Early planning and inheritance

Paying for College
1

<p>Hi all,</p>

<p>I've been lurking here for around 6 months, but this is my first post! There seems to be a lot of expert advice here, so I'm hoping to gain from your expertise.</p>

<p>My mom passed away about a year ago, and we have inherited approximately $200,000. Our household income is around $75,000 per year, but through frugal living and occasional gifts from family we've managed to save close to $20K in each of our two children's 529 plans since they were born (they are currently ages 8 and 9). We plan to add $1200 per year to each until they graduate. Both my husband and I contribute to IRAs, and I will receive a pension for roughly 50% of my salary when I retire. We have no debt other than the house (which will be paid off in 6 years) and our vehicles (owe around $8k each with 0% interest). </p>

<p>So I'm looking for advice - how should we handle this $200K? We've considered paying off the house early, but our current interest rate (3.3%) is so low it seems senseless to do so when we're on track to pay it off in 6 years anyway.</p>

<p>Other ideas: 403b plans through work, brockerage account, more money in 529 plan?</p>

<p>If we put the money in a brockerage account, how will that affect financial aid in the future? I understand we're only "penalized" 5.6% of assets under the current rule, but what about if we end up using that money for college and take some out each year - thus showing it as "income" and potentially reducing our financial aid award for the ensuing years?</p>

<p>I realize I'm thinking way ahead here (still 9 years before either child applies anywhere!), but both kids have been identified as gifted students and we're thinking that this money may allow them more educational choice when the time comes.</p>

<p>Sorry for the longish post - thanks in advance for your time!</p>

2

<p>You might want to spend a couple of hours with a fee-only financial planner because you want to look at the big picture, not just your children’s college education (although that’s important too). If you feel comfortable investing this windfall, you can read up on investing theories and select one that makes sense to you. One option would be to park it all in an index fund and leave it alone for the next 4-5 years. Another option would be to select 4 different classes of mutual funds (value, growth, international and bonds) and allocate 25% to each, rebalancing every year. Or you could put some percent into age-based 529s for each child. The risk there is that the money is tied up and not easily available for emergencies if you need it in the next 6-8 years. The advantage is that the money is growing tax-free, but depending on your deductions you might be in a low bracket and so this is less advantageous for you.</p>

<p>Whatever you do, revisit your investments two years before your first child goes to college. At that point funds can be moved in the 529s for favorable treatment by the financial aid formulas.</p>

<p>If you use 529 funds or other savings for college, they are not double-counted as income.</p>

<p>It’s never too soon to start thinking about how to pay for college :)</p>

3

<p>I would put the money into a Roth IRA, if you can, before the 529 - you can avoid any early withdrawl penalty if you use it for education, but if you don’t need it, it’s already invested for your retirement.</p>

<p>I second the advise to talk to a fee-only financial planner. That fee buys you time with someone who has no particular interest in having you put your money is a set of specific investments. It’s in his best interest to help you get the most out of your plan, so you will recommend him to others.</p>

<p>And don’t worry about investing - when you sell your stocks to fund their education, only the gain would be income, not the full amount of the withdrawal. And if you have any stocks that have lost value, you could potentially capture the loss in your base year (end of Junior year, beginning of Senior), to reduce your adjusted gross income. A good financial planner should be able to explain how that and other strategies would work.</p>

4

<p>First off, let me disclose that I am a financial advisor and asset manager for typically higher net worth families. I also think most “advisors” are really just salespeople who know very little and charge a lot. My firm works as both a fee advisor and also as an asset manager (Fee-based) if the clients wants to use us for that function. Just FYI, I have no intention of soliciting clients on CC and wouldn’t even provide contact info if someone here begged to work with us - it would be inappropriate use of the forum and likely break some stupid industry rule. That said…</p>

<p>My advice is typically to focus on funding your retirement first, then kids’ college costs. How to invest the money? I’d never give that advice on a website for someone I don’t know. however, just to help you on the college financial aid part, the money you withdraw from an after-tax account is NOT income and appears nowhere on FAFSA or CSS profile. Only the dividend income and realized cap gains would be added to your income for tax purposes and FAFSA/CSS purposes. The balance of the account (if not a retirement account) would be reported as an ASSET not income.</p>

<p>So, in general, here are some ideas on investment account types (an IRA is NOT an investment, it’s an account type). Rioth IRA’a for what you can each year. Yes, maybe add to 403B/401k as well (I’m assuming you need more retirement funds - if you have less than $300k in those accounts then you likely do, but very specific to your situation). Also, does your state give an income tax deduction for 529 contributions? If so, maybe some there as well. The rest into an investment account invested appropriately for your time horizon for needing the money. Stock index funds sound great until the market tanks and your account goes down 40% (or $80k if a $200k account). There’s a reason most retail investors have missed the 100% market recovery since 2008 - they are scared to lose any more!</p>

<p>The truth is, when it comes to the college aid part, a LOT depends on what sort of schools your kids wind up qualified for, what your job income is at the time and many other factors. If you get much of this windfall into retirement vehicles over the next few years, then yes, it counts less against you for aid (counts no tat all for FAFSA only schools). However, you lose some freedom with the money in doing so so there’s a trade-off… as there is with most any financial decision.</p>

<p>Lastly, you guys are a financial planners dream client! Not rich or high income, but frugal, live within your means, no debt other than mortgage, have a PENSION coming, get a windfall and don’t blow it!!! Congrats, you’re heading for the 20% of our generation that will have a reasonably well-funded retirement. Most don’t and won’t. Teach your kids the same thing - HS and college won’t.</p>

5

<p>I would definitely pay off the home first. That frees up HUGE cash flow. I have a friend whose financial planner advised her to have her home paid off by the time her children enter college. That way her monthly house payment can be used to pay for college. That is smart!</p>

6

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<p>Another good thing about Roth IRA is that contributions, the money you put into Roth IRA, can be withdrawn from Roth IRA free of taxes and penalties. I think it is the best feature of Roth IRA and gives Roth IRA owners a lot of flexibility.</p>

7

<p>Do remember that money withdrawn from a Roth IRA is considered income by FAFSA and PROFILE. Yeah, I know…doesn’t make sense, but them’s the rules. </p>

<p>Rundmc put it very well. It depends on the schools that your kids end up choosing as to the best investment strategy. And you don’t know that till the 11th hour. Paying off the house is great, but keep in mind that PROFILE schools do look at that home equity value (though usually capped) as an asset. And borrowing against it might be an issue during times when credit is tight, and if your house value drops drastically as it has done in some places. </p>

<p>The fact of the matter is that most colleges in the US, the vast, vast majority of them, gap when it comes to financial aid packages. So the more you can afford, the better the options for your kids. I see posts all of the time of families looking for the best fit school for their kids, and they are rolling off the names of schools that are highly selective so admissions is not a go, though financial aid is good, and schools that gap, so they really cannot afford them. If your EFC or what a given college says you should pay is $30K and you can afford to pay $10K, given financial realities, it is not likely to happen. Having the money gives you the flexibility.</p>

8

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<p>All the money (including contributions) or just capital gains? </p>

<p>And I agree, doesn’t make sense to me either, but I am not making the rules :(.</p>

9

<p>All. Yeah. It doesn’t make sense. It’s a hybrid plan, so they treat as such. Your contributions to it are already included as income, which is also the case with a regular IRA since you have to add that year’s contributions back to your AGI. So that is no different. It is not recognized as an asset, nor are earning to it included as income. Again just like the regular. And when you withdraw from it, the whole withdrawal is counted as income just like the regular IRA. As I said, them’s the rules.</p>

10

<p>Is there a dollar limit on what you can put in a Roth per year? Of not, then I agree that is a choice worth pursuing.</p>

11

<p>The 2013 contribution limits for Roth IRAs are $5,500 if you’re under age 50 and $6,500 if you’re over age 50. There’s an income phase-out so higher income earners aren’t eligible to contribute. The OP is within the income limit and so can contribute.</p>

12

<p>Thanks so much for all the valuable info thus far - I didn’t think about the fact that Roth IRA distributions would count as income for financial aid purposes. Good to know!</p>

<p>Several people have recommended to us that we pay off the house - however, with an interest rate of 3.3%, couldn’t we almost certainly do better, even with the current state of the economy, with the money invested in a brockerage account? I’m thinking an average of 5% over the next 8-10 years. If it’s in a brockerage account and we have some disaster that prohibits us from paying off the house 6 years from now (our current plan), we can always take it out of the account and pay off the house then. In other words, I’m hoping to maximize our returns - does anyone believe this thinking is inaccurate? I guess this plan also assumes no significant long term tanks in the market!</p>

<p>Lastly, a dumb question: If we put the majority of the money in a brockerage account and withdraw some of it for college when the time comes, can we withdraw the principal instead of the capital gains and avoid claiming it as income for financial aid purposes? I guess I’m just unclear as to how we know a withdrawal is from the principal or from the capital gains. Sorry for my ignorance!</p>

<p>Most people in our area (probably in the neighborhood of 99%) go to instate public U’s. I attended a Tier III public U, and my husband never went to college. I guess, like all parents, we’d simply like to offer our kids more options should they have the stats for them. Too bad we won’t know, as someone else mentioned, until the 11th hour where they’d like to attend!!</p>

13

<p>I agree with fund retirement. I like Scott Burns’ advice for the couch potatoe, which is basically use Vanguard, low fee funds or EFTS, and split between equity and bonds.</p>

<p>Under current law, you can generally designate which shares you are selling to minimize capital gain.</p>

14

<p>Another question: Say we invested the money in Vanguard, Fidelity, etc. mutual funds. Would it be wise to roll over the capital gains each year into our Roth IRAs instead of funding them out of our salaries? This would also free up some cash each year to pay for vacations, piano lessons, etc.</p>

15

<p>First, do something fun you normally couldn’t afford. Most mothers would appreciate that. It could be anything from buying a big screen TV for $1000 to going to Hawaii for $10,000.
Second, fund your retirement first. Your kids can pay for college with jobs, loans, and scholarships. You cannot pay for retirement with any of those.
You are smart to know that a 3.3% mortgage is not as good as an investment that makes a higher percentage rate.
You throw a wrench in things by wanting money each year for vacations, piano lessons, etc. A consultation with a fee-only financial adviser is great advice.</p>

16

<p>And remember, you’ve got time. My state only allows a tax advantage on up to around $3000 per year. Even if h and I each had an account for each kid, we’re talking about 12k a year. A more likely scenario is each kid has an one account, so $6k. There’s a limit on IRA contributions. I’d probably fund tax advantaged accounts (retirement then 529) up to the limit for several years. Whatever isn’t deposited in a given year can be invested according to a strategy you’re comfortable with.</p>