September 2018

Back to the Future: Planning for College

Author: Thomas Dowling, CFP®

Back to school means back to the future. By future, I mean your little, or not-so-little, one’s collegiate future. No matter what grade your child is in, back to school reminds us of the end result.
How am I going to pay for college? Are my grandkids going to be able to afford to go to the college they want to attend? Are they going to qualify for financial aid if I help them? Are they going to be in debt for the first 20 years of their working life?

All of us, at some point or another, will have or already have been haunted by the above questions.
529 Plans

A 529 plan can be extremely effective for paying college expenses, however be aware there can be some pitfalls, specifically with distributions and financial aid. A 529 plan is an education savings plan used to pay the costs of qualified educational institutions nationwide. Although contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is withdrawn to pay for qualified educational expenses (including private K-12). Additionally, many states currently offer residents a tax deduction or credit for 529 plan contributions. For example, in South Carolina, you have an unlimited state tax deduction up to the maximum contribution amount of $500,000.
www.futurescholar.com/resources/commonquestions

Even though 529 plans can differ from state to state, you can be a South Carolina resident, invest in an Ohio plan, and send your student to college in New York. However, choosing an out-of-state 529 plan may mean forfeiting any state tax advantage.

What about financial aid?
A 529 account owned by a parent for a dependent student is reported on the federal financial aid application (FAFSA) as a parental asset, which is assessed at a maximum 5.64 percent rate in determining the Expected Family Contribution (EFC). This is considerably less than the 20 percent rate on non-529 assets owned by the student.

A 529 account also has favorable treatment in the income portion of the financial aid eligibility formula. A distribution from the parent-owned 529 plan to pay college expenses will not be considered income.

However, grandparents…
This leads to the pitfall for grandparent-funded college 529 plans. A grandparent-owned plan is not reported as either a parent’s or a student’s asset, so it will not affect their eligibility for need-based financial aid; however, distributions from the grandparent-owned 529 plan technically are considered a gift to the student and treated as untaxed income in the following year. This aspect of a 529 plan is far less understood and could affect the student’s eligibility for financial aid.
www.savingforcollege.com/grandparents/answer.php?grandparent_faq_id=10

What can we do?
Keep in mind that each person’s circumstance is different, therefore you should consult your tax and estate advisor. A few solutions may be:
• Wait to withdraw money from the grandparent-owned 529 until after the financial aid form has been filed for the student’s sophomore year.
• If your plan allows, switch the owner to the parent of the student or the student themselves (the latter can bring up a host of other issues and should be considered carefully).
• If your plan does not allow this, transfer the plan to a state 529 that does allow switching. In the case of South Carolina and Georgia 529 plans, they do allow for changing the owner from a grandparent to the parent of the student.
www.savingforcollege.com/compare_529_plans/?plan_question_ids[]=78&page=compare_plan_questions

Other considerations:
• Off-campus housing. Here is another possible pitfall, because room and board expense no longer appear on the school bill. You can use the 529 plan funds for off-campus living, but only up to the amount the school charges for room and board. For example, if the off-campus living expense is $12k and the school allows for $10k, you can only use $10k from the 529 plan.
• Computer and Internet services. You can pay for a computer and Internet expenses; however, they must be used primarily for the benefit of the student, and here is a caution. Watch out when the Internet bill comes bundled with other services.
• Withdrawing too much money. If it’s within 60 days of the distribution, you can roll it back into a 529 plan, provided you have not rolled over that child’s 529 account within the prior 12 months. If it is after 60-days but within the same calendar year, you can look to prepay next year’s expenses if the school allows. If it’s after year-end, there’s not much you can do about it. You need to pay tax and penalty. But remember, it is on the earnings, not the contribution amount.
Please consult your financial, estate and/or tax advisor regarding your personal circumstances and if these strategies may be suitable for you. An investor should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.

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