Q&A: Saving and investing for a child

Dear Liz: I recently got a court judgment for my daughter’s father to pay me child support. She is 1 year old, and it will be about $1,500 a month. I would like this money to be a gift for her when she is older. I’m told not to put it in her name now, as it may hurt her chance for financial aid for college later. How do you recommend I save and invest it for her? I’d like her to have it when she is a young adult.

Answer: This could be quite a gift for a young woman. If the money earned a 5% average annual return over time, you could be presenting her with a check for half a million dollars.

Consider putting at least some of the money in a 529 college savings plan. Withdrawals from these plans are tax-free when used to pay qualified college expenses. College savings plans receive favorable treatment in financial aid formulas because they’re considered an asset of the contributor (typically the parent), rather than the child.

Q&A: College savings strategy

Dear Liz: I will be 66 in May 2016. My wife is 68 and retired. She began receiving Social Security when she turned 66. I am still working, making a high six-figure income, and will continue to do so until I reach 70, when my Social Security benefit reaches its maximum. I plan to use my Social Security earnings to save for my grandchildren’s college educations (unless an emergency occurs and we need the income). I want to maximize the amount that I can give them. What is the best strategy, taking into consideration the recent change in Social Security rules relating to “claim now, claim more later”?

Answer: You just missed the April 29 cutoff for being able to “file and suspend.” Before the rules changed, you could have filed your application at full retirement age (66) and immediately suspended it. That would allow your benefit to continue growing while giving you the option to change your mind and get a lump-sum payout dating back to your application date.

Since Congress did away with file-and-suspend for people who turn 66 after April 30, that option is off the table for you. There are other ways to maximize your household benefit, said economist Laurence Kotlikoff, author of “Get What’s Yours: The Secrets to Maxing Out Your Social Security.” They include:

•Your wife suspends her benefit and lets it grow for another two years, then restarts getting checks when she turns 70.

•At 66, you file for a spousal benefit. People who are 62 or older by the end of this year retain the ability to file a “restricted application” for spousal benefits only once they turn 66. That option is not available to younger people, who will be given the larger of their spousal benefits or their own benefits when they apply.

•At 70, you switch to your own, maxed-out benefit. Again, the ability to switch from spousal to one’s own benefit is going away, but you still have the option to do this.

Consider saving in a 529 college savings plan, which offers tax advantages while allowing you to retain control of the money. You can even withdraw the money for your own use if necessary, although you would pay income taxes and a 10% federal penalty on any earnings.

You should know, however, that college-savings plans owned by grandparents can mess with financial aid. Plans owned by grandparents aren’t factored into initial financial aid calculations, but any disbursements are counted as income that can negatively affect future awards. One workaround is to wait until Jan. 1 of the child’s junior year, when financial aid forms will no longer be a consideration, and pay for all qualified education expenses from that point on.

Obviously, you won’t have to worry about this if your grandchildren wouldn’t qualify for financial aid anyway. If your children also make six-figure incomes, that’s likely to be the case.

Q&A: Best way to pay for college

Dear Liz: We have two children in college, both entering their junior years. We have two more in high school. The two currently in college need additional financial assistance, as they’ve tapped out their federal student loans.

We are middle class, grossing about $125,000 a year, so we don’t qualify for much financial aid. We’re considering a cash-out refinancing of our home, but we feel as though we can do it only once, since each time we refinance it will cost us some fees, plus interest rates are likely to start edging up soon.

However, if we take out a big chunk of cash that could last us for the next two years for the first two children, and possibly some for the other two, we’re concerned that having that much cash sitting in the bank will reduce the amount of financial aid we receive, which would be counterproductive.

Is there a way to earmark the extra cash clearly for education expenses so that it doesn’t count negatively on our Free Application for Federal Student Aid (FAFSA)? Or do we just need to take this year’s cash out now, and refinance again each year (which seems crazy)?

As an aside, now that we have a little experience with this college thing, we will guide the two younger ones to community college or living at home while attending a less expensive public college, or something along those lines.

The first two just sort of went — without a lot of financial forethought.

Answer: The chunk of cash from such a refinance would be counted as a parental asset, provided the savings account is in your names and not those of your child.

So a maximum of 5.64% of the total would be included in any financial aid calculations. That’s not a big bite, but if you’re not getting much financial aid it could offset or erase the small amount you’re getting.

The bigger danger is that you’re taking on debt for something that won’t increase your own wealth or earning power. If you should suffer a severe-enough financial setback, such as a layoff, you could wind up losing your home.

In general, parents shouldn’t borrow more for their children’s college educations than they can afford to pay back before retirement — or within 10 years, whichever is less.

This rule of thumb assumes that you’re already saving adequately for retirement and will continue to do so while paying back the debt. If that’s not the case, you shouldn’t borrow at all.

If you’re going to borrow and can pay the money back quickly, a home equity line of credit may be a better option than a refinance. Interest rates on lines of credit aren’t fixed, but the costs are significantly less and you can withdraw money as needed.

Yet another option: parent PLUS loans, which currently offer a fixed rate of 6.84%. Approach these loans cautiously. It’s easy to borrow too much, since the program doesn’t consider your ability to repay. And like federal student loans, this debt typically can’t be erased in Bankruptcy Court.

Q&A: Tuition gifts and tax breaks

Dear Liz: You recently answered questions about tax breaks for college education expenses. We are contributing $20,000 to our grandson’s college education yearly. He is not our dependent. We are senior citizens with a gross income of about $110,000. Is there any deduction for this expenditure that we might qualify for?

Answer: Your grandson is a lucky young man. Since he’s not your dependent, though, you can’t take any of the available education tax credits or deductions.
The good news is that you don’t have to worry about filing gift tax returns. Each person is allowed to give any other person up to a certain limit each year without triggering the need to file such returns.

This amount, called the annual gift exclusion, is $14,000 this year. Together, you and your spouse could gift up to $30,000 to one person. You wouldn’t actually owe gift taxes until the amounts exceeding this annual exclusion totaled $10.86 million as a couple.

Even if you were giving more than $30,000, there would be a way to avoid filing gift tax returns, and that’s to pay the college directly. Amounts you pay directly to a college or to medical provider are exempt from the limits.

Q&A: The value of associate degrees

Dear Liz: Please continue to encourage people to look into two-year technical degrees. I got my associate’s degree in mechanical engineering and in my first job earned more than my father.

Later I worked for a company that made touch-screen point-of-sale terminals. Time and time again, I trained waiters who had bachelor’s or master’s degrees but couldn’t find better jobs. I now work for a large computer company and have folks sitting around me with those same higher degrees.

Answer: On average, people with two-year degrees are paid less than the average four-year degree holder. One in four people with associate’s degrees, however, earns more, according to the Bureau of Labor Statistics.

These jobs are often in the technical and health fields. Four of the BLS’ 30 fastest-growing job categories require two-year degrees. Those positions include dental hygienist (median annual earnings of $70,210), diagnostic medical sonographers ($65,860), occupational therapy assistants ($53,240) and physical therapist assistant ($52,160).

Other well-paying jobs with good growth prospects requiring two-year degrees include funeral service managers ($66,720), Web developers ($62,500), electrical and electronics drafters ($55,700), nuclear technicians ($69,060), radiation therapists ($77,560), respiratory therapists ($55,870), registered nurses ($65,470), cardiovascular technologists and technicians ($52,070), radiologic technologists ($54,620) and magnetic resonance imaging technologists ($65,360).

Q&A: Uniform Transfers to Minors Act

Dear Liz: My in-laws have gifted stock to our children through the Uniform Transfers to Minors Act (UTMA) to help pay future college expenses. The value of the stock has increased significantly over the past few years.

We would like to sell the shares and move the proceeds into more stable investments for our children. What are our options for those funds? Do you recommend one option over another? I don’t expect them to get much need-based financial aid.

Our household income is approximately $95,000 a year. We have 529 plans for each of our three children and account currently has $6,000 to $9,000.

Answer: If you only have one child in college at a time, then you’re right that you probably won’t get much need-based aid.

If, however, your kids are close enough in age that more than one will attending college simultaneously, you may qualify for more help than you think. One way to find out is to use the EFC Calculator at the College Board website, which can give you an estimate of the amount your family is expected to contribute to higher education costs.

If your kids may get need-based financial aid, then they probably shouldn’t have money in UTMA or other custodial accounts. UTMA accounts and their predecessor, Uniform Gift to Minors Act or UGMA accounts, used to be a good way to save on taxes but changes to the so-called “kiddie tax” rules have made them less appealing.

Income from the accounts above $2,000 a year for children under 19 and full-time college students under 24 is now taxed at the parent’s rate. What’s more, these custodial accounts count heavily against families in financial aid calculations.

Often it’s best to spend down the money by the child’s junior year in high school (by paying for tutoring, a laptop, private school or other expenses that benefit the child.)

Another option is to transfer the proceeds to a 529 college savings plan, since these state-run investment accounts typically are viewed favorably in financial aid formulas. What’s more, the plans offer professional management and diversified portfolios known as “age-weighted” options that grow more conservative as a child approaches college age.

You’ll want to talk to a tax pro about what makes sense in your specific situation, especially since selling the shares all at once may trigger a big tax bill.

Q&A: 529 plans vs. education tax breaks

Dear Liz: You recently mentioned in your column that you can’t use any of the three education tax breaks — the American Opportunity Credit, the Lifetime Learning Credit or the tuition and fees deduction — for expenses paid with 529 college savings plan money. This has me wondering if those 529 plans are really worth it.

Wouldn’t you have to have a really large amount invested to have enough earnings to make it worth not taking one of the credits?

Answer: If college were cheap, that might be a problem. But most people have far more college expenses than they can write off on their tax returns.

The average net price for one year at a four-year college — the published cost minus free financial aid such as grants and scholarships — was just under $13,000 last year, including tuition, fees, room and board. The average net price was around $6,000 at two-year public colleges and $23,550 at private four-year schools.

Many people pay a lot more, as the sticker prices at colleges continue to rise.

As mentioned in the previous column, the three available tax breaks are mutually exclusive, so you can’t take more than one in any given year.

The most generous credit, the American Opportunity Credit, reduces taxes dollar-for-dollar for the first $2,000 of college expenses and then by 25% of the next $2,000 — for a total of $2,500 per student.

If your qualified education expenses exceed $4,000, as they probably will, those tax-free 529 plan withdrawals will come in handy.

Q&A: Investing vs Saving for college tuition

Dear Liz: We recently inherited some money. We’ve never had much. We want to invest our inheritance for our kids’ college education.

We asked around to find investment firms that people have had a good experience with. But how do we know they are honest and make sound investment decisions? How do we know if the rates they are charging are fair and reasonable? (For example, one charges a percentage of the value of the account. How do I know if their rate is a fair amount?)

Answer: If you want to invest the money for college education, you don’t need to consult an advisor at all. You simply can use a 529 college savings plan. These plans allow you to invest money that grows tax-deferred and can be used tax free for qualified college expenses nationwide.

These plans are sponsored by the states and run by investment firms. You might want to stick with your own state’s plan if you get a tax break for doing so (check http://www.savingforcollege.com for the details of each plan).

If not, consider choosing one of the plans singled out by research firm Morningstar as the best in 2014: the Maryland College Investment Plan, Alaska’s T. Rowe Price College Savings Plan, the Vanguard 529 College Savings Plan in Nevada and the Utah Educational Savings Plan.

College savings plans typically offer several investment choices, but you can make it easy by choosing the “age weighted” option, which invests your contributions according to your child’s age, getting more conservative as college draws nearer.

If you still want to talk to an advisor — which isn’t a bad idea when dealing with a windfall — you’ll want to choose carefully.

Relying on friends and family isn’t necessarily the best approach. Many of the people who invested with Bernie Madoff were introduced to him by people they knew.

Most advisors aren’t crooks, but they also don’t have to put your interests ahead of their own. That means they can steer you into expensive investment products that pay them larger commissions.

If you want an advisor who puts you first, you’ll want to find one who agrees to be a fiduciary for you, and who is willing to put that in writing.

Here are three sources for fiduciary advice:

•The Financial Planning Assn. at http://www.plannersearch.org

•The Garrett Planning Network at http://www.garrettplanningnetwork.com

•The National Assn. of Personal Financial Advisors at http://www.napfa.org.

Garrett planners charge by the hour with no minimums. Expect to pay around $150 an hour.

NAPFA planners often charge a percentage of assets — typically about 1%.

FPA members charge for advice in a variety of ways, including fees, commissions and a combination of the two.

Any planner should provide you with clear information about how he or she gets paid.

You’ll want to check the advisor’s credentials as well. The gold standard for financial planners is the CFP, which stands for Certified Financial Planner.

An equivalent designation for CPAs is the PFS, which stands for Personal Financial Specialist. People with these designations have received a broad education in comprehensive financial planning, have met minimum experience requirements and agree to uphold certain ethical standards.

Each of the organizations listed above has more tips for choosing a plan on its website.

Q&A: American Opportunity Credit for college expenses

Dear Liz: I am confused regarding my ability to take advantage of the American Opportunity Credit for college expenses in filing my 2014 tax return.

My accountant told me I didn’t qualify because my adjusted gross income exceeds $80,000. Yet when I researched on the IRS website, I seem to qualify. I paid qualified education expenses for my son to get an MBA and am claiming him as a dependent on my return, since he is unemployed and I support him. My adjusted gross income was $84,905.

The IRS rules discuss modified adjusted gross income less than $90,000. Is my accountant thinking of another tax credit that I don’t qualify for? Can I take advantage of any credit for providing educational expenses for my son to obtain a graduate degree? I filed for an extension in order to resolve this issue.

Answer: Education tax breaks can be baffling because each has different income limits, eligibility requirements and qualifying expenses.

Three of them — the American Opportunity Credit, the Lifetime Learning Credit and the tuition and fees deduction — are mutually exclusive. That means you can take only one per year, and you can’t use any of them for expenses paid with a tax-free 529 plan withdrawal.

It’s no wonder that many people who may be eligible to take these breaks don’t take advantage of them, even though they could shave thousands of dollars off their tax bills.

The American Opportunity Credit is usually the most valuable credit. It reduces taxes by up to $2,500 per student and is 40% refundable, which means people can get up to $1,000 back even if they don’t have any taxes to offset.

But the credit can’t be claimed for more than four years, and any year in which the old Hope Credit was claimed counts toward that limit. Since your son was in graduate school, it’s possible you already used up your ability to claim the credit.

You can qualify for the full tax break if your modified adjusted gross income is below $80,000 as a single filer or $160,000 for a married couple filing jointly. The credit gets smaller as your income goes up. After $90,000 for singles — and $180,000 for a married couple filing jointly — the tax break is no longer available.

If you can’t take the credit, your son might be able to claim it — if he had taxable income last year and you opt not to take a dependency exemption for him. Discuss this possibility with your tax pro.

You make too much money for the other two options: the Lifetime Learning Credit and the tuition and fees deduction. The Lifetime Learning Credit offsets 20% of tuition and certain other required expenses up to $2,000 per tax return.

In 2014, the credit was gradually reduced for modified adjusted gross incomes between $54,000 and $64,000 for singles, and $108,000 and $128,000 for married couples filing jointly.

The tuition and fees deduction reduces taxable income by a maximum of $4,000 for incomes up to $65,000 for single filers and $130,000 for joint filers, and by up to $2,000 for incomes over $65,000 for singles and $130,000 for joint filers. There’s no deduction for incomes over $80,000 for singles and $160,000 for joint filers.

Q&A: Graduation gifts and financial aid

Dear Liz: Our grandson’s stellar high school performance and his family financial situation were such that he was admitted to his state university with grants sufficient to pay all school fees, including room and board, with no loans or work-study. His grandmother and I have a 529 account in his name that has enough money to pay about twice his estimated books and living expenses, given this level of financial aid.

His other grandparents gave him a high school graduation present of a check for four times the annual estimated books and living expenses. Does he need to amend this year’s financial aid form to reflect this generous gift? Should I suggest he put part of the gift aside for future years to diminish the effect on future financial aid?

Because of his unexpected gift, we plan to not use the funds in the 529 account until needed for his undergraduate or possible graduate school expenses. If he doesn’t need the money, we plan to transfer the balance to his younger sister’s 529 account.

Answer: Your grandson won’t have to amend this year’s financial aid forms but he will have to declare the gift on next year’s form. That could indeed reduce his financial aid package, since such gifts are considered to be the student’s income and thus will be counted heavily against him next year.

There’s not much that can be done about it now, but generous grandparents in this situation might think about holding off on their gifts until the student’s final year in college when financial aid is no longer a consideration. Paying that last year’s expenses, or paying down any student loan balances, would be a gift without repercussions.