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Posts Tagged ‘College Financial Aid’

For college-bound students, funding retirement has to be the farthest thing from their minds. Yet, with a little planning, parents may be able to kill two birds with one stone. Unfortunately, most parents of college-bound kids tend to overlook some obvious ways to lower the cost of college but wisely using the tax code and some retirement planning techniques can help.

It may be a low-priority item, but this strategy can help parents when it comes to planning how to pay for college. How?  By lowering the Expected Family Contribution (or EFC) of the family and sheltering assets in a retirement account, there is the potential for qualifying for more needs-based financial aid.

Roth IRA

Consider using a Roth IRA for any earnings that a student has from part-time work.  For students over 16 they can put away up to $5,000 each year (or up to their total earnings, whichever is less) from all those part-time or summer jobs. Students already in college can also use this same strategy.

A Roth IRA allows any wage earner regardless of age to put money away now and then later withdraw money without paying taxes on the earnings. When you contribute to a Roth IRA, there is no tax deduction as there is with a traditional Individual Retirement Account (IRA) but there are other advantages.

If a student earns money and the parents leave it commingled in one of their accounts, the balance will potentially be assessed at the student’s higher rate as an asset available for paying for school.  Parents may want to maintain control over funds and have the earnings put into an account in their name but this will show up as a parental asset subject to assessment by the financial aid formulas used by colleges.

On the other hand, funds in a Roth IRA are not counted and will not affect financial aid calculations.

Follow the Road Map

The key to this strategy is following the rules of the road. Any funds placed in the account as a contribution may be withdrawn at any time free of taxes or penalties.

For earnings that may accrue on the account balance, these may be subject to income taxes or penalties but there are exceptions.

Converted Assets

For amounts that were converted from another IRA and recharacterized as a Roth, there are special rules.  For amounts that meet the five-year holding test (from the date the account was first opened) then no income taxes or early withdrawal penalties apply. If a withdrawal is made within five years, then a 10% early withdrawal penalty applies unless it is for a special purpose.  One of the eight special purposes is withdrawals used for higher education expenses.

Withdrawals of Earnings

While income taxes will apply, no 10% early withdrawal penalties apply when the proceeds are used for one of eight special purposes including higher education expenses.

Distribution Rules

For distributions from a Roth IRA you need to note that Roth contributions are always considered to be the first amounts withdrawn.  These are not taxable.  Then any amounts that were converted from other IRAs are considered to be withdrawn second and subject to the time line noted above.  Finally, earnings on the account are considered to be withdrawn last.

Ideal for the Self-Employed Parent

Consider employing your kid in your business and paying them instead of just giving them an allowance.  I write about this on a previous blog found here. This way you can lower the taxable profit from your business which may help you qualify for more financial aid.  And by diverting the wages earned into a Roth IRA as a contribution, your child will not have this asset exposed for the financial aid calculations.

Use It Now or Later

This strategy can be used for late-starters, those who haven’t saved enough for upcoming college bills.

But it can also work very well if you start early.  Since there is a five-year rule in place, open a Roth IRA account even while the child is in middle school and working part-time outside the home or in the family business.  Then by the time the child is ready to enter his third or fourth year of college, he may be able to withdraw some of the earnings to pay for costs without paying any penalties.

By using this strategy, parents can help their students learn to save and the funds can be available in a tax-efficient way during college to pay qualified education expenses.  Or they can skip the withdrawals while in college and use them later for graduate school or to help pay for their first home purchase.

Advantages of This Strategy:

  • Shelters assets from financial aid calculations
  • May help lower family Expected Family Contribution (EFC)
  • Instills value of saving early for goals
  • May help accumulate capital that can be used later for school with tax efficient withdrawals
  • May help save for future home purchase or better yet … retirement

 

For more tips, check out my free webinar offered monthly. For a current schedule visit the Clear View website.

 

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In the initial article of this series, I mentioned ten specific ways to lower college costs.  These included such ideas as taking Advanced Placement exams to earn college credit, considering an in-state college, using the American Opportunity Tax Credit  formerly known as the Hope Education Credit, employing your child in your business or investment real estate business and encouraging your child to use the proceeds to fund a Roth IRA.

But even if you haven’t stashed a lot aside for expected college costs, there are strategies you can take to maximize the financial aid that your child may be able to receive.

Many parents mistakenly believe that they “make too much money” to receive aid.  Or they look at the “sticker price” of a private school and think that it is way too expensive to afford.  In reality most people never pay the full sticker price and with some planning ahead of time many can find ways to make even such private schools within reach.

Yet many would be surprised to find out that by speaking with a knowledgeable professional they increase their chances for an aid package that makes college more affordable and less stressful to their personal retirement plans.

Remember that the more time you have before your child or children begin college, the more options you have.  But even if college tuition bills loom on the horizon, there are things that you can do to be better prepared.

Expected Family Contribution:

Everything depends on the Expected Family Contribution (EFC) calculated from a review of income and asset documentation and the Free Application for Federal Student Aid (FAFSA) completed after January 1 of your student’s senior year of high school.

A particular formula is applied to this information to determine what income and assets are eligible from the family (including the student) toward the total cost of a year at college for everything from tuition and fees to room and board, books, supplies and travel.

  1. So this first year, called the “base year,” is the crucial one.

Ultimately then, your goal is to lower your EFC by employing strategies that lower your income or assets in the crucial base year.

Consider this:  If you own a business, you could increase your outflow for needed equipment that results in a lower net income.  You could delay your billings and collections to also lower your net income.  While a business owner needs to report the value of a business, the FAFSA form is not the place to brag.  The value of one’s business need only include actual cash on hand and tangible assets but not intangibles like “goodwill.”  This may help lower the value of your business and increase the amount your student may ultimately be eligible to receive.

On the other hand, maybe you’ve always considered starting a business or because of your job prospects this has become a necessity.  Don’t wait until the children have started or finished school.  By launching the business in the base year, you will incur expenses (including possibly depreciation on equipment) that will lower your reported income.

Even if you don’t own a business, you may have some control over the income and assets you report.

If your child will need a car, a computer or other school supplies, consider buying them in the year before completing the FAFSA.  Since credit card debt is not taken into account in the FAFSA, use extra cash instead to pay off these debts.  Another option might be to prepay property taxes or your mortgage which also provides you with an added tax deduction. All of these strategies will lower the cash on hand.

If you’re expecting a year-end bonus, then try to negotiate with your employer to defer receipt of the bonus into a non-base year.  By doing so, you’ll avoid having the colleges count this twice: once as income in the base year and then again possibly as an asset in your savings accounts.

It’s important to minimize assets held by the student.  So consider using savings or investment accounts held in the student’s name to acquire a car or computers or other needed supplies.  It’s also a good idea to dissuade grandparents and family members from giving cash gifts to the child.  In lieu of a gift to the student, a grandparent could direct the same amount of cash to pay toward the college tuition or fees.

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