It is here! As we approach the end of the year 2016, it is a great time to review your personal financial planning strategies, specifically related to saving and paying for college. Do your college financial aid year-end planning now! Listed below are financial aid and college funding strategies that can be put into place to help maximize the resources of a family. It is important to review them every year to reflect any changes in the family size or income as well as any new tax implications. These college financial year-end planning strategies are not normally addressed by the college financial aid office since these are personal financial planning strategies that cross over their legal responsibility. Many families do not realize that the college financial aid officers cannot explain all of the ways to pay for college since they are unable to provide personal financial advice.
Student debt has almost doubled since 2006. As educational costs continue to rise, families must find the best ways to maximize their resources and lower the student debt for their children. To do that properly, investment and tax strategies need to be included in a plan when paying for college. Therefore, it is important to review your college financial year-end planning each year. Here is a list of ideas that are often not discussed that you may find helpful.
Income Taxes and Financial Aid
For most parents, the college years come at the same time typically when it is the person’s highest income earning potential. Many of us look for the best ways to lower our personal income tax. The most common way to do this is through contribution to a tax deferral programs such as an IRA, 401k or 403b programs.
In the years that you file for financial aid, the amounts contributed to tax deferral programs are added back in as income. Depending on a family’s income, this deferred income could be weighed in the EFC calculation up to 47%. By understanding the consequence of these contributions on your financial aid position, it can help you make better long-term tax decisions versus the cash flow advantages of not making the contributions.
Prior Prior Impact on High School Students
With the implementation of Prior Prior, the time table for college financial aid positioning starts much earlier. To evaluate this position, a family will need to calculate their EFC or Expected Family Contribution. The parents’ and student’s income are driven by the financial information that comes from their tax return. Families need to match their tax year with their financial aid submission years. By doing this exercise, they may increase their abilities to maximize their financial aid position. EFC PLUS has a free estimating EFC calculator that is on our website to help you in this process. Understanding your EFC number is the starting point to any college financial plan.
For high school sophomore parents, any financial decisions made after 12/31 will affect your financial aid position. The tax year and school year do not match. The base tax year for the college bound student starts with the second semester of their sophomore high school year and the first semester of the junior high school year. This is why the 12/31 date is so important for high school sophomore families.
At the same time, I actually feel that it is not a bad time for high school freshman to review their position. This is especially true for students who have assets in their name.
A big myth in college financial aid positioning, is to have no assets in the child’s name. That is not always true and is the reason a family needs to understand their personal EFC. To make that decision, a family needs to understand the parent components of their EFC calculation and the cost of attendance (COA) for each college on the student’s list. In some cases, you may be putting assets in the child’s name to maximize tax savings.
If the parent’s portion of the EFC is greater than the COA then the student assets will have no effect qualifying for need-based financial aid. The student may still qualify for merit-based money depending on their application strength for that college. If you have the detail of the parent’s part of the EFC calculation then you are able to complete the full analysis.
By knowing your numbers, the common myth of taking all of the assets out of the students name can be better illustrated with the number below.
Parent’s Income EFC value: 25,000
Parent’s Assets EFC value: 12,000
Parent’s EFC value: 37,000
Student’s Income EFC value: 1,500
Student’s Assets EFC value: 1,600
Student EFC value: 3,100
Total EFC: 40,100
College 1 – COA: 31,000
No need- based aid
Moving student’s assets will have no impact. Parent EFC of 37,000 is greater than College 1 COA- 31,000.
College 2 – COA: 55,000
Qualify for 14,900 of need-based aid
Moving student’s assets will have an impact. Parent EFC of 37,000 is less than College 2 COA- 55,000. This will decrease their total EFC by $1,152 if the student’s assets liquidated and reported as a parent’s asset
Before liquidating any assets, you need to review this with your tax and financial advisor. There are legal and tax regulation that you could trigger. These triggers may work against you. As an example, the “Kiddie Tax Law” requires a student who has unearned gains over $2,100 to be taxed at their parents rate. This could be as high as 23% versus a tax-free gain of zero if managed correctly.
Prior Prior Impact on College Students
The Prior Prior change also has an impact on how you look at the financial planning position for the current college student. This change in the FAFSA could work to the advantage of the current college student. Assuming the child will graduate in four years, the last tax year needed for the FAFSA documentation will be their first semester of the college sophomore year. This can change your strategy for paying for college. As an example, liquidating stock options to pay for college will have no impact beginning in the second semester of their sophomore year in college.
This will also be especially helpful for students who have paid internship or co-ops. Paid internships and co-ops are great experience for career building opportunities but from a financial aid positioning stand point they may increase a family’s EFC. Most summer jobs do not generate enough income to affect the student’s income portion of the EFC calculation. Since many internship programs have higher salaries and the timeframe is typically longer, the income earned is normally higher and could make the student portion of the EFC calculation higher. Paid internships after second semester of their college sophomore year will not be included in the undergraduate EFC calculation. This assumes the student does graduate in four years.
529 Plan Review
Review and understand the benefits of using a 529 plan as part of your college funding strategy. Currently, 32 states offer some type of state income tax incentives to contribute to a 529 each year. Most of these require a family to use the in-state 529 college saving program. There are 5 states that do not require the contribution to be to in-state 529 plans. These states are Arizona, Kansas, Missouri, Montana and Pennsylvania.
With these tax incentives, many families overlook the advantages of using 529 while a student is in college. Most think it is only a pre-college opportunity. Using the state income incentives can add up to thousands of dollars over the multiple years, depending on the state. It is very important to understand your state’s 529 plan rule before considering another state’s plan. A 529 plan could enhance a family’s tax deductions and college saving opportunities, each year.
In cases where a relative wants to help with college, knowing the difference between state plans can work to your advantage. This could allow the donor to compare states plans and maybe open the plan in their state of residency or gift the parent the money, if their state offers a better option. Before making this a decision, you should consider other factors such as the financial aid impact and asset control. This is where reviewing your end of the year planning can help you maximize your long term goals.
American Opportunity Credit and Other Income Tax Incentives
For proper tax planning, timing is everything. A simple task of when you pay a bill can make or break your ability to take advantage of an earned tax credit or deduction. Many times, we overlook these opportunities since we provide our financial information to our tax advisor after 12/31 of each year. As college funding has become more complex, it may be important for families to review their year-end situation with their tax advisor prior to 12/31, so that they do not forfeit some of the educational tax incentives.
The American Opportunity Credit is a very good example. Many of us will use our saved money in a 529 plan to pay the bills sent by the college. This would include tuition, fees, room, board, books and other related cost. If a family used only 529 money to pay this bill, the family may be forfeiting a $2,500 tax credit. You are unable to use the same qualified expenses for multiple tax incentives.
To qualify for the American Opportunity Credit, the income criteria must be under $90,000 if filing Single or Head of Household and under $180,000 if filing a Married return. In addition, only certain qualified expenses can be used. These are tuition, fees and books.
If a family has paid all of the qualified expenses using 529 money and feel they qualified for this credit, you could move up your payments for an upcoming semester. The amount to be paid will need to be $4,000 of the qualified expenses listed above to fully take advantage of this credit.
There are other educational tax advantages to consider such as the Lifetime Learning Credit, student loan interest deductions and other 529 uses that you need to review before the end of the year with your tax advisor.
Student Loan Plan
Last month, we wrote various articles on student loans and the numerous loan repayment options. The year-end maybe a great time to review what debt has been incurred and what the future looks like. Our new EFC PLUS In-College calculator helps students and parents understand their financial future by gathering the current debt and projecting the debt needed until graduation. It will then calculate all of the loan repayment options and build a personal budget.
There are various studies showing that having the information about a student’s debt will assist in better student loan decisions and reduce future student debt. At the same time, most families do not practice this process. As pointed out at the beginning of this article, student debt has almost doubled in the past ten years. It is a growing concern for our children’s financial future.
To review your federal incurred debt, the student and parent will need their FSA ID. You log onto the National Student Loan Database System (NSLDS.ed.gov). Enter your FSA ID and the student loan and federal grants will be listed. For Parent PLUS loans, these will be listed under the parent’s FSA ID.
It is also important that families understand the structure of the student loans. The types of loans used to finance an education will affect the loan repayment plans and forgiveness options available to the student. The debt structure may also impact a parent’s credit score if they have co-signed for a loan. The loan co-signer has the same financial responsibility as the student. If the student defaults, this may affect the parent’s credit score and their ability to borrow other money.
As you can see, paying for college has become much more complex. If you are a little proactive and look beyond the financial aid process, families can save thousands of dollars in college costs.
According to a recent FINRA study, less than 30% of families did any financial or debt planning concerning college funding. The colleges only provide information on a one-year basis. One of my biggest goals is to change the college financial model so that students and parents start considering the financial outcome of their education and not just the college name on the diploma.
Again, we encourage families to begin their college financial year-end planning! When a family reviews and organizes their financial information each year, it allows them to establish and keep on track with their college funding strategy and plans.