If saving for college were a race, it'd be a marathon, and even those 26-mile races culminate in a hard push for the finish line.
So it is that college saving does not end when the kid enrolls as a freshman at State U. In fact, in the years that follow this event, strategies to increase available assets, maximize financial aid and reduce taxes and interest expense take on more importance.
The following strategies will ensure your clients have enough money to get Junior to the end of his senior year:
Get thee to the bank
Before they drop their freshman off at the dorms, parents should open up a home-equity line of credit. This safety net ensures that an emergency (like a parent's illness or job loss) won't jeopardize short-term financial support for the student's matriculation plans. Why a home-equity line of credit, instead of a home-equity loan? Because the LOC's flexibility allows the parents to tap only the amount that will be spent, and no more. If the parents instead get a lump sum from a home-equity loan that exceeds the current educational costs, the surplus cash will count as an aid-reducing asset.
Get a student loan, too
Whether the clients need the help or not, they should consider taking out a qualified student or parent loan. The interest may be tax-deductible, and many loans don't need to be repaid until the student gets out of school. But the most attractive feature is the subsidized interest rate. Susan Dynarski, a Harvard expert on paying for college, estimates families receive a benefit equaling up to 30 percent of whatever amount they borrow — meaning that parents or students taking out $10,000 in loans would get a $3,000 advantage to their net worth.
If the family still has any unfortunate balances in the kid's name, spend all of that money immediately, before tapping into any of the parental assets. An empty account should help the student qualify for more aid in the later years of college.
…529s last, just in case
Earnings in state college savings plans are tax-free during both the accumulation and the distribution phase, as long as the money goes for qualified higher-education expenses. And since right now most financial-aid programs count 529 plan money as an asset of the parents, there are few superior vehicles for saving for college expenses. But some financial advisors and their clients worry that because of expiring tax legislation and/or changes in the federal financial-aid formula, 529 assets could one day result in higher taxes and a big reduction in financial aid. They're using these doubts as an excuse to give college savings plans the cold shoulder, but they're probably overreacting. Even in the unlikely event that future qualified 529 withdrawals are both taxed and reduce financial aid, families may still be able to minimize the monetary loss by waiting to tap the accounts until after the family receives the financial-aid office's “expected family contribution” for the student's senior year. A typical college senior will have a tax rate that is next to nothing, and since he has completed his last financial-aid request, liquidating the 529 plan can't hurt the overall aid package he will receive.
Don't get a job
Many of us took advantage of the summer break between college semesters to increase our work hours (and our measly bank accounts). But a student's income can have a tremendous negative affect on aid packages. Generally each dollar earned over the first couple thousand reduces aid by up to 50 cents. On an economic basis, it is smarter to have the student take summer classes instead of working. The extra credits will allow a lighter class load during the regular school year, or early graduation (which really cuts the cost of going to college).
Happy birthday to you
Are you one of those advisors with high-net-worth clients who don't qualify for any financial aid and are planning on paying for college by selling their profitable stock or mutual fund positions? If so, have the parents gift the shares directly to the student and let him sell the securities. Instead of a scenario in which the older generation pays a 15 percent capital-gains tax, the lower-income child would likely pay only 5 percent in federal taxes on the profits.
A gift from Grandma
Benevolent grandparents may be willing and able to write big checks to cover unmet college expenses. But giving more than $11,000 to the younger generations could make it necessary to file a gift-tax return. For these bigger donations, advise the grandparents to make the payments directly to the college or university. As long as the money doesn't touch the hands of any of the descendants, gift taxes will be avoided (see IRS Publication 970 for more details).
Your clients and their children should resist the temptation to pay off higher-education loans any faster than the longest possible repayment schedule. Instead, they should consolidate various accounts into one extended loan, and pay them off via an automatic monthly deduction from their checking account. The corresponding rate could be the cheapest money your clients ever borrow. For instance, recent graduates who combine loans and automate the payments could pay as little as 2.75 percent in annual interest. And whether the student or the parents borrowed the money, up to $2,500 of interest paid each year may be tax-deductible.
Money that would have otherwise gone toward paying student loans down faster than necessary can instead be channeled into the new graduate's 401(k), home down payment, or a 529 plan for yet-to-be-born children. After all, in a few decades the cost of attending four years at Harvard should be (gulp) a tidy half-million or so.
Writer's BIO: Kevin McKinley
is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future. kevinmckinley.com