College Q&A - questions about financial aid - WSJ article
Family Money
College Q&A
Answering readers' questions about financial aid
By ANNE MARIE CHAKER
December 18, 2006; Page R6
From navigating 529s to 401(k)s, saving for college makes many of us want to dial 911.
It's a dizzying area of personal finance, and the rules for federal aid continually change with the political climate. Earlier this year, the Republican-controlled Congress lopped off nearly $12 billion from the federal student-aid program. Now, with Democrats about to take control of Congress, college affordability is back on the agenda. Big promises range from interest-rate cuts on student loans to restoring some expired tax deductions for tuition.
Meanwhile, the rising cost of college continues to outpace the overall rate of inflation, and knowing how to save wisely has never been more crucial. We hope that answering some of your queries will help clarify things a bit -- and perhaps ignite more thoughts and questions from you. As always, you can email us at reports@wsj.com3 with puzzlers we might answer in future columns.
* * *
When marrying my second wife, it was always our understanding that her kids' college education would be her and her ex's responsibility, not mine. Now we find that my finances will be assessed, potentially lowering the amount of aid available to my stepdaughter, who plans to enter college next fall. My wife cannot afford tuition on her own, and her ex's inability to contribute could jeopardize my stepdaughter's chance of going to the school she wants. How do we make the best case for financial aid?
If the child has lived the most in your household in the year prior to applying for federal aid, that makes your wife the "custodial" parent. That, in turn, makes her the one responsible for filling out the federal aid form. As her spouse, you are required to report your income and assets, too. The government considers you a source of support regardless of any previous agreement you may have had with your wife.
The problem with that rule, as you point out, is that it lets the noncustodial parent off the hook. "There are a lot of situations where this doesn't make a lot of sense," says Joe Paul Case, financial-aid director at Amherst College, Amherst, Mass.
But many private institutions, including Amherst, will focus mainly on the two natural parents, rather than the custodial household, in judging how much of their own aid to give. So while the federal formula might not be as generous in your situation, some schools can fill in any shortfalls in federal funds with their own institutional resources.
* * *
When colleges base their financial aid on parent income and assets, do they include a 529 plan in their calculations? I am contributing to such a plan that was set up in the beneficiary's grandfather's name (I am the great-grandfather) in order to avoid it being counted. Was this a good strategy?
It is indeed a good strategy when it comes to qualifying for federal aid. The federal formula for assessing how much a family can pay for college is strictly focused on the finances of parent and child. So 529 plans opened by grandparents go uncounted in the federal calculus.
In distributing their own aid, however, colleges often look at all 529 plans that name the student as beneficiary. So even if the strategy works for the federal-aid calculation, it won't necessarily work for the institution's own aid assessment.
* * *
I have an 18-year-old scheduled to enter college next fall, and have $165,000 saved, about one-third of which is in a Uniform Gift to Minors account (the rest is in a 529 plan). My adjusted gross income of over $200,000 a year makes it unlikely that I will qualify for need-based aid. Should I move funds now from the UGMA account -- containing a mix of stocks and bonds -- to a 529 plan? The advantages of having the funds in a 529 are clear, but I like the flexibility of maintaining two college pools.
You're right that your income probably puts you out of the running for need-based aid, so your planning should focus on how to maximize the amount you have available for college after taxes.
If you liquidate the UGMA to transfer that money to a 529 account, you'll pay capital-gains taxes on those funds. But from then on, that money will appreciate tax-free in the 529 account, whereas if the money stays in the UGMA, any investment gains will continue to be taxed.
Taxes aren't the only thing to consider, though. You will want to take a hard look at the returns you've achieved in the UGMA, suggests Mark Kantrowitz, publisher of FinAid.org4, and compare them with the returns you'd likely see in a tax-free 529 plan. If you seem to be doing a lot better in the UGMA, even with the taxes, then that's a strong reason to stick with what you've got.
* * *
Since our son was a baby, we have saved diligently for college. However, I think we made one big mistake. One of his mutual funds is not in his name; with college two years away we would like to switch it to a custodial account. Is that possible at this late date?
It's not too late to switch ownership of any college-savings funds you have, but in doing so you don't want any account to be in your son's name. That's because when you apply for federal need-based aid, only as much as 5.64% of parental savings is considered available for college, compared with 35% of savings in the child's name -- though the latter rate will drop to 20% starting July 1, 2007.
Your best bet is probably a 529 account, set up in your name and naming the child as the beneficiary. A married couple can contribute as much as $24,000 a year to a 529 without incurring gift taxes.
There is also an "accelerated gift" option that allows a donor to exceed the annual limits by averaging the gifts over a five-year period.
* * *
I have been saving for my daughter's education, but it's entirely in my 401(k) plan. I will be retiring in another four years or so. Rather than take out money now from my 401(k) as a taxable distribution to pay for her tuition, would it make more sense to finance part of her education through loans -- and repay after I'm retired (and at a lower tax bracket)?
Withdrawals from your 401(k) plan to pay for college are taxed and also carry a 10% penalty, so you may want to avoid paying for college that way.
One alternative is borrowing from your 401(k) -- that way you avoid the taxes and penalties, and the interest you pay goes right back into the account, so in essence you're paying it to yourself. However, you will still lose out on any investment gains you might have made on the amount you borrow.
Mr. Kantrowitz, the FinAid.org publisher, suggests federal loans are a better way to go, because while you will pay interest to the lender instead of to yourself, that amount is likely to be less than what you would give up in investment gains by borrowing against your retirement plan.
--Ms. Chaker is a staff reporter in The Wall Street Journal's Washington bureau.
Write to Anne Marie Chaker at anne-marie.chaker@wsj.com5
College Q&A
Answering readers' questions about financial aid
By ANNE MARIE CHAKER
December 18, 2006; Page R6
From navigating 529s to 401(k)s, saving for college makes many of us want to dial 911.
It's a dizzying area of personal finance, and the rules for federal aid continually change with the political climate. Earlier this year, the Republican-controlled Congress lopped off nearly $12 billion from the federal student-aid program. Now, with Democrats about to take control of Congress, college affordability is back on the agenda. Big promises range from interest-rate cuts on student loans to restoring some expired tax deductions for tuition.
Meanwhile, the rising cost of college continues to outpace the overall rate of inflation, and knowing how to save wisely has never been more crucial. We hope that answering some of your queries will help clarify things a bit -- and perhaps ignite more thoughts and questions from you. As always, you can email us at reports@wsj.com3 with puzzlers we might answer in future columns.
* * *
When marrying my second wife, it was always our understanding that her kids' college education would be her and her ex's responsibility, not mine. Now we find that my finances will be assessed, potentially lowering the amount of aid available to my stepdaughter, who plans to enter college next fall. My wife cannot afford tuition on her own, and her ex's inability to contribute could jeopardize my stepdaughter's chance of going to the school she wants. How do we make the best case for financial aid?
If the child has lived the most in your household in the year prior to applying for federal aid, that makes your wife the "custodial" parent. That, in turn, makes her the one responsible for filling out the federal aid form. As her spouse, you are required to report your income and assets, too. The government considers you a source of support regardless of any previous agreement you may have had with your wife.
The problem with that rule, as you point out, is that it lets the noncustodial parent off the hook. "There are a lot of situations where this doesn't make a lot of sense," says Joe Paul Case, financial-aid director at Amherst College, Amherst, Mass.
But many private institutions, including Amherst, will focus mainly on the two natural parents, rather than the custodial household, in judging how much of their own aid to give. So while the federal formula might not be as generous in your situation, some schools can fill in any shortfalls in federal funds with their own institutional resources.
* * *
When colleges base their financial aid on parent income and assets, do they include a 529 plan in their calculations? I am contributing to such a plan that was set up in the beneficiary's grandfather's name (I am the great-grandfather) in order to avoid it being counted. Was this a good strategy?
It is indeed a good strategy when it comes to qualifying for federal aid. The federal formula for assessing how much a family can pay for college is strictly focused on the finances of parent and child. So 529 plans opened by grandparents go uncounted in the federal calculus.
In distributing their own aid, however, colleges often look at all 529 plans that name the student as beneficiary. So even if the strategy works for the federal-aid calculation, it won't necessarily work for the institution's own aid assessment.
* * *
I have an 18-year-old scheduled to enter college next fall, and have $165,000 saved, about one-third of which is in a Uniform Gift to Minors account (the rest is in a 529 plan). My adjusted gross income of over $200,000 a year makes it unlikely that I will qualify for need-based aid. Should I move funds now from the UGMA account -- containing a mix of stocks and bonds -- to a 529 plan? The advantages of having the funds in a 529 are clear, but I like the flexibility of maintaining two college pools.
You're right that your income probably puts you out of the running for need-based aid, so your planning should focus on how to maximize the amount you have available for college after taxes.
If you liquidate the UGMA to transfer that money to a 529 account, you'll pay capital-gains taxes on those funds. But from then on, that money will appreciate tax-free in the 529 account, whereas if the money stays in the UGMA, any investment gains will continue to be taxed.
Taxes aren't the only thing to consider, though. You will want to take a hard look at the returns you've achieved in the UGMA, suggests Mark Kantrowitz, publisher of FinAid.org4, and compare them with the returns you'd likely see in a tax-free 529 plan. If you seem to be doing a lot better in the UGMA, even with the taxes, then that's a strong reason to stick with what you've got.
* * *
Since our son was a baby, we have saved diligently for college. However, I think we made one big mistake. One of his mutual funds is not in his name; with college two years away we would like to switch it to a custodial account. Is that possible at this late date?
It's not too late to switch ownership of any college-savings funds you have, but in doing so you don't want any account to be in your son's name. That's because when you apply for federal need-based aid, only as much as 5.64% of parental savings is considered available for college, compared with 35% of savings in the child's name -- though the latter rate will drop to 20% starting July 1, 2007.
Your best bet is probably a 529 account, set up in your name and naming the child as the beneficiary. A married couple can contribute as much as $24,000 a year to a 529 without incurring gift taxes.
There is also an "accelerated gift" option that allows a donor to exceed the annual limits by averaging the gifts over a five-year period.
* * *
I have been saving for my daughter's education, but it's entirely in my 401(k) plan. I will be retiring in another four years or so. Rather than take out money now from my 401(k) as a taxable distribution to pay for her tuition, would it make more sense to finance part of her education through loans -- and repay after I'm retired (and at a lower tax bracket)?
Withdrawals from your 401(k) plan to pay for college are taxed and also carry a 10% penalty, so you may want to avoid paying for college that way.
One alternative is borrowing from your 401(k) -- that way you avoid the taxes and penalties, and the interest you pay goes right back into the account, so in essence you're paying it to yourself. However, you will still lose out on any investment gains you might have made on the amount you borrow.
Mr. Kantrowitz, the FinAid.org publisher, suggests federal loans are a better way to go, because while you will pay interest to the lender instead of to yourself, that amount is likely to be less than what you would give up in investment gains by borrowing against your retirement plan.
--Ms. Chaker is a staff reporter in The Wall Street Journal's Washington bureau.
Write to Anne Marie Chaker at anne-marie.chaker@wsj.com5
Labels: college planning
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