money for any other reason than for educational purposes for the beneficiary = 10% tax on the amount withdrawn

con: possible missed state tax credit benefit (if allowed tax credit for each educational account)

 

separate accounts:

pro: no withdrawal tax penalty (when using the money for educational purposes for that beneficiary)

pro: some states have tax credit benefits for contributions to EACH account, which maximizes your state tax credit for educational contributions

 

It seems to come down to individual situations:

1. age spread of the children, to make sure you're not going to have 2 or more drawing from the same account at the same time (which requires tax payment on the amount withdrawn for the child(ren) not the beneficiary)

2. how much you are able to put into the account(s), and how long will the account(s) compound interest for you

 

These articles are all several years old (so state tax laws may have changed), but they lay out some of these pros and cons:

- US News & World Report (July 15, 2015): "3 Reasons to Open Multiple Accounts"

- Wealth Front (Aug. 2, 2015): "Be Smart About Your 529 Plan Beneficiary" -- superfunding 1account

- The College Investor (June 26 2016): "How to Save for college with Multiple Children"

 

Perhaps if your children are fairly close in age and still young, and if you don't have great state tax credit benefits for an individual account for each, try for 2 accounts to boost compound interest benefits? So child #1 and child #2 are the beneficiaries, and as child #1 finishes, switch to child #3 as the beneficiary on that account, and as child #2 finishes, switch to child #4 on that account??

 

Just a guess, as I am NOT a financial advisor expert! :)  BEST of luck as you start looking ahead to saving for college! :) Warmly, Lori D.

Edited March 6, 2018 by Lori D.

[Gwen in VA]

Funny warning -- do make sure someone will be in a position to spend it!

 

I have a friend whose child is attending more of a trade school and it is not accredited. 529 funds can't e used for it. Her younger sibling went ROTC and so didn't need any aid. Thankfully her oldest got married and the spouse is going back to school and so can use the money, but for a bit they thought they were really going to lose that money completely!

[TarynB]

Funny warning -- do make sure someone will be in a position to spend it!

 

I have a friend whose child is attending more of a trade school and it is not accredited. 529 funds can't e used for it. Her younger sibling went ROTC and so didn't need any aid. Thankfully her oldest got married and the spouse is going back to school and so can use the money, but for a bit they thought they were really going to lose that money completely!

 

That's great that they could use it for school after all - but just to clarify for anyone else reading, they wouldn't have lost the money completely.

 

They could have withdrawn the money and used it for anything (non-educational purposes), they just would have had to pay income taxes on the gains plus an additional 10% penalty. So, not as good as using it for school, but not lost completely.

 

529s can also be transferred to future grandchildren.  :thumbup1:

Edited February 27, 2018 by TarynB

[Arcadia]

con: removing money for any other reason than for educational purposes for the beneficiary = 10% tax on the amount withdrawn.

I think it is tax on the tax rate in the year you withdraw plus a 10% penalty on the amount withdrawn. So if my tax rate is 28% this year and I withdraw from a 529 plan for an unqualified expense, I would be taxed 28% +10% = 38% for federal tax returns. Same scenario as early withdrawal of 401k funds.

 

“If assets in a 529 are used for something other than qualified education expenses, you'll have to pay both federal income taxes and a 10% penalty on the earnings. (An interesting side note is that if the beneficiary gets a full scholarship to college, the penalty for taking the cash is waived.)†https://www.schwab.com/resource-center/insights/content/529-account-what-happens

[Lori D.]

I think it is tax on the tax rate in the year you withdraw plus a 10% penalty on the amount withdrawn. So if my tax rate is 28% this year and I withdraw from a 529 plan for an unqualified expense, I would be taxed 28% +10% = 38% for federal tax returns. Same scenario as early withdrawal of 401k funds.

 

“If assets in a 529 are used for something other than qualified education expenses, you'll have to pay both federal income taxes and a 10% penalty on the earnings. (An interesting side note is that if the beneficiary gets a full scholarship to college, the penalty for taking the cash is waived.)†https://www.schwab.com/resource-center/insights/content/529-account-what-happens

 

+ 10% penalty, yes. :) Unfortunately. ;)

[teachermom2834]

I think it is tax on the tax rate in the year you withdraw plus a 10% penalty on the amount withdrawn. So if my tax rate is 28% this year and I withdraw from a 529 plan for an unqualified expense, I would be taxed 28% +10% = 38% for federal tax returns. Same scenario as early withdrawal of 401k funds.

 

“If assets in a 529 are used for something other than qualified education expenses, you'll have to pay both federal income taxes and a 10% penalty on the earnings. (An interesting side note is that if the beneficiary gets a full scholarship to college, the penalty for taking the cash is waived.)†https://www.schwab.com/resource-center/insights/content/529-account-what-happens

Hmm...maybe I am misunderstanding but federal income taxes have already been paid on the principal contributions to the 529. So 10% on the principal contributions + 10% penalty and income tax on the earnings. So not as painful as a 401K withdrawal. ???

[Arcadia]

Hmm...maybe I am misunderstanding but federal income taxes have already been paid on the principal contributions to the 529. So 10% on the principal contributions + 10% penalty and income tax on the earnings. So not as painful as a 401K withdrawal. ???

I think the withdrawal for 529 or 401k is assumed to be from earnings first before touching the principal contributions. I would double check of course with your tax accountant and whichever company holds your 529 plan.

 

From Fidelity Investments https://www.fidelity.com/customer-service/how-to-take-529-distributions

“You can withdraw money for non-qualified expenses, but it will be subject to federal income tax and a 10% federal penalty tax; there may also be state or local income tax, as well as interest or dividends taxâ€

 

From ScholarShare https://www.scholarshare529.com/plan/details.shtml

“Taxable Withdrawals

The earnings portion of this type of withdrawal is subject to federal and state tax but does not include the additional federal 10% tax. Say your child receives a full or partial scholarship or attends a military academy, you can withdraw certain amounts from your 529 account that will not be used for qualified higher education expenses and those amounts will be subject to tax on the earnings portion of the withdrawal, but will not be subject to the additional federal 10% tax.

 

Non-Qualified Withdrawals

The earnings portion of this type of withdrawal will be subject to tax, including the additional 10% federal tax. Examples might include using the money for a car, vacation or home improvement. But even if you urgently need to pay a medical bill and withdraw money from your 529 plan as a last resort — that withdrawal would still be subject to tax, including the additional 10% federal tax.â€

[JanetC]

For states with state income tax, the 529 may have state income tax advantages, and corresponding state income tax penalties for early withdrawal as well.

[Bootsie]

I would talk to a good financial advisor who is knowledgeable with college savings/financial aid, as well as state tax credit laws, as there are a number of factors to consider:

 

one account:

pro: you can switch the beneficiary to a later child

pro: one large account accrues more compound interest than multiple smaller accounts (esp. if started when DC are very young and you adding $3000-5000 or more a year -- more years to accrue interest)

con: removing money for any other reason than for educational purposes for the beneficiary = 10% tax on the amount withdrawn

con: possible missed state tax credit benefit (if allowed tax credit for each educational account)

 

separate accounts:

pro: no withdrawal tax penalty (when using the money for educational purposes for that beneficiary)

pro: some states have tax credit benefits for contributions to EACH account, which maximizes your state tax credit for educational contributions

con: possible missed compound interest benefit (depending on ages of students and how long you have for interest to build before needing to start using the accounts)

 

I am not understanding the compound interest arguments.  If I have $1000 in five separate accounts for 10 years or $5000 in one account for 10 years, the compound interest would be the same.  

[DawnM]

We opted not to do 529s.  

 

We have had a couple of friends get burned with them.  One family had 2 kids.  One didn't go to college and the other got a full ride.

 

Another family had two kids.  Neither went to college.

 

They had to take the penalty.

 

We just saved in IRAs and savings accounts.  But we haven't touched that yet as I we are trying to cash-flow college with me going back to work.

[TarynB]

We opted not to do 529s.  

 

We have had a couple of friends get burned with them.  One family had 2 kids.  One didn't go to college and the other got a full ride.

 

Another family had two kids.  Neither went to college.

 

They had to take the penalty.

 

We just saved in IRAs and savings accounts.  But we haven't touched that yet as I we are trying to cash-flow college with me going back to work.

 

In reference to the bolded, if a student gets a scholarship, a 529 withdrawal up to the amount of the scholarship can be taken by the account owner with no 10% penalty (but income taxes will still apply), i.e., the 529 money is not lost or "wasted" just because a scholarship is awarded.

Edited March 7, 2018 by TarynB

[JanetC]

Be careful about using IRA money for college, especially before age 59 1/2

 

1. You still owe income tax for a traditional IRA or rollover, just not the penalty (Roth is tax free if it's been 5 years since the contribution)

 

2. You will be penalized by the financial aid formulas

 

https://www.fidelity.com/learning-center/personal-finance/college-planning/using-retirement-savings

[Rachel]

Thanks for the thoughts.

-Our first three children are relatively close in age, each about 2 years apart. So it is quite likely they will overlap attending college.

-Our state does have some tax benefits for contributions to 529s, I’ll check into whether there are tax advantages to more than one account.

-It is quite unlikely we will max out contributions at this point, but once our mortgage is paid off I could see that being a possibility.

 

At this point I feel confident at least 2 of the kids will go to college. The third is only 5, so I don’t really have any idea about him yet. We have 14 nieces and nephews though, so I guess if none of our kids go to college we could find a family member to help.

[Lori D.]

I am not understanding the compound interest arguments.  If I have $1000 in five separate accounts for 10 years or $5000 in one account for 10 years, the compound interest would be the same.  

 

My bad. I was looking at something else and made a mistake. ;)

[madteaparty]

We opted not to do 529s.

 

We have had a couple of friends get burned with them. One family had 2 kids. One didn't go to college and the other got a full ride.

 

Another family had two kids. Neither went to college.

 

They had to take the penalty.

 

We just saved in IRAs and savings accounts. But we haven't touched that yet as I we are trying to cash-flow college with me going back to work.

I also don’t see the point of earmarked savings except that some states offer a state tax benefit for doing so Edited March 6, 2018 by madteaparty

[JanetC]

I also don’t see the point of earmarked savings except that some states offer a state tax benefit for doing so

 

Savings accounts and other non-tax advantaged accounts (mutual funds, etc) -- you pay federal taxes on the interest or capital gains every year, so your principal doesn't grow as fast. The longer your time horizon, the more this can add up over time.

 

IRA - see link in post 26 how using IRA money for college can hurt you in the financial aid formulas. Basically, getting income from an IRA will be assessed more strongly than liquidating an asset for college.

 

[Bootsie]

Savings accounts and other non-tax advantaged accounts (mutual funds, etc) -- you pay federal taxes on the interest or capital gains every year, so your principal doesn't grow as fast. The longer your time horizon, the more this can add up over time.

 

IRA - see link in post 26 how using IRA money for college can hurt you in the financial aid formulas. Basically, getting income from an IRA will be assessed more strongly than liquidating an asset for college.

Capital gains are only taxed when they are realized.  If I buy a stock for $10 when Johnny is born and sell it for $100 when he is 18 to pay for college, the $90 in capital gains is not taxed until I sell the stock.

 

Mutual funds can be purchased within a tax-advantaged account.  For example, I can purchase mutual funds with money in my IRA.  

[JanetC]

Capital gains are only taxed when they are realized. If I buy a stock for $10 when Johnny is born and sell it for $100 when he is 18 to pay for college, the $90 in capital gains is not taxed until I sell the stock.

 

Mutual funds can be purchased within a tax-advantaged account. For example, I can purchase mutual funds with money in my IRA.

If you invest directly in a stock, the gain will not be realized until sale. However, the best course for most people is to invest in a basket of stocks through a mutual fund. The fund will buy and sell pieces if its portfolio over the years (as well as receiving dividends and earning interest if it holds bonds). A portion of the taxes on these events creates taxable income even if you haven't sold the fund.

 

Yes, an IRA will shield you from those taxes, but again see the link in post 26 on how the financial aid formulas treat IRA withdrawals.

[DawnM]

The FAFSA EFC number (Estimated Family Contribution) is what is used to determine a student's financial need. The higher the number, the less perceived need. The EFC is calculated by a worksheet/formula (you can look it up in the FAFSA EFC Formula Guide for 2018-19) that more heavily weights student income and student assets than parent income and parent assets

 

student income = 50%

parent income = 47%

student assets = 20%

parent assets = 5.65%

(from the most recent figures I could find)

 

A 529 account is an asset, and is taken into consideration in determining the EFC number, so much less of that asset is counted if it is in the parent's name.

 

And yes, any switches need to happen by 2 years before the student attends college, as the new FAFSA now stretches back that far in looking at family income and assets to determine EFC.

 

(I'm doing a session on Financial Aid this Friday for my homeschool group, so this was a great practice opportunity question, Garga -- thanks!   :laugh: )

 

 

You can get a quick estimate of your FAFSA results at the FAFSA4caster, or an even quicker/rougher estimate from your adjusted gross income off of the Troy Onink color-coded chart way down in his helpful article: "2017 Guide to College Financial Aid: The FAFSA and CSS PROFILE".

 

How'd I do -- am I ready for Friday? LOL!

 

Interesting

 

My friend claims that even though her husband didn't have income coming in, the fact that he owns a business makes them ineligible for financial aid.  

 

That didn't seem right to me, but I  think there is a lot she isn't telling me.

 

Now I am wondering if they didn't qualify for LOANS because of the huge loan they had on the business?????  

[Bootsie]

If you invest directly in a stock, the gain will not be realized until sale. However, the best course for most people is to invest in a basket of stocks through a mutual fund. The fund will buy and sell pieces if its portfolio over the years (as well as receiving dividends and earning interest if it holds bonds). A portion of the taxes on these events creates taxable income even if you haven't sold the fund.

 

Yes, an IRA will shield you from those taxes, but again see the link in post 26 on how the financial aid formulas treat IRA withdrawals.

I was not trying to suggest that someone should use an IRA for college-related expenses.  I was trying to clarify that a mutual fund is not a "tax advantaged" or a "non tax advantaged" account.  Both tax advantaged and non-tax advantaged accounts may hold mutual funds.  

[JanetC]

I was not trying to suggest that someone should use an IRA for college-related expenses. I was trying to clarify that a mutual fund is not a "tax advantaged" or a "non tax advantaged" account. Both tax advantaged and non-tax advantaged accounts may hold mutual funds.

Gotcha!

[DawnM]

In reference to the bolded, if a student gets a scholarship, a 529 withdrawal up to the amount of the scholarship can be taken by the account owner (parent) with no penalties, i.e., the 529 money is not "wasted" just because a scholarship is awarded.

 

They had a hefty penalty, so I am not sure how that worked.  Does it cover grants too?  

[DawnM]

529 accounts have an account owner (which should be the parent, ideally) and a beneficiary which is your kid. If you don't use it all, the beneficiary can be changed to another close family member (sibling, parent, child, even cousin) with no penalty as long as you don't try to change it too often.

Edited to add: some states have tax benefits for 529 contributions for the account owner.

 

I do know this.  We just had no intention of waiting for a grandchild to go to college, and we certainly weren't giving it away to a cousin.  We wanted to save for our own kids.

 

Anyway, it has worked out fine for us.

[madteaparty]

Savings accounts and other non-tax advantaged accounts (mutual funds, etc) -- you pay federal taxes on the interest or capital gains every year, so your principal doesn't grow as fast. The longer your time horizon, the more this can add up over time.

 

IRA - see link in post 26 how using IRA money for college can hurt you in the financial aid formulas. Basically, getting income from an IRA will be assessed more strongly than liquidating an asset for college.

Yes I know. I still don’t think, the way we invest, the tax saved on earnings is worth it, owing to the restrictions. Edited March 7, 2018 by madteaparty

[TarynB]

They had a hefty penalty, so I am not sure how that worked.  Does it cover grants too?  

 

Yes, grants and scholarships are treated the same for this.

 

They would have had to pay income taxes on the 529 withdrawal up to the amount of the scholarship/grant; they should not have paid the additional 10% penalty. Perhaps the people you're talking about are interchanging the terminology and mistakenly referring to the income tax as a "penalty". I'm sure if they weren't expecting it then it might have felt like a "penalty" to them.

Edited March 7, 2018 by TarynB

[Julie of KY]

Also, some take the 529 money out with the penalty not realizing that they can withdraw the amount of the scholarship penalty free (but not tax free). I also agree that they might simply call the income tax owed a big penalty.