Congratulations. Your high schooler has reached that time when she’s seriously beginning to think about college. While she’s balancing the good advice she gets from her guidance counselor with the gossip she gets from friends and college social media sites to narrow down her list of school choices, you’ll have the relatively much easier job of figuring out how you’ll will pay for it.
And just in case you haven’t checked tuition rates since you graduated a lifetime ago, you may be in for some sticker shock. The College Board reports that a moderate college budget, including tuition, room and board, and fees, for an in-state public college for the 2017–2018 academic year averaged $25,290. A moderate budget at a private college averaged $50,900. And the bills from many private schools, especially in the Northeast, can easily total $70,000 per year.1
Now, whether you can foot the entire bill yourself or in combination with scholarships and financial aid such as federal student loans and work study your child receives, it’s important to start thinking about where your portion of the bill will come from.
You may not want to wait until her final semester to figure this all out. Knowing the financials in advance will help alleviate one of the many pressure points you both will be feeling at this time.
Start with the costs
Once you and she have created a preliminary list of prospective schools, get an estimate of the total costs by using each school’s college cost calculator. Nearly every college web site has one. Some only require basic income and net worth information. Others make you enter copious amounts of personal information.
At the very least, have information on your current income, last year’s federal tax form, and a current estimate of your net worth by your side, as well as your child’s income information and any assets under her name. Also have her GPA and SAT and ACT scores ready—some schools ask for this information up front.
The result of this process will be a ballpark figure of the total annual costs, minus any potential scholarships your child could receive and any additional financial aid she may be eligible for. The remainder is euphemistically called the “Expected Family Contribution” (EFC)—the amount you and she will need to pay.
Keep in mind that these are, at best, estimates, and, at worst, false advertising. You won’t know the actual offer until she is formally accepted. And if she needs federal financial aid, she (or, more likely you) will need to apply for it through the Free Application for Federal Student Aid (FAFSA). Be warned: The FAFSA process is time-consuming, complicated and often frustrating. And since many schools award financial aid on a first-come, first-served basis, it’s not something you want to put off to the last minute.
Gather your funding sources
Once you have a rough idea of how much the EFC for different schools will be, you may want to start figuring out how you (and she) will pay your share of the bill.
Ideally, you’ve anticipated these costs by saving enough for her college education in a 529 College Savings Plan, Coverdell Education Savings Account, or a Uniform Transfers to Minors Act (UTMA) account.
If these accounts alone will cover all of her estimated college costs (or, at least your EFC), congratulations—most of your work is done.
However, if these accounts won’t cover the entire bill, you may need to use a variety of funding sources. Let’s take a look at how to wisely use any or all of the following sources that may be available:
- 529 or Coverdell plans
- UTMA accounts
- Direct gifts to colleges
- Cash accounts (such as money market funds)
- Sales of taxable investments
Notice that IRA assets are not included here. We’ll get to that later.
529 or Coverdell plans
Draw from the 529 and Coverdell accounts first. When used for qualified higher education expenses the withdrawals are tax free. And, this is why you’ve been contributing to these accounts all these years, right?
If there is money left over after your child’s educational journey is completed, you can assign another person as beneficiary. This other person might be another child, a grandchild, or even yourself.
Alternatively, you can just liquidate the account. Keep in mind that the earnings portion of the money you withdraw will be taxed and penalized if not used for educational purposes.
If you (or your child’s grandparents) established and funded a Uniform Transfers to Minors Act (also known as Uniform Gifts to Minors Act) account for your child, then these accounts can also be a good source for educational funding.
But keep in mind that, unlike most 529 plans, once your child reaches adulthood (age 18, or 21, depending on the state) she gains control over how the money in the account is used. So there’s not much you can do if she decides to spend it on a new car or a trip around the world instead of college.
Direct educational gifts
If your child’s grandparents are looking for a tax-advantaged way to help defray her (and your) college costs, you may want to suggest that they make a direct gift to the educational institution to help pay for her tuition and expenses. These direct payments aren’t subject to the $15,000 per donor ($30,000 per couple) annual gifting limitation.
Tapping cash and taxable investments
It’s better if you don’t need to raid your personal nest egg to pay for your child’s expenses, unless this is part of your plan. But if you must do so we recommend that you:
- Use your taxable cash investments first. Bank accounts, money market accounts, or even expiring CDs are the preferred source of capital because there is no tax consequence to withdraw this money.
- Use a tax-management strategy to minimize capital gains when liquidating taxable investments. You may want to sell those with unrealized losses first. Next, you may want to sell appreciated assets you’ve held for a year or more so you’ll pay the long-term capital gains tax rate, often a more favorable rate. Try to save selling short-term appreciated investments for last, since these gains will be taxed as ordinary income.
If this process seems too overwhelming, a financial advisor can help you figure out how to tap these sources of funding in a way that may minimize tax consequences.
Tip: Avoid Roth-raiding
We’ve had several clients ask if it’s better to withdraw money to pay for their kids’ college costs from their Roth IRA than from their taxable accounts. They point out, correctly, that even under the age of 59½ they can withdraw money from a Roth IRA for qualified educational expenses without paying a 10% early withdrawal penalty, as long as their account has been established and funded for at least 5 years.
The counterargument? Your IRA is meant for your retirement. Even if you don’t think you’ll need your IRA assets during retirement, you never know what the future may bring. A catastrophic illness, a bankruptcy, or other unforeseen events could someday create a need for this capital.
And consider this: All early withdrawals of earnings from a Roth IRA are taxed as ordinary income, rather than as long-term capital gains.
Start your homework today
Your student may be able to pull off doing her assignments until the night before they’re due, but that’s a recipe for disaster when it comes to college planning. The earlier you can get your funding plan in order, the better prepared you and your child will be to take that next important step in her life with a little more confidence and a little less tension.
If you need help either starting a college savings plan or a college spending plan, feel free to contact me at [email protected]
This article was authored by Christopher Gullotti, MSFP, CFP®, a financial advisor located at Canby Financial Advisors, 161 Worcester Road, Suite #408, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
© 2018 Canby Financial Advisors