Q&A: Is it time to rethink college savings?

Dear Liz: My wife and I have three kids ages 4 and younger. We have been diligently saving in our state’s 529 college savings plans for all of them. Now with various concepts of free college and student debt relief gaining traction, I’m wondering if we would be better off simply investing future amounts elsewhere that don’t lock it into educational expenses, which may look very different in 14 to 18 years.

Answer: Politics is the art of the possible. Although some student debt relief is possible, as is some expansion of free college options, it’s hard to imagine a U.S. where college educations are entirely free for everyone.
Even in states that currently offer free two- or four-year public college options, the aid is typically limited to free tuition, which means students still have to pay for books, housing, meals, transportation and other costs. Some programs are need based, which means not all students qualify, and many students choose other non-free options, such as private colleges and graduate school.

So the advice hasn’t changed: If you can save for college, you probably should. You may not be able to cover all the costs of your children’s future education, but anything you save will probably reduce their future debt.
In an uncertain world, 529 college savings plans offer a lot of flexibility. The money can be used tax free for a variety of college expenses, and any unused funds can be transferred to a family member — including yourself or your wife, should either of you want to pursue more education. If you withdraw the money for non-education purposes, only the earnings portion is typically subject to income taxes and the 10% federal penalty.

Q&A: Are those 529 college savings plans still a good idea?

Dear Liz: Last week we had an infant come into this world and we’re already thinking about college. I know you’ve addressed this before, but things change and I was wondering if the 529 plan is still the way to go. If our son decides not to go to college, what are the tax consequences?

Answer: Congratulations! Yes, state-sponsored 529 college savings plans are still a great way for many families to save for future college costs. The money grows tax deferred and withdrawals are tax free when used for qualified education expenses.

Even if your son opts not to go to a four-year college, he will probably need some kind of post-secondary education. Withdrawals from 529 plans can be used to pay for any accredited school in any state, including community college and trade schools.

On the off chance that he doesn’t get any kind of schooling, or conversely gets a full ride, you can change the beneficiary so that the money pays for the education of a sibling or other close relative, including yourself. And if nobody wants to use the money for schooling, you can simply withdraw it. The earnings will be taxed and subject to a 10% penalty.

Q&A: How to protect a child’s education savings from greedy adults

Dear Liz: I understand that money for children’s college education can be put in a bank account with a parent as the trustee under the theory (I suppose) that the child might make bad decisions. In my case, money that I had worked hard for was put into a custodial account and then used by my parents for “necessary” household expenses. My family was not impoverished. This was a dreadful memory for years, and I’m not the only one. Social Security money for a relative, a child, was lost in a divorce. In another case, money was given to a parent for education, but was used in a failed real estate deal, with the children never realizing the money was meant for them. How can money be invested for a child’s education without it being available to an adult for “necessities”?

Answer: When parents take money that belongs to their children, they may not think of it as stealing. But that’s exactly what it is, legally and, of course, morally. There are clear rules for custodial accounts and trusts that should prevent such self-dealing, but often the child’s only recourse would be to sue the parents. That could make for some awkward Thanksgiving dinners.

There wasn’t much you could have done as a child to prevent the theft. But if you ever want to give money to another child, think carefully about the integrity and ability of the person you’re putting in charge of the money.

First pay attention to how they handle their own money. Someone who’s deeply in debt or living paycheck to paycheck may not have the skills to be a good steward.

Then ask yourself, “Could I see this person taking the money if they were really hard up for cash or could otherwise justify it to themselves?”

Then pay attention to your gut reaction. If you believe the person has integrity, that doesn’t mean something bad can’t happen, but you’ve certainly reduced the odds. If you have questions, or you don’t know the person well, you may have other options.

For college expenses, you can open a 529 college savings plan, name the child as the beneficiary and continue controlling the account yourself until the money is paid out for college.

This approach can have potentially large financial aid implications if you’re not the parent, so you may need to delay distributions until after the child files his or her last financial aid form. Sites such as SavingForCollege.com have more information about how these plans interact with financial aid.

A 529 plan probably will be the best option in most situations. Otherwise, you can consult a lawyer about setting up a trust and naming a trustee other than the parents. Trust distributions also can affect financial aid, so you may need to time those carefully.

Q&A: Redirecting a 529 college savings plan

Dear Liz: Years ago when my children were young, we established 529 college savings plans for them. Unfortunately, both children ended up in the wrong crowds and never entered college. We still have the funds. What are our options? We do have a grandson now; would it be possible to change the beneficiary?

Answer: Yes. You can change a 529 plan’s beneficiary without triggering a tax bill as long as the new beneficiary is a “qualifying family member.” By the IRS’ definition, that includes the original beneficiary’s child or other descendant. (Qualifying family members also include spouses and siblings, parents, in-laws, uncles, aunts, nieces, nephews and cousins.)

Q&A: This 529 college savings plan has a problem: no kids

Dear Liz: When I found out I could save for my future children by enrolling in a 529 college savings plan and not pay taxes on the growth, I started doing that three years ago. Since then I got married, and my wife decided to get an MBA. I have $41,000 saved away for my currently nonexistent children. Am I able to transfer that money to my wife and use it to pay for her MBA without getting penalties?

Answer: Yes.

The beneficiary of your 529 plan is not actually your unborn children, since you can’t open these plans for nonexistent kids. When you started the account and were asked for the beneficiary’s Social Security number, you probably provided your own.

That could have created a small problem down the road when you did have kids because changing the beneficiary to someone one generation removed — from parent to child, for example — is technically making a gift, and gifts in excess of $15,000 per recipient per year are supposed to be reported to the IRS using a gift tax return. Fortunately, you wouldn’t actually owe any gift tax until you’d given away several million dollars above that annual limit.

By contrast, changing the beneficiary to a family member in the same generation — from yourself to a spouse, for example — is not considered a gift and wouldn’t trigger the need to file a gift tax return.

Q&A: A reader’s college funding rules

Dear Liz: I’d like to share with other parents how my husband and I paid for college for our two daughters. We had three rules. 1. If an out-of-state or private college was chosen, then they would be required to pay us back the difference compared to an in-state public school. They both did opt for that and both paid us back every cent. 2. We would only pay for four years and not one more day. Get in, get out. Go to summer school and work jobs. 3. They would receive a monthly allowance of $100 only. Both daughters got a fabulous education, are grateful and felt they had invested in their future well. So did we and we are very proud of them.

Answer: As well you should be! Obviously, many parents can’t afford to be nearly as generous with their kids, but those who can be should think about putting limits on their generosity to make sure their progeny are motivated to get the most out of their education. One caveat: Getting a degree in four years has become increasingly difficult at many public colleges because of budget cuts. You don’t say when your daughters graduated, but today’s parents may need to keep that in mind when figuring out how much to contribute.

Q&A: What to consider before giving money for law or medical school

Dear Liz: Our daughter is in medical school using scholarships and student loans. We are now in a position to help her out, but worry that financial help might work against her sources of aid. Would it be better to pay some on her outstanding loans, give her money, pay some of her living expenses or put the money into a savings account to give her when she graduates to use towards paying down her debt? The amount we could give her would not be enough to pay for everything each semester, just something to ease her burden. We don’t want to jeopardize her ability to receive aid.

Answer: While nearly all graduate students qualify as independent — which means that parent financial information isn’t required to get aid — some medical and law schools do consider parental assets and income in their calculations.

Your daughter should call her school’s financial aid office anonymously to ask about its policy regarding parental aid, said Lynn O’Shaughnessy, a college financing expert at TheCollegeSolution.com. If your help would hurt, you can use the savings account route but you needn’t wait until she graduates to give her the money. Once she files financial aid forms for her last year, she should be able to accept your largesse without consequence.

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.