Episode: 08-09-2022 | College Funding

Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP® Dollars & Common Sense · College Funding Kevin Zywna, Wealthway Financial Advisors:  Good evening. Not that I want to rush summer or anything, but I thought we would talk about a topic that is starting to pop up here this time of year because […]

Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP®

Kevin Zywna, Wealthway Financial Advisors:  Good evening. Not that I want to rush summer or anything, but I thought we would talk about a topic that is starting to pop up here this time of year because it is getting to be back to school time for college students. I know people are starting to make tuition payments and so I thought it would be a good time to talk about how to fund college and college tuition. Fantastic. I’m looking forward to making my daughter’s tuition payment on August 20.

Allison Dubreuil, Wealthway Financial Advisors: I was going to say congratulations to you because you got one done now. And only one left to go, right?

Kevin Zywna, Wealthway Financial Advisors: One done-ish. The other one working, rising senior. So, one more year.

Allison Dubreuil, Wealthway Financial Advisors:  But that doesn’t necessarily mean it’s the end of dependency.

Kevin Zywna, Wealthway Financial Advisors:  No, it doesn’t. That could be a whole separate show, though.

What Is The Likelihood For College Scholarship?

Allison Dubreuil, Wealthway Financial Advisors:  Okay. Well, tonight we’re going to talk about college funding and some ideas and hopefully practical tips on how to approach it if you are thinking that your child or grandchild is a gifted athlete or a brilliant student and is likely to get a free ride. I don’t want to be a dream crusher. But 0.3% of people get a complete free ride. Point three. That’s hardly anybody. I think we need to talk about how you’re going to fund tuition if you’re looking to pay for your child or grandchild.

Kevin Zywna, Wealthway Financial Advisors: Less than 1% receive full college scholarship. And the numbers are only slightly better for general athletic scholarships. I think you have the most success when it comes to academic scholarships or sometimes unique skills. I guess what I would call them, maybe music, theater, dance, the arts, right? There are also some opportunities there. But still very competitive. Depending on a scholarship to fund the majority of higher education is not a strategy that we would recommend.

Allison Dubreuil, Wealthway Financial Advisors: Let’s talk about expectations versus reality. Some research has shown that families expect that they’ll pay 30 to 40% out of pocket, and that the rest of the 60% will be covered by grants, scholarships, gifts, or I guess, maybe loans. People expect to cover about 30 to 40%. But the reality is that most people are going to need to cover at least 50% of tuition costs. Because grants, scholarships, family gifts, and student loans don’t necessarily cover as much as people had thought before they started looking into this.

Kevin Zywna, Wealthway Financial Advisors: So, there’s some wishful thinking, when it comes to college planning. Like maybe I won’t have to pay as much as I think I’m going to have to. But in reality, it’s at least half – usually 50 to 55%, comes out of the parent pocket. Some of that gets shouldered over to the student. Which I will say we do think is a good idea to help teach the students good financial habits early on in life, and then also to get them focused on the task at hand by having some skin in the game and some money on the table. Usually, they pay a little bit more attention in class and maybe a little bit more diligent in doing their homework when they know they aren’t getting a free ride for Mom and Dad. True, can be true depends on the person. Of course, there are those that are self-motivated that don’t need that extra help. But for those who don’t, we usually recommend giving the child some skin in the game. Okay. As promised, when we get a call in line, we’re going to break and talk to that caller right now we’re going to go to Chesapeake and speak with Kathy. Good evening, Kathy, you’re on Dollars & Common Sense.

Impact Of TSP Withholding From Your Paycheck

Caller:  Good evening. Question on a TSP withholding from the paycheck. So, my husband and I are retired navy. And with our extra jobs, we’re in a higher tax bracket. But my question is, why am I doing an after tax contribution to my TSP, when I do believe we will not be in such a high tax bracket, when both of us actually retire, retire? And so, the arguments have been going back and forth. And I wondered what your opinion would be.

Kevin Zywna, Wealthway Financial Advisors:  Argument between you and your husband or you and your husband against somebody else?

Caller:  My financial adviser said do the pretax withdrawal because we are in a high tax bracket, close to like 38%. I’m not sure what we can do anymore to bring taxes down considering the withholding went up so high. And it is one of those things where, are we really going to be in this higher tax bracket, or a tax is going to go up so much? I haven’t read the new law. I’ve heard not very good things about the so called inflation Reduction Act. So that’s the financial advisors. He’s not strong on it. He’s just recommending it. And my husband is like no, we’re going to have to pay such high taxes when we retire, retire, just keep pulling it out on your after tax income.

Allison Dubreuil, Wealthway Financial Advisors:  Well, it is a good question, Kathy. Because the decision revolves around some unknowable. You know, we don’t know like you said what the tax law is going to be in the future. And we don’t absolutely know what tax bracket you’ll be in in the future. But you can do some pretty good projecting that can get you in the ballpark based on what your retirement income will be and what your required minimum distributions from your TSP will be and whether those are going to be significant, significant enough to push you into a high enough tax bracket. But I think the crux of the decision is, if you believe you’re going to be in a lower tax bracket in retirement, you will want to get your tax deduction today while you’re in a high tax bracket and then plan to have to pay the tax in retirement hoping that you’ll be in a lower tax bracket.

Caller:  That’s exactly what I thought. And I do appreciate both of you. And also, the college comments, because we just lived through all that. And what people can’t plan for is all the other expenses, the rent, the utilities, above and beyond tuition. So, thank you.

Kevin Zywna, Wealthway Financial Advisors:  All right. Thanks for the call, Kathy, we appreciate it. When it comes to making pretax or Roth contributions in a 401K plan or the TSP plan, you basically want to get your tax deduction when your taxes are the highest. For most people, they’re in the highest tax bracket, the late stages of their career and so that argues for making the pre-tax or deductible contributions to your company retirement plan.

Allison Dubreuil, Wealthway Financial Advisors:  Yes, it can be more nuanced. There can be a reason why, if you’re in a high tax bracket, you still may choose to make Roth contributions. If you have all your money in pretax buckets already then you may decide to put money in Roth buckets. You may want a little bit of diversification. You want some options in retirement. To have a bucket that’s tax free so you may decide to bite the bullet, pay the taxes on it today just to have some flexibility down the road. So, I have seen that, and I can see where a case can be made for that.

How Does Employment After Retirement Impact Social Security?

Kevin Zywna, Wealthway Financial Advisors:   We’re going out to Newport News now. I’m going to speak with Jeff. Good evening, Jeff, you’re on Dollars & Common Sense.

Caller:  Fully retired not working a job. I’m 73. I’m getting Social Security and it’s not enough to pay the bills. I want to go out and earn more money. I’m worried that if I earn money, it’s going to cut into my Social Security. Is that going to happen?

Allison Dubreuil, Wealthway Financial Advisors:  Good question. Jeff. You said you’re 73?

Caller:  Yes.

Allison Dubreuil, Wealthway Financial Advisors:  Okay. So, once you reach your full retirement age, which is different for everyone, but for you would have been probably, you know, 65-66. Once you’ve reached your full retirement age, then you’re not penalized for any earned income. Your benefit is not reduced based on any earnings. You can earn as much as you want and keep your full social security check. With the caveat that it will be subject to income taxes if you earn over a certain amount.

Caller:  Everybody gets income tax, I understand that. I have one more idea for you, on the person who was worried about pretax and after tax on their savings. Right now, the market is so far down, it probably makes more sense to be putting it in a Roth system and going into the market. Because when the market has gains and it goes back up in several years, that’s untaxed earnings. Whereas doing it the other way, they would put it into a standard Roth, the earnings would be taxable.

Kevin Zywna, Wealthway Financial Advisors:  I don’t think the equation hinges on market performance. The market’s performance is going to be the same whether you make pretax or post tax contributions. It’s really the tax brackets. That’s the big driver. And while we know what the tax brackets are today, we don’t know what the tax brackets are going to be, say five years into the future, because that’s a decision that gets made by Congress. And so those are always subject to change. And that does put an element of uncertainty into the whole decision making. But we do appreciate that comment, Jeff.

Allison Dubreuil, Wealthway Financial Advisors:  Yes, sometimes I think of it as like, would you rather pay tax on the seed, or the harvest? And so, I am a big proponent of Roth, because you’re paying tax on the seed. And then the growth, which is the harvest, which would, in theory, be much more over the years, would be tax free. But you know, it’s if you’re in a high tax bracket, and it just depends on the entire situation, it’s hard to give blanket advice well, on anything we talk about. So, we’re speaking in generalities.

Kevin Zywna, Wealthway Financial Advisors:  Especially when it comes to contribution between pretax or post tax dollars and a retirement plan or a lot of times in Roth conversions. It’s not as cut and dry as a lot of articles I read try to make it seem. It is not. There’s a lot more nuanced, a lot more complexity involved in the calculation, if you’re trying to maximize your overall net worth. Okay, we’ve got to go to Smithfield now. Kyle, good evening, you’re on Dollars & Common Sense.

What Are The Best College Funding Options For Young Children?

Caller:  Hey, so I have a five year old and a three year old. The five year old is about ready to leave private school and go into public kindergarten. My question is, we’re going to have some income that we haven’t really relied on too much. How can we best put that to work for his future? Whether it’s for college or some other path that he chooses later in life?

Allison Dubreuil, Wealthway Financial Advisors:  Great question. So, you said that he’s going to go to public school, you think going forward through K through 12.

Caller:  At least for now. Put them in public school. Definitely. Cost of, you know, about $1,000 a month that my wife and I were thinking about putting into like a 524. But some of our concern is that if he doesn’t go to college, what that will look like tax wise and whether it will be punished with fees or something like that, when we go to pull it out and use it for something other than college if that was the path that he chose?

What Is A Virginia 529 Plan?

Allison Dubreuil, Wealthway Financial Advisors:  Yes. Okay, so good question. So, I think you’re talking about a 529 plan, Kyle, which is a college savings account. And you can make contributions to a 529 plan. If it’s a Virginia 529 plan, and you live in Virginia, you get state tax deductions for contributions that go into a 529 up to $4,000 a year. And you can invest the money in the account. The money grows tax free. And then if it comes out for higher education expenses, it is tax free. Higher education expenses are broadly defined. Now they include things like trade schools. Really any, it doesn’t have to be a four year university, it can be any sort of higher education. It doesn’t have to just be tuition. It can be for fees and expenses and room and board and supply. So, it’s pretty broadly defined.

Kevin Zywna, Wealthway Financial Advisors:  Things like computer training school, sometimes a beauty school, the truck driving schools, as so it doesn’t have to be college. So that even though we kind of say it for that, it’s post-secondary, qualified post-secondary schools that are eligible for student aid under Title Nine. You can check this out right now at https://studentaid.gov/. If you have an institution in mind, they’re all pretty much listed there. It’s much broader than college number one, and then also yes, the expenses. It can be used for tuition, fees, books, room, board, computers, equipment, internet, anything to help with the college expenses except for beer and pizza.

Allison Dubreuil, Wealthway Financial Advisors:  Now if he really doesn’t go in that direction at all and there is no secondary education then you still have flexibility. So, the money can come out for any reason. You’re just going to pay tax on the earnings where it would come out tax free if it was for higher education expenses. Or you can transfer it to the younger child, and they can use the money to buy a car.

Kevin Zywna, Wealthway Financial Advisors:  We’re going to continue the conversation with Kyle, in Smithfield, who was asking about college funding options for his two young children. Is that right, Kyle?

Caller:  Yes, that’s correct. I guess the follow-up with that is if my children decided that they want to leave the state of Virginia and go to a university somewhere else or Trucking School in a different state or whatever that may look like, what are the impacts? Are there any impacts to contributing directly to the 529 Virginia plan? That would come from that. And then I think the follow up question to that is outside of the 529. What are other steps that can be taken to prepare as early on as possible for whatever’s next in life for them?

Allison Dubreuil, Wealthway Financial Advisors:  Well, we’ll tackle the first question, which is easier. Are there any negative impacts when if you have a child that goes out of state? I would throw this to Kevin because he’s got two kids out of state. But it depends on the college savings vehicle. If you do something like pre-paid tuition, then yes, that can cause a little more complications. If you go out of state.

Kevin Zywna, Wealthway Financial Advisors:  It would limit the value of the pre-paid tuition program that is under the Virginia 529 umbrella.

Allison Dubreuil, Wealthway Financial Advisors:  It’s under Virginia College America college savings plan but actual 529 savings account is not state specific in terms of where the student goes the only state suspicious specific part of the plan is that Virginia’s plan offers the state tax deduction for Virginia residents and each state has their own plan and you can go invest in like the Oregon’s plan. If you think that Oregon has a great plan, you just won’t. You might probably not get a tax benefit from doing that. But it has no relationship to where the child goes to school.

Kevin Zywna, Wealthway Financial Advisors:  I think that’s perfect. That’s what I was looking for. So just to clarify, there’s a prepaid Virginia Plan and then there’s just the regular 529, which encompasses, like a tax deduction, or you can have it invested in overtime and not be punished. I guess if they were to leave the state. We’re fortunate enough that Virginia has one of the best 529 plans in the nation so that you really don’t have to look much further than that. And yes, there are two different types of programs. One is the prepaid tuition, which we generally don’t recommend. Then the other one is Virginia Educational Savings trusts, which functions a lot like a TSP or a 401K. You put money into it, you can invest into the plan, there’s no guarantee what you’re going to get on the back end. But if you have a long enough time horizon, and you do with your kids at five, and three, that if you started now, you’re looking at 15 years for one and about 18 years for the other, where that money can grow. And then you have total flexibility of where you use it. It does not have to be state specific there. So, does that make some sense, Kyle?

Allison Dubreuil, Wealthway Financial Advisors:  Right. You got it. That’s correct. We like the 529 savings plan. We just caution people about over funding them, there’s a balance. So, you want to save. We encourage people to start as early as possible saving because time on your side is going to make that much easier. So saving as much as you can now is great, but we would caution against over funding the account, because you can also use other investment accounts to pay for college, when the time comes, you may have cash flow that you can use on a monthly basis from your earned income, you may have just regular brokerage investments that you can access without penalty to help supplement as well. And we did talk a little bit at the top of the show about scholarships, grants, things like that or work study, or maybe you’re going to choose to have your kids take on a little bit of responsibility and paying. So, we usually recommend a combination of sources and not over funding the 529 plan.

Kevin Zywna, Wealthway Financial Advisors:  But you do have the flexibility of being able to change beneficiaries on the plan. So, in your case, Kyle, you probably want to set up one account for your five year old and another for your three year old. And if it turns out the five year old, joined the Navy never went to institution of higher learning, then you could transfer the funds from the five year old to the three year old. And hopefully you would get used in that regard. So, you do have flexibility there. And it doesn’t have to be used up by age 22 or anything like that. It’s I think we’re stretched out to age 30 Now, also can be used for graduate schools, and it could be passed to a niece or nephew or cousin. While that’s probably not your primary purpose, just know that it can be done. And there’s a lot of ways to ultimately try to find a use for those funds.

Caller:  Alright. I think that answers everything I have.

Kevin Zywna, Wealthway Financial Advisors:  Okay. All right. Thanks for the question. We appreciate it. We’re going to go to Virginia Beach and speak with Larry. Good evening, Larry, you’re on Dollars & Common Sense.

What Are EE Savings Bonds And How Are They Used?

Caller:  Thank you for taking my call. I have EE savings bonds that I bought my kids 30 years ago. They’re ending, not earning interest anymore. And I was wondering if I could use them for my grandson. And would they still be tax free?

Kevin Zywna, Wealthway Financial Advisors:  Yes, so first of all, EE savings bonds can be used for any purpose. They’re not exclusive to education, right. If they get used for education, then yes, there is a sheltering of the interest that was earned on them. I don’t know off the top of my head but I think we might be able to find out in a few minutes, so as long as they get used for higher education expenses, then there is some protection or some deductibility of the interest on the savings bonds and it doesn’t have to be for your own children.

Allison Dubreuil, Wealthway Financial Advisors:  But were you asking Larry about the implications of transferring ownership or are we just talking about the tax benefits?

Caller:  Generally, just the tax benefits.

Allison Dubreuil, Wealthway Financial Advisors:  The tax benefits, okay. Yes, the interest on EE bonds can be tax free for college if it’s qualified educational expenses for the parent or dependent child. So it sounds like it’s pretty specific tuition and fees towards a degree or certificate program for you, the owner of the bond or a dependent child.

Kevin Zywna, Wealthway Financial Advisors:  Okay, so I had that wrong. It does need to be a dependent child. Yeah. Okay. I think there’s an ownership though. And I think there’s an income limitation to be able to do that as well.

Allison Dubreuil, Wealthway Financial Advisors:  I don’t know. I don’t have that in my fingertips. But I’m sure that we can find that.

Kevin Zywna, Wealthway Financial Advisors:  Yes, it doesn’t happen too much anymore. A lot of people did that savings bond. As an investment vehicle for college before there was a Coverdale savings account, educational account before there was the 529 plans. Nowadays, the 529 plan is far and away the most superior savings vehicle for setup, second post-secondary education that exist. And Virginia has got one of the best. So, it’s a no brainer, easy decision, the 529 plan for most people is going to be their preferred route there. So, I guess in your case, Larry, because you didn’t use it for your kids, then you might be able to transfer ownership of the bonds to allow it to work for the grandkids.

Allison Dubreuil, Wealthway Financial Advisors:  Yes, I would need to investigate the specifics on that. But I think that might trigger a taxable event if you do that. So, I would be cautious.

Kevin Zywna, Wealthway Financial Advisors:  And if nothing else, if it’s not earning any interest now, which you say is not, and you’re not going to use it for education, then just cash them in. I mean, you’re not earning any interest. They’re not doing you any good at this point. Those funds should be used for something.

Caller:  Yes, I’m with you there on that. That was my last ditch effort – if I can use it for my grandson.

Allison Dubreuil, Wealthway Financial Advisors:  Yeah, I mean, you can. So, it sounds like if it’s your grandson, you pay tax on the interest. But yes, you can certainly go ahead and use those funds for anything you want. You’re just going to owe tax on the interest.

Caller:  Okay, thanks very much.

Kevin Zywna, Wealthway Financial Advisors:  Alright, Larry, thanks for the call. Appreciate it.

College Funding Options

Allison Dubreuil, Wealthway Financial Advisors:  Yeah, so we covered 529 plans, which is probably your best bet and trying to save to self-fund education expenses. Then like you mentioned, Kevin, the Coverdell Education Savings account that’s kind of going by the wayside, because you’re very limited use, you can only add $2,000 a year. So that’s not a great option versus the 529, you’re not limited to how much you can put in as contributions. I think that the limit is $400,000 per beneficiary, but not many people bump up against that.

Kevin Zywna, Wealthway Financial Advisors:  And nor would we recommend them no, no.

Allison Dubreuil, Wealthway Financial Advisors:  If you are, you don’t have as much time on your side. Well, first, let me just say, because we were talking to Kyle who had the three and five year old’s, and he was, looking at starting to save each month, let’s just give you a ballpark of what you might need to save if you wanted to fund. Let’s call it 100% of expenses of average public university.

Kevin Zywna, Wealthway Financial Advisors:  And just because you can doesn’t mean you should but go ahead with your example.

Allison Dubreuil, Wealthway Financial Advisors:  For example, if you wanted to cover 100% for a four year public university, you would need to start saving today, about $600 a month for a newborn. If it’s a five year old, six year old, it’s about $850 a month. And so, for the older the child, obviously you’re playing catch up. The more you would need to save because you don’t have as much time for the invested funds to grow and to compound.

Kevin Zywna, Wealthway Financial Advisors:  And we would make this comment as well. Even people who feel very strongly about education and giving their kids the best education, they can and have strong opinions about their children wanting their children to go to college. These are big numbers, that you must sacrifice that a lot of people will have to sacrifice their own financial security, their own retirement to try to max fund their child out or children’s college education. So, there are loans, there are scholarships, there is work study for college, there is none of that for retirement. So that’s why we often recommend that most people should, without guilt give their children a financial stake in that college education. It serves multiple good purposes, one of which is allowing you some act to free up some excess cash flow to ensure that you and your spouse are taking care of yourselves financially for the long term.

Funding College By Reducing The Cost Of College

Allison Dubreuil, Wealthway Financial Advisors:  Yes, and while we’re talking about savings and how to pay for college, and I didn’t want to focus too much on this, because we’ve talked about this a lot in the past, but another aspect is reducing the cost of college. So that means staying in state versus going out of state. Virginia has wonderful public universities, that might mean choosing Community College for just your basic Gen Ed’s that you need. That can save you significant amounts of money doing community college before finishing at a full time university.

Kevin Zywna, Wealthway Financial Advisors:  Virginia has a fantastic program to do two years of community college and then transfer into Virginia Public schools. You graduate with that Virginia Public degree.

Allison Dubreuil, Wealthway Financial Advisors:  Right. So, we’re talking about savings and how you can get ahead of savings and how you can fund 100%. But it should be combined with cost reduction strategies and a conversation with the student about the reality of this investment that you are, they, or both of you are making. Yes, we’ve been talking about the main savings vehicles. If you’re going to try to, hopefully, had that off with savings as early as possible.

Don’t Pay For College From Your Retirement Savings

But let’s talk a little bit about what maybe not to do. So, we’ve touched on this a little bit. But one of the things I found shocking was this statistic that two out of three parents consider using retirement funds to pay for children’s education, don’t do it. And like Kevin said before, there are other avenues for education funding. There aren’t a lot of bailouts for retirement. There’s not a retirement loan program so to speak. There are so many other negative consequences to withdrawing from your retirement funds for education. Taxes, it’s probably going to be a big tax hit penalties if you’re under 59 and a half. Not to mention that those withdrawals for even though they’re used for college. They could count against any other aid or help that your student might get so leave the retirement plans out of the equation and prioritize yourself and your retirement for first and then figure out the education equation.

There can be other ways if you haven’t pre-saved, and you, you don’t want to do 100% student loans, there are other things you can do. You can perhaps access home equity, which was a good idea, a decent idea when interest rates were rock bottom. Now, home equity rates might not be as favorable as getting an actual education loan. If you have a whole life insurance policy, you can use cash value or not huge proponents of that being a strategy, proactive strategy. But if you do have a policy, and you don’t need it for other reasons, then that could be a use is to use that for education funding. And even though I don’t say, don’t take out of retirement accounts, if you’re going to do retirement accounts, then you probably want to look at using the Roth because that can come out tax and penalty free. But pretend I didn’t say that don’t do it.

Kevin Zywna, Wealthway Financial Advisors:  Should be your funding source of last resort. And usually with loans, I mean, student loans. Now, it does depend on year, but most students, regardless of income, regardless of parent income, students are typically all eligible for it totals out to about $27,500 now that they can borrow over a four year period. So between some work study, between some parent loans, you’re better off actually getting those loans in most cases than taking funds out of retirement accounts. So don’t do that.  I want to give you this little bit of perspective. Current college costs, and Virginia average cost $25,000 for public universities. $25,000 Right now. The most expensive, William and Mary $37,000. And in our backyard, Norfolk State University is $20,000. Old Dominion $22,000. And the two biggies University of Virginia is about $30,000 Virginia Tech $23,000 all in with room and board.

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