Let’s face it: the time has arrived to send your child off to college. You haven’t made many savings. In fact, you might not have saved anything at all if you’re like many parents. Where should you draw money from to pay the expenses if you don’t want your child to be burdened with school loan debt and you have additional cash you don’t need for retirement? Here are some things to think about.
Does Your Child Own Any Property?
If such is the case, there are a few reasons you would want to withdraw money from those assets earlier other accounts. First, since 20% of their worth is taken into account in the aid formulae, they have the biggest influence on financial aid eligibility. (This exempts property in a 529 savings account or a coverdell education saving A/C, which are considered as parental assets.
Second, once they reach the legal drinking age in your state, your children are free to spend that money anyway they see fit, which may differ from how you would. Because of these factors, you might wish to spend this money on a new computer or other personal items before submitting the Free Application for Federal Student Aid when your child turns 18 years old.
Are there funds in your education savings accounts?
You will clearly want to spend this money towards school if you were able to save for it in a 529 or Coverdell school Savings Account. This enables tax-free withdrawal of the earnings. If you use the money for something else, the earnings would be liable for taxation and perhaps a 10% penalty. You might be able to cash in your U.S. government savings bonds and use the proceeds tax-free for your child’s education if you meet certain income and other restrictions.
Do You Possess Taxable Property?
These assets take precedence over access to retirement accounts because they are counted in the financial aid formulae and lack the tax benefits of retirement accounts. In fact, if you hold assets that have lost value after you purchased them, you can deduct up to $3,000 annually from your regular income taxes using the losses. (If your losses exceed $3,000, you may carry the surplus forward indefinitely.)
What if your assets increased in value?
Giving the assets to your children and having them sell them is one option. Even though it might be at a reduced rate, they will still be required to pay capital gains tax. Investment income is taxed at the child’s capital gains rate, which is likely zero, after the first $1,150 is earned tax-free. Any amount over $2,300 will, however, be subject to your greatest marginal income tax rate, which is probably greater than the capital gain rate you would have paid if it was in your name. Therefore, you won’t benefit greatly from using your child’s name.
Is Your Home a Secured Loan?
If you’re lucky enough to hold at least 20% equity in your house, borrowing against it might be a better option than using your retirement funds or having your child take out school loans. That’s because the interest rates on home equity loans are probably lower than those on student loans and what you may anticipate from the investments in your retirement account.
However, there is a clear disadvantage. Your home will be in jeopardy if you are unable to make the payments. Consider whether the savings outweigh the danger.
Is Your Retirement Plan Borrowable?
The benefit of borrowing money from your retirement account is that you can return it together with the interest you paid. However, that does not imply that it is free. The money you would have made if those monies had remained invested is what you really paid for. Another drawback is that you often have to pay it back over a 5-year period, so be sure you are able to afford those payments. Last but not least, find out if your retirement plan needs you to pay the remaining loan balance if you quit your work for any reason. If it does, doing so will be seen as a withdrawal and could result in taxes and a 10% penalty if you’re under the age of 59 1/2.
Do You Really Need to Give Us This Money?
No matter where you’re taking the money out from, keep in mind that you might want to use a retirement calculator to be sure you won’t need the money for retirement. In the end, just because you don’t give your child any money doesn’t imply you don’t love them or want them to go to college. It just means that, like most students, they will have to borrow the difference. But if you don’t have enough money saved for retirement, good luck locating a lender who will loan you the shortfall.