Ask Liz Weston

Get smart with your money

College Savings

Q&A: Saving and investing for a child

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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

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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

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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

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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

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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

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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.