If you believe most advertising for various college savings plans, such as 529 plans, saving for your child’s college expenses should be really simple.
Start early. Sock away enough money. Earn a ‘sufficient’ return.
Presto! There will be enough money in that pot of gold to pay for the college of your choice – or whatever school your child could get into.
But the reality is far more complicated. So, here’s how to blow up your chances of getting aid. Hey, after all, there’s only so much money to go around. If you don’t get it, someone else will be more than happy to take your share.
Step 1 – Not understanding the financial aid formula
Most people think that only the ‘poor’ people get financial aid. While poor people do get aid, it is certainly not limited to that socioeconomic category.
How much aid you get is driven mostly by income, not savings or assets. Start with your tax return. But things like 401(k) plan contributions (which save current income taxes) get added back for financial aid purposes (adding income, and therefore reducing aid).
Also, for things like selling your primary residence, you may be able to shelter up to $500k (for a married couple) in capital gains. But guess what. That non-taxable gain looks like you just got a $500k bonus. You just made more money…goodbye aid.
Step 2 – Don’t save efficiently
Different types of savings vehicles also have different impacts on aid. The assessment rate on savings could be 0%, 5.6%, or 20% - depending on the type of asset and how it’s titled. For the sake of others, please save in your student’s name so the assessment rate is the highest – and qualify for less aid.
Step 3 – Don’t spend smartly
You’re about to fill out the FAFSA, but you know that little Johnny needs a car for school. You can choose to take the money from any number of sources. Johnny has that savings account for tuition. So, instead buy Johnny’s car using parental money – which assessed at the lower 5.6% rate.
This way, you leave more money in the higher assessed account and get less aid.
Step 4 – Don’t take advantage of any ‘scholarships’ from the IRS
Once Sally is in school and you’re writing checks for tuition, please don’t take advantage of any number of tax breaks. Like the new American Opportunity Tax Credit which can be worth up to $2,500 in reduced taxes per year.
Or if you get student loans, up to $2,500 in student loan interest can be deducted on your tax return.
Step 5 – Don’t plan ahead
Like cramming for that exam in college the night before, you’ll just take it as it comes when your child packs up for State U. The FAFSA form is due in January but much of the income information is from your tax return.
So, for this year, FAFSA was due in January 2009. But at that time, most people had not yet filed taxes, so the latest tax return available was 2007 (2008 tax return was due April 15, 2009)
That means planning for financial aid has at least a two year lead time. Miss that deadline and no financial aid for your child in the first year of college.
Hey, the government needs the money to pay for everything else. Please do your patriotic duty and don’t have Uncle Sam help Sally with college.
Answer to last week’s trivia question: C – Income tax free only to the extent of qualified expenses. Contrary to what most believe, distributions from 529 plans are not always tax free – even when used for college expenses.
This week’s trivia question: According to the US Dept. of Agriculture, for a baby born in 2008 to a family with over $100k in income, what is the cost, on average, to raise that child to age 17 – NOT counting college costs?
A. $50,000
B. $112,000
C. $367,000
D. $1.1 million
