Saving and Paying For Sibling's College Expenses

Paying for College
1

Our situation:

Older son just finished his sophomore year in in-state public university. Paid two years of his college expenses from the 529 savings in his name. Young son just graduated from high school and will attend a private college with the estimated EFC of around $30,000 per year. Both are going to take a gap year, however, and restart the school in 2018.

My older son’s 529 account has enough remaining to cover up to his senior first semester but short for the last remaining semester.

My wife and I have healthy 401k’s, Roth IRA savings and a very healthy investment in company stocks with dividend pay outs. We actually began the Roth IRA savings not for our retirement purposes (we have enough to retire on our 401k’s, our stock holdings and others) but to pay for our boys’ college cost. We, however, don’t have enough saved in the Roth IRA to pay for the rest of the younger son’s college expenses. We plan on saving about $1,500 a month for our older son, and if we do that for the remaining year, we can cover his remaining semester of his senior year, and he’ll graduate debt free.

My question is: given our situation, what’s the best way to 1) put $1,500 a month? In his 529 account? In our Roth IRA accounts? In our bank savings account? 2) For our younger son’s estimated $30,000 a year EFC, is it better to tap into our Roth IRA accounts (with no penalty, I understand, when used for education expenses) or sell our dividend paying stocks (which then raises our earnings) or tap into our 401k (with no penalty, again, when doing so for education expenses).

We can tap into either our Roth IRA or 401k accounts without hurting our retirement. We also intend to save (going back to the first question) about $2,000 a month for our younger son’s college expenses when the school starts after the gap year.

Not having any financial management expertise with nuanced details for the inner workings of college FA and tax implications, etc., I’d very much welcome your opinions and recommendations.

2

You haven’t provided your income, nor noted if you can afford to pay the $30K out of current income. How much will your second child’s EFC change after older child graduates, or will it be $30K for all 4 years?

Given what you’ve indicated about your general asset level, with your stocks and investments, have you been handling your taxes yourself or have you been getting them prepared by a financial advisor? I am presuming you may be qualifying for the AOTC, but I understand that at some income levels this is phased out.

3

@3puppies - Out of our current income (I’m retired, so from my wife’s earning), we can save about $1,500 to $2,000 a month for this gap year, and that should be, combined with the 529 savings remaining, enough to graduate our older son debt free. When our younger son starts, we can continue to save about $2,000 a year towards his college expenses of about $30K a year EFC for the duration of first 2 years when both of our sons are in college. After those two years when both sons are in college, I’d expect my younger son’s college cost to go up to around $40,000 EFC a year for the remaining two years, assuming he can graduate in 4 years.

My first question is what’s the best way to place $1,500 to $2,000 during this gap year and beyond, i.e., into the 529 savings, Roth IRA, bank savings account, cash? My second question is, when these continuing savings aren’t obviously enough to cover our younger son’s expenses, especially for the remaining two years of his college, which assets of ours is best to tap into, i.e., stock holdings, Roth IRA or 401K?

Yes, I’ve been handling our taxes myself.

4

To a large extent you are asking an investment advisor question. I am not an investment advisor. I am however in a somewhat similar situation being retired with two children in university (or at least I will in September).

The one thing that jumps out to me in your post, is that it sounds like you might have a significant investment in one stock, or at least individual stocks. I might be biased since I worked my entire life in high tech and individual high tech stocks have plummeted on occasion, but to me having a lot invested in one stock is risky. Given the current valuations I think that even having a lot invested in a stock based mutual fund is a bit risky.

The other thing that I wonder about is the extent to which selling stock to gather cash for college will result in a higher reported income, which could reduce your need based aid. I didn’t get from your post how you managed to find a private university that costs $30,000 per year. Is this based on merit aid, need based aid, or something else?

As such, given that you need the money soon my first thought would be to hedge against a possible decline in stock values and try to take some of the “one stock” holdings, even a dividend paying stock, and use this as the first place to sell and take out cash. Also, given that you are going to need this money in about 12 months, I would be inclined to store most of it in a bank account. The folks managing your sons’ 529 probably have a conservative allocation based on when your kids will be in university, which implies that the 529 is also a good place to store money for the short term as long as you don’t put in more than you will need (since the 529 funds are limited in terms of how you are allowed to use them). The problem that I see with this approach is that selling stock will increase your apparent income, which could reduce need based aid. I don’t know the best way to handle this.

By the way, as long as your wife is working I am assuming that you can probably get reasonable health insurance through her employment. If she retires, then health insurance will be very expensive until you both reach 65 and get medicare, and insuring an adult child for example after graduation and before he finds a job can be very difficult if both parents are retired.

5

For clarification – a 529 account owner can use the funds for anything he/she wants. Any part of a 529 distribution that is not used for a qualified expense will expose the earnings portion of the non-qualified part to income taxes and potentially a 10% penalty. Money that has been contributed to a 529 account can always be taken out at any time without a tax or penalty being imposed. That being said, every distribution from a 529 will made using the then current contribution/earnings ratio. A 529 account owner who is fortunate enough to have large gains in the account could have a hefty income tax bill (and maybe the 10% penalty) on the earnings portion of any non-qualified distribution.

6

Is second son going to a Profile School? Some Profile schools treat different types of parent assets differently. Their formulae are all different - I recall one school telling me that for “cash” assets, they consider everything over two months primary rent/mortgage/tax payments, but another school said they consider every nickel. Some schools will consider Roth IRA’s as “available” depending on the parents age. While for most schools, it might not make any difference, there are those of us who like to know how things work, so we can maximize the FA we get - even if it would result in only $50 more aid.

Since your spouse is still working, can she take a loan against her 401K for the remaining 2 years to pay for the education expenses? Depending on the terms, and if there are any fees, etc., this might be another option to consider.

7

For savings you expect to use in one year, put it in the safest option available.

I like Mark Kranowitz’s financial aid explainers in general. Here is his on using IRA’s for college

http://www.finaid.org/savings/retirementplans.phtml

8

@DadTwoGirls -

First, happy retirement to you next month! Wishing you many many fulfilling years ahead. <:-P

As noted, I’m already retired and my wife is due to retire in a couple years, and when she does after 25 years with her company, she will be able to continue to use her company provided health insurance plans. It’s very likely, though, that she will continue to work until our younger son graduates from college debt free.

I was expecting someone observant about my stock holdings to note the riskiness of such holdings, but without getting into whatever the rationale for my investment behavior, let’s suffice to say that these are not even in mildly volatile sector. Although there are no such a thing as safe sectors and all stock play is inherently risky, these are as close to the level of being “safe” as our 401Ks which alone are healthy enough for us to rely on for our retirement years. I’m also always on top of every movement of these stocks, so to speak, and alert to take actions.

The problem, as you noted, is that selling these stocks will raise our income. In fact, we had to exercise my wife’s company stocks in 2015 as the deadline was approaching and unfortunately the timing was bad and we had to report that as a part of the total income for all FA applications. I did make a note of our “atypical” income in 2015 in all FA applications and while about half of the schools that offered admission hardly gave any merit or need-based money (as I expected), I was surprised that the other half offering admission wildly varied with the offers, the best offer being only about $5,000 a year more than what I’ve been paying for my older son’s in-state public. My younger son’s (chosen) college expense of $30,000 EFC estimated figure was based on the school’s need-based offer from our 2015 atypical income year adjusted to our typical 2016 income with one sibling in college.

Selling the stocks, at this point, is the very last option. As for saving into my older son’s 529 account for the coming year, one thing I’m not sure is how my younger son’s school will look at his older brother’s 529 account when calculating the need-based money for my younger son. My guess is that the estimated total amount of some $30,000 in the sibling’s account probably won’t make much of a difference given how they calculate such assets?

I’m also very interested in learning about which of the noted resources (Roth IRA, 401K) other than selling the stocks that’d be most advantageous in tapping into when cash savings run out eventually.

9

@3puppies - My younger son’s school in question is Princeton, and it has its own internal FA application I had to fill out. Funny thing was I didn’t even know it had its own internal FA application until they notified us in late February to fill it out. If my memory serves me right, I think I sent CSS Profile to Princeton, as well, but I’m not too sure as I tried to FORGET the whole college application process since completing the final paper work.

Didn’t know about the option of taking a loan against my wife’s 401K. Thanks, will certainly keep that option open in case.

10

@AroundHere -

Thanks for the link. Exactly what I need to read!

11

As for the loan disadvantages in the link @AroundHere provided - I have a pet peeve about the following

The fact that you’re repaying yourself interest with after-tax dollars is independent from the tax benefit of your contributions to the retirement plan. When you take the loan, you do not lose the tax benefit, because the loan is still an asset and remains a part of your 401(k) account. This is a loan. If you took a loan outside your plan, you’d repay it with after tax dollars, so why would anyone expect to get additional tax benefits on the loan repayments?

Again, the money you borrow is still invested in your retirement plan - you are effectively locking in a set interest rate for a portion of your plan’s assets. Whether or not this locked in rate is better or worse than your other investment rates is unknown - because you don’t know what the market will do.

The first part of this is true, it is a loan so you have to pay it back. The second part is only true if you decide to stop your ongoing 401k contributions. You are not losing the money your retirement funds would have been earning - but you are losing the opportunity of other use of the money you repay it with.

This depends on how you have chosen to invest, and of course is only true if your 401(k) investment has not performed well at the time you take the loan. Lots of 401(k) plans are doing really well lately.

Some plans do not allow loans, while some plans allow multiple loans for any reason - others restrict them such as only allowing them for some reasons, or only allow one at a time. Sometimes, people will take a small loan from their plan, so they can show they have exhausted the loans available, and then they are allowed to take a hardship withdrawal.

Loans from a 401(k) are not a good idea for everyone, but they make a lot of sense in some situations. A lot of plans offer them, and depending on interest rates and fees, age, job stability, other investments and options, etc. they can be among the best choices people have. I encourage people to check with their Plan Administrator to determine if a loan makes sense for their own situation.

12

“First, happy retirement to you next month! Wishing you many many fulfilling years ahead.”

The “in a month” is the two girls in university. Retirement happened a year ago. Nonetheless, thanks for the good wishes! I am enjoying retirement, and glad to do so while I am still relatively healthy (and when the stock market happens to be at a high level – which I don’t assume is permanent).

I too will take a look at Mark Kranowitz’s recommendations.

13

My bad, I misread your statement. Happy retirement, nevertheless! :slight_smile:

14

Have you been regularly selling off stock to match your losses to your gains? if not, you need to start. You would sell anything which is trading at a loss-- you can carry forward your losses if you need to. But I’m assuming that some of your holdings are in a mutual fund where you are paying capital gains every year…this year you minimize your tax bite by matching your losses to your gains-- assuming you’ve owned these assets for a long time there are bound to be losses every year.

Does your state provide for a tax credit or deduction for contributions to the 529’s? Some do. If yours does, then contributing the cash into the 529 is probably the most tax efficient strategy for your savings. You don’t know whether the market will go up or down, but your state income tax bill is a pretty predictable number assuming one retiree and one wage earner… any savings there are net extra to you.

And when you say “exercise your wife’s stocks” I assume you mean exercise her options, yes? Will this be a problem this year and next year as well? (many options are granted on a three year rolling basis, i.e. 1/3, 1/3, 1/3). Depending on the value it might be worth getting professional help here. If you are talking about 5K extra in income then it’s not that big a deal. But if it’s 50K or more you need professional help. Your wife’s company may offer an hour or two with a financial planner (for free) as part of her employee benefit package- very few employees take advantage of this, and it’s a great deal. Most companies do NOT refer to planners who get a cut of what they sell you. They will refer you to a fee only planner (and the company foots the bill for some portion of the consultation) who will have a better understanding of how to handle stock, options, a 401K plan or other financial instrument for work than a layperson can have.

15

@blossom -

Yes, I was talking about my wife’s company stock options and it’s not an issue any more.

And yes, my state provide tax deduction for contributions to 529, so it sounds like continuing to contribute to that account would be my best bet. My memory is rather fuzzy as to whether Princeton’s internal FA application asked to report my son’s older brother’s 529 account holding or not, but even if it did and I will have to, I doubt that it’d make much of an impact with only about $30,000 asset under my older son’s name?

16

By the time you need to do Princeton’s FA application it won’t be 30K- you will pay your older son’s tuition for his post gap year out of the 529, correct?

17

Yes, @blossom, it won’t be 30K, I was using a very rough estimate. Right now I think I have about 30K remaining in my older son’s 529. If I put in $1,500 a month into his account during this gap year, we’d add 18K to 30K for 48K total. When my older son returns for his junior year next fall, I expect to wire about 12K for the first semester, so we’d actually have about 36K remaining. I believe it’s around Jan 2018 that I’d have to do Princeton FA, so then we’d have about 37.5K to report.

18

But in January of 2018 you’ll already have paid Son 1’s Spring semester, correct? So it’s 36K minus the 13K or so for the next semester.

Not challenging you on the math, just not understanding what the problem is. If you are covering all of his qualified expenses for the remaining two years of his education then there isn’t going to be much money left- whether Princeton looks at it or not is a different issue- regardless.

What am I missing? I think you pay as you go for Son 1 out of 529, continuing to put money in throughout his education down to the last dollar so you max out your state tax deduction. For Son 2 you essentially do the same, but you make up the gap by either borrowing from your 401K or selling stocks which are trading below what you paid so take the loss (you get the cash but you offset your capital gains in other parts of your portfolio with the losses so you don’t owe extra tax.) Anything left in Son 1’s 529 can easily be used for Son 2 (or for grad school) so no worries about maxing out on the tax deduction but over funding his tuition.

Son 2 gets a job during the year, and a better job/more hours during the summer to keep down the amount you need to tap to bridge the gap.

What am I missing? If you’ve got a whole life insurance policy you may find it convenient to borrow against that as well- talk to your agent.

19

@blossom - “But in January of 2018 you’ll already have paid Son 1’s Spring semester, correct? So it’s 36K minus the 13K or so for the next semester.”

My older son’s gap year lasts until next summer, and I believe we don’t pay for his Fall semester until then (I forgot exactly when the deadline for the first Fall semester payment was). Regardless, I’m more worried about the most effective way to fund my second son’s college. Our stock holding is primarily of my wife’s company’s dividend earning stocks (options and direct purchases) – no mutual funds of any kind other than Roth IRA and 401K – and some individual stocks that I’ve been playing for two decades or so with NO losses on any of those holdings, so selling any of them are going directly to our reported income. We’ve been long-term stock investors, and I’ve weeded out losing stocks many years ago. I need to read the above mentioned link to see all the pluses and minuses of tapping into either Roth IRA or 401K.

20

So your entire portfolio is up, you’ve fully funded your retirement, and you’re worried about an increase in your income (due to selling stocks which you’ve held for two decades or more) reducing your financial aid?

Is THAT the problem?