With the cost of college education skyrocketing and outpacing wage growth by nearly eight times, it is not surprising that student loans make up the largest portion of the U.S. non-housing debt.
According to College Board, the average cost of tuition and fees for the 2018-2019 academic year for an in-state student at a four-year public university has increased 2.8 percent from the prior year to $21,370. A four-year private university increased 3.2 percent from the previous year to $48,510. What techniques and strategies could be utilized to reduce the burden of potential student debt and keep it from snowballing? How can we best optimize our cash flow to fund all our goals and not become overwhelmed by the escalating cost of education?
The One-Third Model is a funding strategy to help us stay on track with education planning by dividing the cost of college into three parts.
• First Part: use current income to start funding one-third of the anticipated college costs with a tax-advantaged savings vehicle.
• Second Part: pay one-third of the costs with your future/current earnings during your child’s college years. This portion has the potential to be reduced by qualifying for financial aid or receiving by scholarships/awards.
• Final Part: borrow one-third of college costs through a combination of student and parent loans. Student loans allow the student to a have vested financial interest in their own educational performance.
The 529 Plan is the preferred tax-advantage savings education vehicle.
This vehicle allows earnings and qualified distributions for K-12 tuition and qualified higher education expenses to be entirely tax free. The caveat is that if the distributions are not used for qualified education-related expenses, then you will owe a 10 percent penalty on the earnings attributed to the withdrawal; as well as, federal income taxes and possibly state and local taxes. The new tax law allows for most states to deduct your 529 plan contribution on your state income tax return, up to the state’s limit. This translates into a higher account balanced and lower taxes for you.
These 529 plans provide exceptional gift and estate planning benefits since they can be supercharged with five years’ worth of the annual gift tax exemption. This means that individuals can contribute up to $75,000 ($150,000 per married couple) per beneficiary in a single year without the money being subject to the federal gift tax. Florida will allow contributions to continue until the 529 plan/s aggregated account balance for the same beneficiary reaches $418,000. A unique advantage of this vehicle is that the value of the 529 plan is removed from your taxable estate, yet you retain full control over the account including the right to ask for the money back at any time. No other vehicle offers this combination of control and estate reduction. In the event that the current beneficiary decides they do not want to obtain a bachelor’s degree, the plan owner can select another qualified beneficiary. There are no tax consequences or penalties when a 529 plan beneficiary is changed to a member of the beneficiary’s family.
Be advised that the 529 plan ownership can have an impact on financial aid, since the Free Application for Federal Student Aid’s (FAFSA) Expected Family Contribution is calculated differently with student assets having a higher weight, the ownership of the plan is paramount. The account owner should be the parent, because when the money is withdrawn from a grandparent-owed 529 plan and is used to pay for college expenses, it is considered income to the student. FAFSA requires student income to be reported and includes 50 percent of the student’s income into the Expected Family Contribution calculation. This means that a distribution from a grandparent-owned 529 plan to pay the student’s education could reduce financial aid by as much as half of the distribution amount.
A plethora of strategies can be used in congruence with a 529 plan, for instance, federal tax credits (American Opportunity Tax Credit and Lifetime Learning Credit); taking qualified education distributions from your Roth IRA or Traditional IRA (to avoid the 10 percent penalty); or even taking a loan from your 401(k) provider (to take advantage of the employer matching contribution. The interest you pay on the loan goes back into your retirement account). These are only a handful of strategies that can be utilized. To determine the optimal solution, we would need to comprehensively research and review your case.
Start the conversation today with a team of seasoned professionals to determine which strategies and vehicles could be used to achieve your goals while not derailing your path towards financial freedom. As a CERTIFIED FINANCIAL PLANNER™ Professional, I enjoy assisting clients with simplifying all of life’s complexities. We at Coral Gables Trust Company look forward to leading you on the path to living your best financial life.