The other night, I watched President Obama’s State of the Union
Address with great interest. I had read
in the news about new taxes for some and tax cuts for others.
What I didn’t expect was the proposal to change how college savings
plans, that is, 529 plans, would change.
The proposed changes are outlined in this article.
You may or may not agree with this idea politically, but from a
financial standpoint, this proposal is the equivalent of a gigantic...YAWN...
Before you high five the President or storm the White House,
consider the following:
1. Should you
even save for college?
Before making sure your child can financially go off to the land of
keg stands and toga parties (sorry, flashback), make sure your own
retirement savings are set. After all,
your child can get scholarships for being a good student. There is no such thing as scholarships for
being a good retiree.
And do you have emergency savings?
If not, this needs to be a priority.
As flight attendants always tell you, put on your own oxygen masks
first (i.e. save yourself) before putting the mask on your child.
2. What about
debt?
I’ve never heard of anyone saying they love their student loans,
but the fact is that federal student loans carry reasonably attractive interest
rates and repayment terms.
The financial aid formula does NOT consider what debt you have
already - like credit cards and car loans.
If you’re up to your eyeballs in debt now, you may want to focus on
paying down your debt first so you can free up monthly cash flow to help your
child with their student loans.
3. There are
other ways to save for college.
One of the key considerations on how to save and pay for college is
whether or not your child will qualify for financial aid. The federal methodology financial aid formula
(using the FAFSA form) is primary driven by income, not assets.
If you think that you will qualify for aid, then maybe a 529 plan
would be advantageous.
If you think you won’t qualify for aid, then consider other
strategies. By the way, don’t fall for
myths here. It could be that don’t
qualify because you make “too much”. You
might not qualify because your kid applied to inexpensive state schools. Or both.
It’s tough to predict where your kid is going for college, so
maximizing flexibility is key.
529 plans, like other parental assets, are assessed, or “taxed” at
a 5.64% rate. That means, if you have
$100 in assets, the college expects you to use $5.64 each year to pay for
college. And that means each year, the
amount of financial aid you get decreases by $5.64.
Other assets that have the same “tax”:
Checking and savings accounts
Stocks and bonds (not in a retirement account)
Cash stuffed under your mattress
But there are some accounts that have a 0% “tax”:
IRAs / Roth IRAs
401k
Equity in your home (FAFSA schools)
Cash value of permanent life insurance
Ultimately, what should you do?
So many people view saving for college as completely separate than retirement,
debt, taxes, etc., but it is not. How to
save and pay for college is based on your individual circumstances, and
proposals from the President may not have any impact on you. What type of account you used to save for
college - 529 or couch cushion - has very little impact on aid.
So go ahead and yawn away at the President’s proposal.
