Parents must factor in 529 and retirement accounts to save for kids' education
FOR THIS EDITION OF "THE BOTTOM LINE" I reply to a question from reader Catherine Hurst:
Her question: I read your recent article on college saving plans ("Education plans stretch saving for kids' school," Oct. 12) with great interest. I recently decided we should begin a 529 plan for our daughters and took a class at our local rec center dealing with planning financially for college.
But the message at the class was this: If you feel that you may qualify for financial aid, you should not put money aside in college savings plans since it will hurt your chances of getting aid. I am now thoroughly confused! What's the smart thing to do?
My answer: Sixty percent of college undergraduates received financial aid during the 2003-04 school year, according to a September study by the National Center for Education Statistics. Hence, it makes sense to consider the implications your college savings decisions have on your child's eligibility for aid.
Retirement account contributions are a viable strategy, given that IRA withdrawals for higher education expenses are not subject to the 10 percent early withdrawal penalty. Unlike other parental "investment assets," retirement accounts aren't included on your child's federal student aid application; 529 plan assets are.
However, the answer isn't that black and white.
"Sure, (529) deposits for college hurt you on the financial aid calculators," says Daniel Dollinger, a certified financial planner and accountant. "But I would still put money aside in 529 plans, which in general are fine, because it provides another way to save and you don't have to pay taxes when you take the money out."
Hence, you'll want to weigh several factors in saving.
Bruce Harrington is 529 plan product manager at MFS Investment Management, which manages college savings plans. He says, "In the debate of 'retirement account bucket' versus 'college savings bucket,' it's tempting to assume that the best type of asset to own when applying for financial aid would be a retirement account, since it's not counted in determining the expected family contribution.
"However, withdrawing money out of any retirement account to pay for college actually could jeopardize financial aid in the following year," Harrington says. "Withdrawals of principal and earnings on traditional IRA accounts are counted as (parental) income on the following year's aid application."
Withdrawals from a 529 plan are considered the child's income on the following year's financial aid application.
But if you open a 529, you're better off doing so in your child's name than your own. "Federal aid formulas count only 5.6 percent of parental assets while counting 35 percent of money saved in a child's name," says Harrington.
Beginning July 1 and for aid packages for the 2007-08 school year, the formula drops to 3.28 percent for parents and 20 percent for students.
There is a loophole: The application for federal student aid asks only for parental and student assets. Anyone else can open and fund a 529 plan in the student's name without impacting the student's financial aid eligibility.
With a 529 plan, if your child opts not to attend college, the assets can be transferred to another family member without penalty, or withdrawn with a 10 percent penalty and income taxes on the growth.
With a retirement plan, if your child skips the education track, you'll still have that money to use, penalty free, but with growth taxed at your ordinary income level, after you turn 591/2. Withdrawals from a Roth IRA aren't taxed, so consider opening one for any and all future long-term savings.
"If you have a choice between retirement and education, then you put it into retirement," Dollinger says.
For those who have maxed out their retirement account contributions, experts say a 529 plan is the next best route.
"People want a golden answer to this question and there really isn't one," says Joylyn Ankeney, a certified public accountant at Merina & Co. "Everyone's tax situation is a little different, and what they want from their investment control is different."
Despite the complexities, remember your ultimate goal: to make sure your child has the resources to afford higher education.
"Unfortunately, some families don't bother to save because they believe that saving puts them in a less advantageous position," Harrington says. "Saving and planning will simply allow you to control your own destiny."
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Comments: 5
Special needs planning should be a focus available from most financial planners with a broad approach, like the CPA or CFA.
Since the 529's vary so much from state to state, be sure to get good info for your locale. For example, in NY, the 529 contributions are not just tax deferred, they also offer a deduction on the state return.
What you don't use for education from these accumulted funds, there is also a deduction or tax credit.
Don't let your law makers lose sight of the importance of these deductions! Call or write by e-mail your Congressmen/women or Senators TODAY so that these education deductions don't become severely limited.
Be sure to touch base with your tax advisor or financial planner for this kind of stuff.
Seems that this appears to be shifting blame back and forth between assemblies of Congress people over balanced budgets.
Educational benefits is one of these. I would prefer to see us able to compete on a global plane. If you want to restrict the monies not going into the coffers, then make the benefits tied into grades.
I urge everyone to make calls or send e-mails to their Congress people (in the House and Senate) to act before the end of the year.