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Allison Dubreuil, Wealthway Financial: We always try to keep this show very planning focused and very timely or topical. And it seems like everybody I know has a kid or a grandchild or a friend or someone who’s launching off to college this week or over the next couple of weeks. Some of us have more than one. I think most people are happy about this probably. Are you going to be an empty nester again?
Kevin Zywna, Wealthway Financial: Temporarily, so yes, for a few months. Until they all come crawling back home with loads of laundry and hungry bellies.
Allison Dubreuil, Wealthway Financial: There you go. So as kids are launching off to college, we thought we would revisit some college funding strategies. Over the past couple months, we have talked about this a few times, but from different perspectives. We’ve certainly covered the cost of college and the challenges that that creates. We’ve talked a lot about saving for college.
What are the right savings vehicles? How do you get started saving early? What if you find yourself launching your student right now and maybe you don’t have enough set aside to fund a full college education? We want to talk about some of those options tonight. I was reading that only 43% of parents even own a 529 savings account. And even much fewer only 7% of parents own a custodial account or a minors investment account and only 6% own a Coverdell Education Savings account. So chances are if you have a student launching to college, you might not have any or enough college savings.
Kevin Zywna, Wealthway Financial: The main funding vehicle is a 529 plan, which is administered individually by each state. Or a custodial account, also known as UGMA or an UTMA account. Very rarely use a Coverdell Education account, which used to be called an educational IRA. (Which makes no sense because the R in IRA stands for retirement.) So they renamed it the Coverdell Education account. Each one has benefits. But overwhelmingly, the 529 plans have the most benefit for most people. You should take heart knowing that Virginia has one of the best administered 529 plans in terms of ease of access, with a good website to make it easy to administer the plan. They have a great investment lineup, so you can target investment strategies that are appropriate for college funding. They also have some of the lowest costs around. So you don’t have to think too hard about it. If you’re a Virginia resident the 529 plan is the best place to save for college funding. I should say any form of higher education. That could include trade schools, and the like, as well. 529 plans are usually your best starting point.
Allison Dubreuil, Wealthway Financial: Let’s start there, with 529 plans. Even if you don’t have all of your projected college expenses saved in the 529 plan, maybe you’re in that 43% that has some saved in the 529 plan. Or perhaps you’re a grandparent who has started a 529 plan for your grandchild. So parent-owned 529 plans don’t impact college funding as much as grandparent-owned. When I say funding, I should say loans and scholarship application. That’s what they call grants or scholarships. They lump loans all into that same category as grants and scholarships. Financial Aid, that’s the word I was searching for, is sometimes also including loans. So parent-owned 529 plans don’t count as negatively on your FASFA when you’re applying for financial aid as a grandparent own 529 plan. So if you have funds for your child and a 529 plan, you would want to use your parent-owned 529 plan first, and save the grandparent-owned 529 plan for the later years. If you wait and take a withdrawal from a grandparent-owned 529 plan until after the final FAFSA application, then it’s not going to negatively impact your student for future financial aid applications.
Kevin Zywna, Wealthway Financial: It’s important to note that the 529 plans are all individually owned – owned by only one person. So that’s either mom, or dad, or grandma or grandpa or Uncle Joe or Aunt Marie. But only one person can own a 529 plan. And then you list a beneficiary of that plan. And that is typically: the owners (typically the parent or grandparent) and the beneficiary (typically the child doesn’t always have to work that way, especially if your child is in their 20s, they can actually own their own plan). But for most people, when you’re starting out in college savings are saving for higher education. The parent is going to be the owner or grandparent and you’re going to list the child as the beneficiary. That’s the structure that’s going to be in place. They are not jointly owned, that comes as a shock to some people.
Allison Dubreuil, Wealthway Financial: When funds come out of the 529 you get to enjoy tax-free earnings. These earnings are available so long as the funds are used for qualified higher education expenses, which is really broadly defined. It covers almost anything: room and board, books, supplies, fees, all the tuition, obviously, all of that good stuff. So the money comes out of the plan tax-free. But again, a parent-owned 529 withdrawal – not so impactful. But a grandparent-owned withdrawal can impact your financial aid application. So just something to be aware of.
If you’ve already depleted your 529 account, or you don’t have one, then the next most logical way to fund college expenses is cash flow. Maybe you’re in your high earning years and you’ve got your living expenses under control. Maybe you’re able to pay out of pocket for these ongoing expenses one semester at a time. If so, it’s still not a bad idea to run those expenses through the 529 plan. Now, I don’t think Virginia 529 would appreciate me saying that. It really is designed as a long term savings vehicle. But you can make a deposit into your 529 plan to enjoy the state tax deduction. So, Virginia 529 plans allow you to take up to a $4,000 per year state tax deduction. And that is per account for contributions made.
Kevin Zywna, Wealthway Financial: This is perfectly legal from a state income tax code perspective. So even if you have a child in college right now, and you don’t have a 529 plan, you could open it up right now. Transfer money from a bank account into the 529 plan. And then move the money from the 529 plan to the school and pay tuition doesn’t have to sit there for any length of time. And by doing so you can get up to $4,000 per account per year of Virginia state income tax deductions, just by doing the administration that way. So it is perfectly legal. There’s nothing wrong with that. You have to jump through a few hoops, but you know, the tax savings can be worth it.
Allison Dubreuil, Wealthway Financial: So if you’re funding college expenses out of cash flow, still make sure you open a 529 for each student and use that as your funding mechanism.
Allison Dubreuil, Wealthway Financial: Yes. So if you have a student that is ready to launch or launching to their college career right now, we want to cover some of the ways that you can pay for education even if you don’t have it all pre saved in a 529 plan. But I did want to just pause for a moment and go through some of the basic mechanics of a 529 plan because we do think they are the best vehicle for saving for college expenses.
They have triple tax advantages. You can take a state tax deduction in Virginia for any contributions that you made to an account. Virginia offers a $4,000 per year, state tax deduction per account and you can carry that forward. If you’re a grandparent contributing, and you’re over the age of 70, then you get to take the whole contribution as a deduction, you’re not limited to $4,000. Also, once the money is in the 529, it will grow tax deferred. So hopefully you’re starting early or investing it and you’re going to have years of earnings. Those will grow tax deferred and then withdrawals are tax-free. If used for qualified higher education expenses, which is very broad tuition fees, room board books, supplies, special needs, computers, equipment and even educational loan payments. That’s one that people don’t really know. You can use your 529 savings to make student loan payments. And another lesser prevalent use is for K through 12, private school or any tuition you can use your 529 accounts for. Those are some of the key pros or reasons why you would want to use a 529 plan for education savings.
Kevin Zywna, Wealthway Financial: Right, there are a lot of tax advantage opportunities with a 529 plan. You have a lot of control and flexibility over the setup of the account, the distribution of the account, and the investment of the account, it’s very accessible. There are no income limits on who can contribute to a 529 plan, unlike Roth IRAs. So they’re open to everyone. Also no age limits on beneficiaries as well. So that’s also helpful. And because they are state administrators, and some states, like Virginia have done a really good job in negotiating bargaining power. They’re also very affordable and low costs and great savings vehicles, compared to other options. So obviously, our number one choice for most people.
Allison Dubreuil, Wealthway Financial: If you don’t have significant savings built up or a VA529 plan, what are your other options? The first most obvious is cashflow. So we talked about you can use your monthly income to fund college expenses. Still beneficial to run it through the 529 to get the tax benefits, even if you’re just usually using regular cash flow.
Another bucket or savings vehicle that can be used for college education is a regular old brokerage account. So maybe you have been saving into an investment account that’s been growing over the years, you can certainly use funds from that account. Any gains would be taxed at capital gains rates, but could be used to fund college education. And again, you could even still run that through the 529. I think that’s the tip of the day. Run everything through a 529 plan.
Kevin Zywna, Wealthway Financial: Well, you got a Virginia state tax deduction just sitting out there waiting for you to take it. So if you got to send the money to school anyway, send it via the 529 plan. Get yourself Virginia state income tax deduction, it’s perfectly legal.
Allison Dubreuil, Wealthway Financial: And you know, a lot of the people we work with do have both a 529 and a brokerage account. Because colleges – there’s a lot of unknowns. If you have a newborn and are trying to start planning for college, you have no idea if they’re going to go to school. Not go to school. Public, private, trade school developing a skill. There’s just such a wide range of possibilities. And some people don’t want to back themselves in a corner with fully funding a 529. Now, there is flexibility with a 529. You can transfer it to other children. There are some circumstances where you can get the money out for other expenses without penalty. But a lot of our clients don’t fully fund the 529. They also use brokerage savings to have some flexibility, since it’s not perfectly clear, early on, what the student may want to do.
Kevin Zywna, Wealthway Financial: And I think I’ll take this opportunity to offer one of our pro tips that we have learned through the years. Even if you can afford to pay 100% of your child’s higher education costs, we recommend that you give your child some financial stake in their higher education. It serves a myriad of benefits. It gives them a financial stake in their future. It tends to focus their abilities more when they know that they are paying for a portion of what they’re getting. And it’s also one of the first real important financial lessons that most people learn in life.
So let the child pay for some portion with scholarships, loans, part time jobs, summer jobs saving up of birthday money through the years. Give them a financial stake. Make them pay for some of it. Well, they won’t be happy initially, but they will look back and thank you for that later because it will develop some very strong financial habits that will stay with them throughout the rest of their life. And if they screw it up, okay, then you can be there as a backstop. Better to screw up when they’re young, when you can clean it up. And the lessons learned from that, then will serve them well for the rest of their life. So please, by all means, give your kids some financial stake in their higher education.
Allison Dubreuil, Wealthway Financial: Yes, well, my mom is listening to this right now. I know so I have feel bad if I support that and I would be hypocritical but yes, that is a good message and you can always bail them out if you need to. Okay, well, that explains it.
Allison Dubreuil, Wealthway Financial: We are talking about how you can fund college education when the time comes. Because most people don’t have enough savings set aside to pay for 100% of the costs when they get to that point. It can sneak up on you. What do you do if you don’t have it set aside in a 529? We talked about funding it through cash flow using brokerage account savings.
But if that is not an option, then surprisingly, a lot of people will turn to their retirement savings next. In fact, two in five Americans are likely to use retirement funds to pay for children’s education. And this is where we will draw the line and say that is most likely a mistake. Of course, there’s not a one size fits all recommendation. Everything is circumstantial.
Taking money out of a retirement account to pay for college expenses will set you back exponentially. Every dollar used for college means several less available for retirement. In fact, for example, if you took $25,000 out of a retirement account, you’d have $80,000 less 20 years later. So it’s a big deal. And the amount that you can put back into a retirement account is limited because there are annual contribution limits for Roth IRAs, traditional IRAs and 401Ks.You really need to think long and hard before you take money out of a retirement account to pay for college.
Kevin Zywna, Wealthway Financial: We understand that some families place an ultra-high premium on education for their children. They are willing to give their children the best educational experience they can at the expense of their own financial health, through retirement or later in life. And, look, it’s your money, you can always do with your money, what you want to do. And it’s understandable.
However, we would really strongly caution against that. Because there are no scholarships for retirement. There are no loans for retirement. There’s no work study for retirement. There are all those things for education. I certainly can understand from a personal perspective. At one time when we were trying to get the kids off the family farm and into white collar jobs and give them a step up on the ladder. That made a lot of sense, to give them that leg up.
But nowadays, with funding mechanisms, so prevalent, almost too prevalent for college, as well as the extraordinarily high cost of college. And the different paths that people can take to get a meaningful career that doesn’t require college. Or may require nontraditional educational environments. You don’t have to mortgage the family farm to put your kids to private school and private college, just to give them a leg up. Again, I know in some families, that is the ultimate priority. And you’re going to do it regardless of what we say. But for most people, we would caution them to think long and hard about doing that. There’s probably other better solutions than simply paying a lot for the most expensive education.
Allison Dubreuil, Wealthway Financial: So let’s talk a little bit about the mechanics. And if you do have to go that route, for whatever reason, if you take money out of your traditional IRA accounts, there’s typically an early withdrawal penalty of 10%, if you’re under 59 and a half. But that penalty can be waived, if you’re using the withdrawal for college expenses – but it is taxed as ordinary income. So that’s going to be a big inflow of ordinary income on your tax return. Then it also does impact financial aid applications for your students. So be very careful about that. With Roth IRAs, you can take your contributions out tax and penalty free any time. So it may seem like a great college savings vehicle or a great bucket to pull from. But again, like I mentioned earlier, you’re so limited on the money that you can get into your Roth IRA, you can only contribute six or $7,000 a year. And if you earn too much, you can’t contribute to a Roth IRA. So there’s really not a lot of opportunity to get that money back into the Roth IRA once you take it out. So again, please make it a last resort and really think it through before you touch either your 401k IRA or Roth IRA.
Kevin Zywna, Wealthway Financial: Just because you can do something doesn’t mean you should, doesn’t mean it’s in your best interest. So a lot of these programs have that flexibility built into them. But rarely should you take advantage of it.
Allison Dubreuil, Wealthway Financial: So another I guess I don’t want to call it an asset. Another bucket you might have in your arsenal could be permanent life insurance. Now permanent life insurance is often sold for a number of reasons. Obviously, for a hopefully first and foremost for a death benefit. But a lot of times insurance salesmen are touting other benefits to permanent or whole life insurance, such as college savings plans or retirement plans. We don’t believe life insurance should be used as a savings vehicle. Savings should be directed to savings accounts. Life insurance should be used for life insurance. However, if you find yourself in a position where you have a permanent life insurance policy that has significant cash value, you can withdraw or borrow against the cash value and you can use that money to pay for college. The money does come out tax-free. Oftentimes it will reduce the cash value, it may reduce the death benefit. And if it’s a loan, you’re going to be paying interest on that amount. So you need to make sure you understand it’s not tax-free money. You’re taking a loan and paying interest to the insurance company.
Kevin Zywna, Wealthway Financial: Don’t let anyone sell you whole life insurance with the idea that you’re going to one day use it to fund your kid’s education. That is a very inefficient use of your funds. And there are many more solutions that you’d be better off directing your funds towards. If one thing we have learned, if there is an objection to life insurance, the life insurance industry has developed a system or program to overcome that objection. For most people, it is not the preferred method of saving for higher education.
Allison Dubreuil, Wealthway Financial: Yes, we just we do come across a lot of people who already have these policies and don’t have a real true need for the policy anymore because they’ve done their financial planning properly. And there’s not a big need for a death benefit. So it is an option if you’re stuck with a policy. But like Kevin said, Don’t set out on that path on purpose. There are much better vehicles for that, like the 529 savings plan, primarily.
Allison Dubreuil, Wealthway Financial: What about home equity? Yes, home equity. Everyone loves to pay their homes off. So lots of people presumably have home equity right now. Yes, so in this environment, it’s interesting, we have people that are constantly asking us about paying off their home. A lot of people have significant equity built up in their home from doing that, or just from the appreciation of real estate prices that we’ve been experiencing lately. It certainly is an asset that is illiquid. But a home equity line of credit is a way to essentially turn that into a liquid asset that you can use for whatever you want. And college expenses could be one of those uses.
Kevin Zywna, Wealthway Financial: But the interest will not be tax deductible if it’s used for higher education. Only the loan money that you use towards home improvements is deductible from a home equity loan. Like Alison was saying, it’s a way of liquefying a relatively illiquid asset. And if there is no other savings, it is a source and it can help. In this interest rate environment, it’s probably a pretty good borrowing source. Just be careful though home equity line of credits tend to be variable. They most likely will start to shift up in the ensuing years. Given that we are at rock bottom interest rates right now. Right now, not a bad source if you need it.
Allison Dubreuil, Wealthway Financial: In this interest rate environment, it’s probably more economical than actual official student loans, which are going to be at you know, 5-6-7 percent, depending on the type of loan. So it could cost you way less and especially if you can walk it in. If you can do a home equity loan, instead of a home equity line of credit. A home equity loan is often a fixed rate. And while you can’t deduct the interest, right now, you’re probably able to get less than 5% on a home equity loan right now.
Kevin Zywna, Wealthway Financial: We are talking about college funding vehicles, pros and cons of each, some strategies, some suggestions to help you meet the high cost of higher post secondary school education. Whether that’s college or trade school or some other sort of institution of higher learning paths.
Allison Dubreuil, Wealthway Financial: Tonight, we’ve been talking about college funding, if you’ve got a loved one child grandchild that’s leaving the nest launching into their college career. And, yes, celebrating but also maybe wondering how you’re going to pay for this?
Kevin Zywna, Wealthway Financial: It’s a costly transition.
Allison Dubreuil, Wealthway Financial: Right, it’s good and bad. But if you don’t have all of those pennies saved up for a full college education, which I don’t even know if you can get it in four years anymore, isn’t it more like five years is common?
Kevin Zywna, Wealthway Financial: It is becoming more common. It shouldn’t be. But I think a way a lot of the schools, especially the large public universities, kind of make it difficult for kids to get through in four years nowadays. Which means extra classes, room and board, extra money for the institution. So you need to watch out for that.
Allison Dubreuil, Wealthway Financial: So if you’re wondering how you’re going to pay for that, we’ve talked a lot about 529 plans. They are probably the best vehicle especially for everyone living in Virginia, we have a great 529 plan. So using that, of course cash flow. Some of you may be in your higher earning years, you may have some wiggle room and be able to just fund normal expenses out of monthly cash flow. But run that through the 529. Get those tax advantages. We also talked a lot about retirement accounts how shockingly, two and five people are likely to raid their retirement nest egg to pay for college – 40% by the way.
Allison Dubreuil, Wealthway Financial: We talked all about why that is not a good idea. There are no loans. There’s no financial aid for retirement. But there are lots of creative things you can do to fund college education. So let’s talk a little bit about that.
Financial aid is a big buzzword. Everyone thinks oh, well, there’s financial aid. Well, financial aid means a lot of things. But most often, it usually means loans. So don’t get your hopes up too high. Of course, there are grants, and scholarships that are free gifts that don’t have to be repaid. Grants are needs based, so grants are usually given to those that don’t have significant income or savings to be able to afford college.
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Scholarships are merit based. Doing good in school is just getting crazy these days. I know I’m sounding old, because when I went to school, a 4.0 doing good. Now it’s like a 4.0 is nothing. You have to get more than a 4.0.
Kevin Zywna, Wealthway Financial: I don’t really understand how you get more than a 4.0, but they’re doing it. And now it’s like getting over 100%. I mean, 100% is 100%. You can’t get more than that. I think it has to do with AP courses.
Allison Dubreuil, Wealthway Financial: That does exist and it’s not enough to be mediocre anymore. Competition is high to get into college. To get a merit based scholarship, you do have to be outstanding. I think it’s like less than 1% of students get athletic scholarship. I know every parent thinks their child is getting an athletic scholarship. Statistically speaking, they’re not.
Kevin Zywna, Wealthway Financial: And I guess I will speak as a parent who has a child who is getting a partial athletic scholarship in field hockey. I will tell you that in all probability, you will spend every bit as much in training camps and travel teams and equipment and individual coaching in order to earn that scholarship in what you will get back. Unless your kid is an athletic freak of nature, which you are probably looking at point 1% of the population. Most people are going to invest so much money in getting their child to that point. That is kind of a wash at the end of the day. If you look over the entirety of their athletic and academic career.
Allison Dubreuil, Wealthway Financial: Good point. So there are some other ways if you really do your homework, you can do a lot of research you can find charitable foundations, religious or community organizations, local businesses. Employers, maybe some civic groups, professional associations, these are all places where you might be able to find a grant or scholarship. But your student has to take the initiative. They have to seek them out and then go through the application process. So that’s something where the parent and hopefully the guidance counselor is really educating the student. So that they can find those opportunities and take advantage of them.
Then, of course, loans, so there are federal student loans, federal parent loans, and then private parent loans. Just a rule of thumb, when it comes to student loans, we typically (and with any rule of thumb, it’s not one size fits all), but we typically recommend minimizing your student loan load to not be more than what you think you can earn your first year out of college. So if you think you can, you’re studying, I don’t know an example, engineering, they probably earned like $100,000 or more per year right out of college, maybe, then you would want to make sure that you limit your student loan debt to $100,000 or less. That way it’s not going to be crushing as you launch into adulthood and you find out how expensive real life is.
Kevin Zywna, Wealthway Financial: Yeah, here’s a good aspect of where people can give their kids a financial stake in their higher education. Because everyone, regardless of income, (as long as you fill out the FASFA, financial aid form, and again, regardless of income), your kids will qualify for federal unsubsidized student loans of a reasonable amount. It’s typically graduates with each year. I think it’s $5500 the freshman year, $6500 their sophomore year, $7500 their junior and senior years. So you add it all up, it’s about $27,000 of student loan debt that is in the name of your child. They have to pay it back beginning six months after they graduate.
That is a very reasonable debt load in today’s society and economy for most people to take on. If you if you work with them through the process, and you show them where the money comes from, and you teach them what a loan is all about, and they feel the pain of stroking that first loan check six months after graduation instead of going to the bar with their friends and drinking beer and eat pizza. They are learning good financial habits that are reasonable and sustainable, and are not overly burdensome.
Allison Dubreuil, Wealthway Financial: And you can always pay the loan off for them eventually.
Allison Dubreuil, Wealthway Financial: I’m going to be excited to see how this works with your family.
Kevin Zywna, Wealthway Financial: Famous last words. No, you’re right. And of course your parent you can always be the backstop if they’re struggling for whatever reason they can’t find a job they graduate into a Coronavirus economy, no fault of their own. Couldn’t find a job in March through June of 2020. Not their fault. You can be the backstop then – that’s understandable.
Director of Financial Planning