by Don Baker, President, Vermont Market, KeyBank When we talk about the cost of college education and student loan debt, we often talk in terms of rising tuition rates and the total amount of money borrowed by recent graduates. We do this for good cause: the cost of college is becoming unaffordable for too many students, and the average amount of debt— $29,400 per borrower, according to the Institute for College Access & Success— is a heavy burden for our youngest workers. Rarely do we talk about the student loan debt shared by parents, but we should because it’s significant.
According to the Federal Reserve Bank, the average student loan related debt for borrowers older than age 50 is $22,700. In addition, more and more parents are financing their children’s education, from $700,000 in 2005 to more than $2 million in 2012.
The fact that parents want to help their children is a good thing. A college education is important to creating opportunities for a fulfilling career and financial independence. However, it is vitally important that parents balance their desire to fund their child’s education with their savings goals for retirement. The best way to do this is to plan and to start saving early.
Education savings strategies
When planning to fund your child’s college education, several plans can help you achieve your goals. Two of the more popular are 529 College Savings Plans and Coverdell Education Savings.
529 Plans are state run and each state has its own version. While 529 plans are included on the Free Application for Federal Student Aid (FAFSA), they have relatively little impact on financial aid eligibility because they are the parent’s asset.
College savings plans let you save money for college in an individual investment account. When you contribute to the account, you typically choose one or more portfolios offered by the plan. The underlying investments of these portfolios are exclusively chosen and managed by the plan’s professional money manager. But keep in mind that college savings plans don’t guarantee a return. If the portfolio doesn’t perform as well as you expected, you may lose money.
529 plansoffer federal and state tax-deferred growth and federal tax-free earnings if the money is used for college. States can also add their own tax advantages to 529 plans.
Vermont is one of just a few states that offers a tax credit instead of a tax deduction for contributions to its Section 529 plan. Contributions to a Vermont 529 plan of up to $2,500 per beneficiary per year by an individual, and up to $5,000 per beneficiary per year by married taxpayers who each make their own contributions, are eligible for a 10% tax credit against Vermont income tax. Of note, any contributor with a Vermont income tax liability may contribute to an account owned by someone else and receive the tax credit. The total amount you can contribute to a Vermont 529 plan is $352,800 per beneficiary account.
One other note is that a rollover of contributions from another state’s 529 plan will also create a credit. In the case that a taxpayer has external 529’s they may consider rolling $2,500 each year to maximize their tax credit.
The Coverdell Education Savings Account (ESA) is an account where up to $2,000 per year per beneficiary can be saved. Amounts contributed to the ESA grow tax deferred and are tax-free distributions if used for qualified education expenses for both K–12 education and college education. Contributions must be made by April 15 following the contribution year. However, the ability to contribute is phased out for joint filers (single filers too) with modified adjusted gross income (MAGI) between $190,000 and $220,000.
Tips for maximizing financial aid
All families, regardless of income, should complete the FAFSA, which is the form that determines college students’ eligibility for financial aid, including loans, work study, grants and scholarships.
You can employ several other tactics that may help you meet the challenge of funding your child’s education. For example, since permanent life insurance with cash value is not included as an asset on the FAFSA, some families use this as a way to decrease “included” assets. The cash value can also provide a means of tax-free distributions for education costs.
Other tips include:
- Keeping account ownership in parents’ names, rather than the student’s.
- Monitor your investments and try to minimize gains from the sale of assets during the tax year before the award year.
- Accelerate or decelerate income, if possible, prior to reporting FAFSA or after the last FAFSA is filed.
- Maximize retirement contributions, which will remove income and assets from the FAFSA.
The important thing to remember is that the best way to pay for your child’s college education is to plan to pay it— as early as possible. It is also important to remember that as much as you may want to help your child out now, you will be doing them a major disservice later if you do not take care of your own financial needs. A banker or financial advisor can help you find the balance between helping your child and meeting your retirement savings goals.
This is not meant to be tax or legal advice. Since tax laws are always subject to interpretation and possible changes, we recommend that you seek the counsel of an attorney, accountant or other qualified tax advisor and visit the Vermont Student Assistance Corporation website at www.vsac.org for information on college planning.
Six things to know about the FAFSA
The Free Application for Federal Student Aid (FAFSA) is used to apply for Federal Financial Aid and helps financial aid offices determine if a student is eligible for grants, federal work study programs or loans. Every family, regardless of income level, should complete it to ensure they can take full advantage of all potential college funding opportunities.
Here are six things to know about the FAFSA that will help you complete it on time and maximize the amount of aid that is available to your student.
- It needs to be completed each year and is due June 30th of the academic year. For example, if a student plans to attend college from July 1, 2014 to June 30, 2015, the FAFSA would be due for federal aid consideration no later than June 30, 2015 and no earlier than January 1, 2014.
- State deadlines are usually earlier and the student’s desired college may have an application deadline as well (often by February 15). File early to ensure schools still have funding available.
- Filing the FAFSA online at www.fafsa.gov is free and the easiest method of filing (www.fafsa.com charges a fee). You may want to file even if your prior tax returns are not complete. By using estimates of income and assets (and later revising them if needed), you can file earlier, which increases the chance of receiving funds.
- Consider which assets should be included on the FAFSA. Common assets to be counted on the FAFSA are savings accounts and investment accounts, including 529 plans. However, retirement plans such as 401(k) plans, pensions or IRAs, as well as the cash value of life insurance should not be included on the FAFSA. The value of a primary residence is also excluded, but rental real estate should be included.
- The calculation generated from the completed FAFSA is the Expected Family Contribution (EFC) or what the government thinks the family can contribute to the cost of the student’s education. This is not the amount you will have to pay for college, but the amount used to calculate how much financial aid the student can receive.
- The FAFSA generates a report called the Student Aid Report (SAR), which is sent to each college or university selected by the student to formulate a financial need for them. Financial need is defined as the difference between the cost of attendance (COA) and the EFC.
For more information about the FAFSA, visit www.fafsa.gov. For more information on the financial impact of savings accounts to the FAFSA, visit www.finaid.org.
Don Baker is President of KeyBank’s Vermont Market. He may be reached by phone at 802-660-4273 or email at [email protected]. © KeyCorp 2014. KeyBank member FDIC. Opinions, projections, or recommendations contained herein are subject to change without notice and not intended as individual investment advice.