Last month, this space was devoted to a discussion of how clients with college-bound children can and should borrow any money available from traditional sources of education loans. Since the publication of that piece, dozens more private student lenders have reduced or eliminated their offerings (only a coincidence, I hope).
What's not a coincidence is that in the middle of this election year, several politicians have clamored for assurance that families will be able to borrow as much as needed to get Junior through school. Far be it from me to question the motivations or effectiveness of our elected representatives. But in case their noble efforts fall short, here are some non-traditional ways your desperate clients can scare up college money at the last minute.
Pros: Clients may be able to deduct a larger amount of interest on loans taken against home equity than they could by using traditional education loans. The interest rate may be lower than what is charged by private education lenders, yet the amount available to borrow against home equity could be higher.
Cons: Lenders are less eager to provide HELOCs and equity loans these days. Home equity loan proceeds may count as an asset, and reduce future financial aid awards. And of course, there is the chance the parents could lose their home if they run into hard times.
Tips: If no more financial aid is forthcoming, clients fearing tighter overall lending standards should borrow all they think they'll need for future college expenses at once, and include a “cushion” in the amount requested to be used to make repayments in a pinch.
IRAs And Roth IRAs
Pros: The contribution portion of Roth IRAs can be withdrawn at any time for any reason with no taxes or penalties. Pre-59½ withdrawals of Roth IRA earnings (as well as any money from regular IRAs) are taxable, but can avoid the usual 10 percent penalty if the money goes for qualified higher education expenses.
Cons: Distributions from IRAs and Roth IRAs can artificially raise income, thereby reducing potential financial aid awards (and taxes). Parents only a few years from retirement should consider waiting until that time to tap the accounts, when taxes should be less and penalties non-existent.
Tips: If this is the only option for parents who are a long way from retiring, consider taking enough out for future needs all at once. Doing so may increase aid awards in upcoming years, and decrease the overall tax rate paid on the withdrawals.
Pros: If an at-work plan allows loans, parents can usually withdraw up to the lesser of $50,000, or 50 percent of the vested value of the account with no credit check or lengthy application process. Interest charged is usually in the single-digits, and paid by the borrower to his own account.
Cons: Repayments are made with after-tax dollars. If the parent loses a job with a 401(k) loan outstanding, the balance may be due immediately. In the then-likely event she can't pay the loan back, it becomes a taxable distribution — when the family can probably least afford to pay the taxes.
Tips: Some company retirement plans allow hardship withdrawals for limited education expenses. But penalties and taxes will still eat up a big chunk of what's taken out under these circumstances.
Pros: Parents and/or students can either work more, spend less, or both to come up with enough to augment any aid and savings. The focus on frugality may help parents have a more secure retirement, and the kids appreciate the value of the sacrifices made by the family.
Cons: A working student may sacrifice grades and credits for hours at a part-time job, delaying both graduation and a big-time salary. Parents should avoid foregoing pre-tax retirement plan contributions, as just the tax savings from continuing to contribute may far outweigh the cost of using other options.
Tips: Many schools will allow a year-long monthly installment payment plan, charging little or no interest. But arrangements need to be made in advance of the start of the school year.
Savings & investments
Pros: The cost of borrowing large sums of money for college will likely exceed the prospective rate of return available on investments and savings, in both magnitude and certainty.
Cons: Liquidating positions may trigger a big capital gains tax bill, as well as unnecessarily reduce financial aid (see below). The drawdown of assets also wipes out the potential of future gains, and may put the clients into a liquidity crunch down the road.
Tips: Moving investments into cash at least a couple of years before it will be needed for college solves two worries: First, it will prevent the anticipated funds being hacked by a sudden market decline. Secondly, it can prevent sales proceeds from artificially inflating reported income (and reducing financial aid awarded).
Life insurance PolicIes
Pros: An unneeded cash value policy's cash value can be tapped to pay expenses, either via a loan from the policy or a straight liquidation. Future earnings of the policy are unlikely to exceed either the rate offered by other investments, or the interest rate paid on borrowed money.
Cons: Again, reaching into the policy's accumulated worth can mean more taxes and less financial aid. Also, with a college student or three relying on your clients' earnings and support, this isn't the time to “go bare” on life insurance coverage.
Tips: If the clients do decide to tap an outdated policy, first make sure they at least have coverage through an at-work policy, or can obtain short-term coverage with some of the cash value policy proceeds.
First Call For Help
The good news for your cash-strapped clients (and you) is that there is an expert resource available that is free, relatively unbiased, and whose sole purpose in life is to find ways to help families pay for college.
It's the school's financial aid office. That may seem like an obvious place to turn, yet it's confounding how many families either never make contact with the financial aid staff at their kid's school, or don't make a follow-up request when panic sets in.
If you're talking clients off of a ledge (figurative or otherwise), suggest they call the school and say, “We don't have enough money to pay you. What do you suggest we do?”
My guess is the school will be even more excited than the clients to make sure the tuition bills get paid.
Writer's BIO: Kevin McKinley
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. You can reach him at [email protected].