Do You Have a College Fund?

Do You Have a College Fund?

Do you have a college fund set up for your children or grandchildren? It is back to school time and that’s a little bit different this year. No one knows if the online classes will permanently change the process of education in the world. Still, I think there will be no substitute for the career benefits of having a degree in an in-demand field from a top notch school. Not everyone needs college, but overall, a higher education is strongly correlated to future earnings and career satisfaction.

The cost of a college education continue to climb. Student debt has become a crippling problem for many young adults I meet. They were told it would be worth it to get their degree, regardless the expense or their future earnings potential. Every parent wants the best for their kids, for them to have the opportunities we did not have. We want for them to be able to pursue their dreams and find their own unique greatness. Helping to pay for college goes a long way to setting up your kids to find their own Good Life.

Like most big financial goals, I think the best way to create a successful college fund is by making it automatic. Establish a 529 college savings account and make automatic contributions each month. If you can only start with $100 a month, great, just get started. Later, you can gradually bump that up to $200 or $300 a month or more.

How Much Should You Save?

A 529 plan will allow you to invest into a diversified allocation. The 529 Plan I use has Vanguard, iShares, and State Street index funds, just like I recommend in our Premiere Wealth Management portfolios. While no one knows future returns, let’s consider how your money might grow at 1%, 3%, or 6%. And then let’s also consider if you start at age zero, 5, and 10 for your kids. This would equate to 18, 13, and 8 years of growth to age 18 and the start of college.

Here is how $250 a month would grow:

There are two main points I think this chart makes. First, it pays to start your college fund early for compound interest. If you wait until your kids are 10, you might have only one-third the amount saved, compared to starting at birth. Second, you aren’t going to grow much if your money is in a bank account earning one percent. (By the way, at $250 a month, or $3,000 a year, you would have contributed a cumulative $54,000 over 18 years, $39,000 over 13 years, or $24,000 over 8 years.)

How to Get Started

A 529 College Savings Plan is an efficient way to create a College Fund, as distributions for qualified education expenses are tax-free. You can even start a 529 for an unborn child and change it to their name once they are born. The important thing is to get started early. Each state sponsors their own 529 Plan. If your state has income taxes, there may be a benefit for using the In-State plan. For Texas, since we don’t have an income tax, there is no inducement to use the Texas plan versus one from any other state. You can use any plan at any college in the country.

While you could save in a regular account for college, there are valuable tax benefits in 529 Plans. Most investors prefer to have different buckets for different goals. This helps address savings goals. Even if your kids are 10 or older, it’s not too late to start your college fund. We are accepting new clients and want to help you get started.

If you’d like an estimate what it might cost to send your kid to a specific University, send me that information. I’m happy to prepare a report for you. We will estimate future costs and calculate a saving and investing plan. (Be prepared to be shocked if you plan to pay for 100% of four years at a private university.)

Learn More About 529s

Looking for details on how a 529 Plan works? Here’s what you need to know.

Want to compare different 529 Plans? Check out SavingForCollege.com

529 Plans are a way for Wealthy Families to create an inter-generational transfer of millions of dollars, potentially tax-free. This linked article calculates that parents who fund $1 million dollars into 529 Plans could be able to cover the college educations of four grandchildren, eight great-grandchildren, and 16 great-great-grandchildren. That’s because when you over-fund a 529 plan, you can always change the beneficiary to a younger generation later. The successor owners of your 529 Plans can keep the accounts open and change beneficiaries, even after you are gone.

CARES Act RMD Relief

CARES Act RMD Relief for 2020

The Coronavirus Aid, Relief, and Economic Security CARES Act approved this weekend eliminates Required Minimum Distributions from retirement accounts for 2020. If you have an inherited IRA, also known as a Stretch or Beneficiary IRA, there is also no RMD for this year. We are going dive into ideas from the CARES Act RMD changes and also look at its impact on charitable giving rules.

Of course, you can still take any distribution that you want from your retirement account and pay the usual taxes. Additionally, people who take a premature distribution from their IRA this year will not have to pay a 10% penalty. And they will be able to spread that income over three years.

RMDs for 2020

Many of my clients have already begun taking their RMDs for 2020. (No one would have anticipated the RMD requirement would be waived!) Can you reverse a distribution that already occurred? Not always. However, using the 60-day rollover rule, you can put back any IRA distribution within 60 days.

If you had taxes withheld, we cannot get those back from the IRS until next year. However, you can put back the full amount of your original distribution using your cash and undo the taxable distribution. You can only do one 60-day rollover per year.

For distributions in February and March, we still have time to put those distributions back if you don’t need them. Be sure to also cancel any upcoming automatic distributions if you do not need them for 2020.

If you are in a low tax bracket this year, it may still make sense to take the distribution. Especially if you think you might be in a higher tax bracket in future years. An intriguing option this year is to do a Roth Conversion instead of the RMD. With no RMD, and stocks down in value, it seems like a ideal year to consider a Conversion. Once in the Roth, the money will grow tax-free, reducing your future RMDs from what is left in your Traditional IRA. We always prefer tax-free to tax-deferred.

Charitable Giving under the CARES Act

Congress also thought about how to help charities this year. Although RMDs are waived for 2020, you can still do Qualified Charitable Distributions (QCDs) from your IRA. And for everyone who does not itemize in 2020: You can take up to $300 as an above-the-line deduction for a charitable contribution.

Also part of the CARES Act: the 50% limit on cash contributions is suspended for 2020. This means you could donate up to 100% of your income for the year. This is a great opportunity to establish a Donor Advised Fund, if significant charitable giving is a goal.

Above the $300 amount, most people don’t have enough itemized deductions to get a tax benefit from their donations. Do a QCD. The QCD lets you make donations with pre-tax money. Of course, you could do zero charitable donations in 2020 and then resume in 2021 when the QCD will count towards your next RMD. But I’m sure your charities have great needs for 2020 and are hoping you don’t skip this year.

The Government was willing to forgo RMDs this year to help investors who are suffering large drops in their accounts. To have to sell now and take a distribution is painful. However, if you already took a distribution, you are not required to spend it. You can invest that money right back into a taxable account. In a taxable account, the future growth could receive long-term capital gains status versus ordinary income in an IRA. I’ll be reaching out to my clients this week to explain the 2020 CARES Act RMD rules. Feel free to email me if you’d like our help.

529 Plan Rules

529 Plan Rules

College is often a parent’s biggest expense after retirement, yet people are hesitant to save because they don’t know the 529 Plan rules. A 529 College Savings Plan is a terrific wealth building investment for families and has more benefits and flexibility than people realize. While I think investors need to prioritize their own retirement and wealth management, that time horizon is much longer than for college. Retirement accumulation takes 40 years and then will be spent over 20-30 years. College saving is 18 years or less and then 4-6 years of spending.

College costs are growing faster than CPI and it already costs $300,000 for four years at most private universities. If your student changes majors, or decides to stay for a graduate degree, their cost could reach $500,000. 44.7 million American have student loan debt, totaling over $1.6 trillion. Students loans are a looming crisis; 11.1% are presently delinquent or in default and repayment is crushing a lot of Millennials. Many of us had student loans when we were younger, but do not fully appreciate how the magnitude of these loans have grown since we were in college.

Yes, there are a few drawbacks to College Savings Plans, and that’s why I want you to understand the 529 Plan rules. The value is so significant that when people get hung up on the rules, I think they risk missing out on substantial tax benefits and investment opportunities. After all, there are rules for 401(k) accounts and Roth IRAs, but most people are happy to navigate those rules to reap the rewards.

Tax Rules of 529 Plans

  1. The primary benefit of a 529 Plan is tax-free withdrawals for qualified higher educational expenses, such as tuition, room and board, and books. You can now also use a 529 Plan towards private K-12 tuition, up to $10,000 a year. You can also use $10,000 towards student loan repayment.
  2. There is no Federal tax deduction for 529 Plan contributions, however, many states do offer a state income tax deduction. In some states, you have to contribute to that state’s plan to get a deduction. In other states, you can contribute to any plan. For Texas, there is no state income tax, so there is no deduction for a 529 plan contribution.
  3. Contribution limits: most plans have very high limits, often $350,000 or higher. However, most donors want to stay under the annual gift tax exclusion of $15,000 per person. The IRS will let you contribute 5 years at once, or $75,000 per beneficiary. If you and your spouse are funding a 529, you can each contribute $75,000 or $150,000 total under the gift tax exclusion. If you want to contribute more than that, you can. You just have to file an annual gift tax return. You will not owe any taxes until your gifts exceed your unified lifetime exemption of $11.58 million (2020). (Note: certain candidates propose to lower the estate tax threshold to $3.5 million. If that happens, you may want to exceed the gift limits now to reduce a future estate tax liability.)
  4. All 529 Plans offer tax-deferred growth, so you pay no taxes on interest or capital gains annually. Now the part that stops everyone in their tracks: non-qualified withdrawals are subject to income tax and a 10% penalty.

Tax/Penalty Only on Earnings

Let’s dissect that a bit more, because it’s not as bad as you might think. The income tax and penalty apply ONLY to the earnings portion, not the whole withdrawal. For example, if you contributed $50,000 to a 529 and it grew to $70,000, you would have $20,000 in earnings. Withdraw the whole $70,000 for a non-qualified reason and you would pay a $2,000 penalty and the $20,000 earnings would be treated as ordinary income. At the 24% tax bracket, you’d pay $4,800 in income taxes.

Withdrawals are pro-rata, meaning earnings are proportional for each distribution. A non-qualified withdrawal from a 529 plan is not subject to the 3.8% net investment tax (the Medicare surtax), if you earn over $200,000 single or $250,000 married.

Ways Around the Penalty and Tax

Everyone is frozen by the thought they might have to pay a penalty, but there are exceptions and ways to avoid it. Here are more 529 Plan rules to know:

  1. If the beneficiary dies or becomes disabled, the 10% penalty is waived. If they receive a scholarship, the penalty is waived. Earnings are still taxable, but no penalty.
  2. You can change the beneficiary to another child, grandchild, other relative, or even yourself. If they can use the money for higher education, you’re back to tax-free withdrawals. If you have two or more children or grandchildren, I think it’s pretty likely that someone in your family is going to be able to use the money.
  3. Kid not going to college? You can do nothing and wait. Just because they turned 18, you don’t have to withdraw the money. It never becomes their money and you never lose control of the funds. You can keep it deferred for as long as you like. Maybe they later go to trade school or an apprenticeship program. That’s a qualified 529 expense. Or maybe they have kids of their own down the road. Now you have a college account for your grandkids.
  4. You can give the money to your kid if you want. The taxes are payable to the distributee. Have the 529 distribute the money to your kids and they will owe any tax and penalty on the gains. (And they may be in a lower tax bracket than you. So, this is good tax planning, not being selfish on your part.)
  5. For long-term care. Let’s say your kids don’t use the money and you don’t have grandchildren and this account sits there for decades just growing tax-deferred. If you become disabled you can change the beneficiary to yourself and receive the disability waiver on the penalty.

More Benefits of a 529 Plan

  1. A 529 remains the property of you, the owner. If you instead funded and UGMA or UTMA, that becomes the property of the beneficiary at the age of majority (18 or 21; 21 in Texas). UGMA equals You Give Money Away. They can spend it on anything they want, including whatever terrible decisions you can imagine. No one is thinking this is possible when someone is three, but you give up all your control with an UGMA.
  2. Creditor Protection. Are you a business owner, doctor, or professional worried about getting sued? 529 Plans are creditor protected.
  3. Financial Aid. A 529 plan is a parental asset, subject to a 5.6% expected family contribution from the FAFSA financial aid process. Put that asset in the child’s name and the expected contribution is 20% a year. A 529 plan in the grandparent’s name is not reportable on the FAFSA.
  4. A 529 Plan will not be part of your taxable estate. You can and should name a successor trustee/owner of the funds for after you pass away. As such, 529 plan could be an important way to create a legacy for your family.

It’s Your Family’s Future

If you like the idea of Tax-Free Growth, a 529 Plan could benefit your family. When people get too worried about the 10% penalty and the other 529 Plan rules, they are often paralyzed to take action. Investors contribute to 401(k)’s and Roth IRAs that have a 10% penalty, but they seem to think that with a 529 it’s going to be worse. To get the best tax benefit from a 529, you want to start as early as possible. Opening a 529 plan for a 17 year old going to college in the Fall does not leave you much time for tax-free growth.

Parents and Grandparents want their children have the same opportunities they had. Many would like for their kids to go to the same or better university than they attended. Let’s start with estimating what four years would cost and what it would take to fund that expense monthly starting now.

Don’t have kids yet? Open a 529 Plan in your own name. When your child is born, you can change the beneficiary to their name. We can fund a 529 with a lump sum, or you can set up small monthly contributions. Expenses on 529 plans have been declining in recent years and many offer low-cost index based investment options. You have daily liquidity, however, most plans restrict you to two trades a year to discourage market timing. Almost all plans offer age-based funds, which adjust to become more conservative as a beneficiary approaches college age.

I hope to make it easy to understand the 529 Plan rules, so you can get started. Please don’t hesitate to email me with your questions, I’m here to help.

How Much Will it Cost to Send Your Kids to College?

I am in favor of college students “having some skin in the game” in sharing in the cost of their education, but many graduates are leaving colleges with crippling student debt today. For parents and grandparents, it’s never too early to start saving for this investment in your child’s future. As part of my education planning for clients, I use specific colleges to estimate how much a future college education may cost and to suggest how much to save monthly. Ready for some sticker shock?

Example 1: Max is 6 years old and his parents hope he will attend their alma mater, Texas A&M. Today, in-state costs (tuition, room/board, books and fees) are $19,702. The projected costs when Max goes to school will be $117,520 for four years. To save this amount, invest $454 a month, starting immediately.

Example 2: Carla is 3 years old and her parents would like for her to be able to attend a private university, such as Southern Methodist University. Today’s annual cost is $61,385. Projected future expense: $400,105. Invest $1,164 a month.

Assumptions

  • Student attends college for 4 years at age 18. Of course, many take more than four years, especially if they change majors or decide to pursue graduate studies.
  • These calculations assume 3% inflation. In recent decades, college costs have increased by 5-6%. Hopefully, these increases will moderate as overall inflation is currently quite low.
  • We are assuming a 6% rate of return on the investments, and tax-free withdrawals from a 529 Plan. Although this is a fairly conservative assumption, it is, of course, not guaranteed.

We can adjust these assumptions, which will change the estimated costs and savings requirements. The calculator gives us a ballpark idea of just how significant an expense it is to send a child to college today, let alone two or three kids. Typically, we run a couple of scenarios to give a range of possible costs for parents.

A 529 College Savings Plan is a great tool for this job. Withdrawals from a 529 are tax-free when used for qualified higher educational expenses. There is no expiration on funds in a 529 and the account owner can change the beneficiary of the account, if one child does not need all the funds. The biggest benefit of a 529 is the tax-free growth, which means that we want to start a 529 as soon as possible for a child to receive many years of compounding. Once they’re 16 or 17, it’s too late to receive much of a tax benefit.

Link: 8 Questions Grandparents Ask About 529 Plans

Want to estimate how much it will cost for your child or grandchild to get the same college education you received, or wish you had received? Send me the details and I’ll get back to you with an estimate. If you’re ready to add college savings to your overall financial plan, I am here to help!

Four Student Loan Forgiveness Programs

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The size of student loans has grown tremendously in recent years. Many college graduates are finishing school with $100,000 or more in debt, especially those who pursue graduate degrees. It is becoming a substantial problem, one which is impacting a whole generation’s ability to become wealthy. Perhaps for the first time in American history, our young people face a tougher road to prosperity than their parents did.

With higher unemployment today for new graduates, and stagnant entry-level wages in many fields, it can be a significant burden to repay student loans, let alone save money for a 401(k), get a home mortgage, or do any of the financial planning steps I typically write about. For those who are struggling with their student debt, there are a number of student loan forgiveness and repayment programs which can help.

Student loan strategies are becoming an important part of financial planning, given the weight of this debt on young people. At Good Life Wealth Management, we’re prepared to help recent college graduates navigate these issues, as well as to work with parents who want to ensure their children get started on a path to prosperity. If your financial advisor doesn’t know about these programs, you need a new financial advisor! Here is an introduction to four loan forgiveness and repayment programs available today.

1) Public Service Loan Forgiveness (PSLF) Program. This program will forgive 100% of your eligible loans after you make 120 payments (i.e. 10 years of monthly payments), while employed full-time in a public service job. To qualify, you should use one of: the Federal Income-Based Repayment (IBR) Plan, the Pay as You Earn Repayment Plan, or the Income-Contingent Repayment (ICR) Plan.

Only loans received through the William D. Ford Federal Direct Loan Program eligible for the PSLF. However, if you have Perkins or FFEL loans, you may consolidate them into a Direct Consolidation Loan and then they will become eligible for the PSLF.

Public service jobs include those with a federal, state, or local government agency or public school or library. Additionally, a full-time job with any 501(c)(3) non-profit organization is also considered a public service job, regardless of what the organization does. For my musician colleagues, please note that a full-time position with a symphony orchestra, opera company, private university, or music school, would all qualify for the PSLF, provided the employer is a 501(c)(3). Likewise for employees who work full-time for an animal shelter or rescue group.

Payments made after October 1, 2007 may qualify for the PSLF. For further details on the program as well as instructions on how to verify and record your eligibility, please visit the Federal Student Aid Website.

2) Maximum repayment periods on Federal income-driven plans. If you participate in one of the three Federal income-driven plans, there is a maximum amount of time under these loans. If you still have a balance remaining at the end of that term, your balance will be forgiven. Please be aware that the amount of the loan forgiveness will be considered taxable income in that year and reported to the IRS.

Here are the maximum repayment periods:
IBR for new borrowers after July 1, 2014: 20 years
IBR for borrowers before July 1, 2014: 25 years
Pay as You Earn Plan: 20 years
ICR Plan: 25 years

Individuals who are making small payments under an income-driven plan sometimes find that their balances are actually growing rather than shrinking. While I’m not sure it’s a good idea to minimize your income for 20-25 years to qualify for this program, you may take some solace in knowing that your debt will eventually be forgiven as long as you continue to make on-time payments.

For details, visit this page on the student aid website.

3) Loan Forgiveness for Teachers. There are several programs offered by both Federal and State governments to offer loan forgiveness to public school teachers. Some of these programs are used to attract teachers in specific high-demand subjects, or to low-performing schools which struggle to attract qualified candidates. In addition to the PSLF described above in #1, teachers in Texas may be eligible for the Federal Teacher Loan Forgiveness Program, or the TEACH for Texas Loan Repayment Assistance Program, Details available on the Texas Education Agency Website.

4) Military College Loan Repayment Program (CLRP). Several branches of the military offer a loan repayment program to new enlisted personnel (not officers). The Army and Navy will repay up to $65,000 in student loan principal (but not interest), paying one-third at the end of your first three years of enlistment.

Payments are made directly to the lender, but are considered taxable income to the individual. For general information on the program, here is a good article on the CLRP. For details on the Army program, click here.

Using a loan forgiveness program could save you $50,000 or more, and allow you to move forward with your other financial goals, such as building an emergency fund, saving for retirement, or buying a home. Since each program has very specific requirements, it’s best to plan ahead and know which program you may be eligible for, and make sure you follow the rules carefully.

Several of these programs apply only to Federal Student loans. Be careful about consolidating your Federal loans into a private bank loan as this could cause you to lose your eligibility for a forgiveness or repayment program.

8 Questions Grandparents Ask About 529 Plans

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It’s summer break and your little grandchildren are one year closer to college. Still haven’t set aside any funds for their college expenses? For grandparents who have the means to help with future tuition bills, the 529 College Savings Plan is a tremendous tool. Here are the Top 8 questions you need to ask when considering if a 529 is right for you.

1) What should I consider when selecting a 529 plan? 

The first step in choosing a 529 College Savings Plan is to determine if there is any benefit or incentive to using the “in-state” plan.  For example, if you are a Maryland resident, you can deduct up to $2,500 per beneficiary off your state income tax return if you participate in the Maryland 529 plan.  For married couples, you can deduct up to $5,000 per beneficiary per year.  If you have four grandkids, that is four beneficiaries, or $20,000 a year. And if you contribute more than these limits, your excess contributions carry forward for 10 years.  In other states, such as Texas and Florida, there are no tax benefits or credits for using the in-state plan, so in those states you might choose from any plan in the country.  The rules vary by state, so you will want to look up this information on www.savingforcollege.com.  
    
2) Are there any drawbacks or limitations to 529 plans that I should be aware of? 

Contributions to a 529 Plan are considered a gift by the IRS and are subject to gift tax rules.  For 2014, the gift tax exclusion is $14,000 per beneficiary.  However, 529 Plans have a special exception to this rule which allows you to fund five years of contributions in one year, or $70,000 per beneficiary ($140,000 per beneficiary if funded by a married couple). 

3) How do assets in a 529 plan impact my estate planning and eligibility for Medicaid? 

Assets in a 529 plan are excluded from your taxable estate, so if you are likely to be subject to the estate tax, 529 plans are a terrific tool to shelter assets from the estate tax while maintaining control of those funds.  Medicaid rules vary by state.  529s may be counted as assets in some states and may be subject to “look back” provisions by Medicaid.   

4) What if I end up needing the money in a 529 plan for my own medical expenses?

Since you control the assets in a 529 Plan, you can make a withdrawal at any time.  A 529 plan is revocable by the owner.  If the withdrawal is taken for a reason other than a qualified higher educational expense, any gains would be subject to income tax and a 10% penalty.  Note that the tax and penalty apply only to the gains, not to your principal.  If you have multiple 529 accounts, select the one with the lowest gains if you need a withdrawal, and then you can change the beneficiaries on the remaining accounts as needed.

5) How do 529 plans affect students’ eligibility for financial aid?

Grandparents’ assets are not disclosed on the Federal financial aid application (the FAFSA), so student financial aid eligibility is actually improved compared to having those same funds held in either the parents’ or student’s name.  Taking a distribution from the 529 plan is considered countable income on the FAFSA, so the best time to use the grandparents’ 529 is in the student’s final year of college. 

6) Can 529 plans be used to help pay for private high schools? 

No, 529 plans are only for post-secondary education.  Most of the time, 529 plans are used to fund undergraduate education at public or private colleges, but you can also use 529s for graduate school, community college, or even for a non-degree trade school.  To confirm if your school is an eligible institution check: http://www.savingforcollege.com/eligible_institutions/ 

7) How do 529 plans impact my taxes? 

Some states offer a state tax deduction for contributions to a 529 plan.  There are no federal tax deductions for 529 contributions, however, withdrawals for qualified higher educational expenses are tax free, so any future gains will not be taxable.  The earlier you establish a 529, the greater potential growth you may have in the account.

8) When does it make sense to pay for college tuition directly or give the money to my child or grandchild to pay for tuition instead of opening a 529 plan?

If a student is within a year or two of college, you may not see sufficient gains in a 529 account to receive much of any tax benefit.  529s are much more attractive when funded at an early age to allow for many years of growth.

While 529 contributions are subject to the gift tax rules, those limitations do not apply to payments made directly for education or medical expenses.  If the expenses are greater than the gift tax exclusion amounts, it may make sense to pay college expenses directly, rather than choosing to file a gift tax return and use up part of your lifetime unified exemption.  Money given to your children or grandchildren will be reported on the FAFSA, which could increase their expected family contribution and potentially reduce their eligibility for other sources of financial aid.  It would be preferable to pay the college tuition bill directly rather than giving money to your children or grandchildren.

If you want more information on 529 plans or would like to calculate how much it might cost to send Junior to Harvard, please email me for a free consultation.