Recently, I delivered a seminar on college planning and based on the questions asked, I came to a realization that many people hurt themselves financially but don’t even know it. Here’s an example …
One way to save for college is using retirement accounts, since the balances are not considered in the financial aid formula. Therefore, you could have $100,000 in an IRA and effectively it is a big fat zero when calculating the family contribution – very financial aid friendly.
Even the tax code helps a bit – withdrawals for qualified education expenses are penalty free from an IRA. Of course, you’d still pay the tax.
However, in the quest to minimize college debt, people will take money out of their IRA to pay for their child’s college bill.
Why is this so bad?
Aside from giving up their future retirement, they also cost themselves hard dollars due to taxes. And most importantly, giving up time for the money to grow and compound.
But think of the financial aid perspective…
Let’s say you withdraw $10,000 from your IRA.
You pay $3,060 in tax (assuming 25% federal, 5.6% MA income tax), leaving you with $6,940.
But now look at what potentially happens to your financial aid. That ‘income’ is assessed at a rate as high as 47%. Therefore, that money you just took out just cost you another $3,262 in financial aid two years from now (remember, income affects financial aid two years forward).
So let’s summarize:
You voluntarily took something assessed at a rate of zero to pay almost 63% between actual taxes and lost financial aid.
Do you regularly volunteer to pay more in tax than you have to?
Your good deed cost over $3,000 in taxes and almost $3,300 in financial aid. So now, you have to come up with that financial aid portion – either withdrawing that money from somewhere else or having to take out a loan – which you were trying to avoid in the first place!
The IRS and your child’s college thank you.
Answer to last week’s trivia question: A – As the beneficiary, you would owe no tax. However, since the policy was individually owned, any proceeds above the estate tax exemption would be subject to tax. In 2010, so far, because the estate tax went away, there would be no federal estate tax due. But if the deceased lived in MA, any amount over $1 million would be subject to a 16% estate tax – paid by the estate.
This week’s trivia question: According to the Social Security Administration, today, there are roughly 3.3 workers that support each retiree. But by 2030, how many workers, estimated, will be supporting each retiree?
A – One
B – Two
C – Three
D – Four
