Now that college age is approaching, it’s time to start getting smart about expenses and cash flow. With college on the horizon, you can get a very realistic sense of what the costs will be. There are a few last-minute tactics you can use to prepare for withdrawals, upcoming tax obligations and impending financial aid applications.
As your time horizon before college narrows, it might be a good idea to review your asset allocations. Generally, as cash flow starts to become a priority, moving assets into stable investments (such as cash) can help ensure steady withdrawals without having to worry about fluctuations in the value of your account. It can also help you predict the difference in savings versus expenses, and plan for alternative sources of cash flow to cover any gaps.
Explore your options today: Contact a Janus Henderson Representative at 800.525.3713 or login to your account to review your allocations as your risk tolerance may change over time.
Financial aid comes in a variety of forms. The most common include loans and scholarships.
How Is Loan/Scholarship Eligibility Determined?
Schools determine financial aid based on an indexed number called the expected family contribution (EFC). This figure accounts for the annual adjusted gross income of parents and the student, along with assets, grants, loans, work/study, etc. Assets and income owned by the student are generally weighted much more heavily than those owned by the parent when making the calculation. In other words, the more money the student has saved or has in earned income, the less financial aid can typically be expected. The EFC also accounts for your family size and number of children in the household attending college. The EFC formula itself is standardized and determined by law. To learn more about how the formula is calculated visit www.studentaid.ed.gov.
How Does My Family Apply?
FinAid.org is a helpful resource for reviewing your student aid options. The Free Application for Federal Student Aid (FAFSA) provides an overview of the loan and college aid opportunities that are available. You can also look online for several private scholarship opportunities based on merit, minority status, special interests and more. With college on the horizon, it’s best to start applying for these as soon as your child is eligible.
Withdrawals from a Coverdell Education Savings Account, 529 College Savings Plan, custodial account or an IRA all have specific tax obligations. Understanding each account's tax obligations will help you strategically plan for more tax-efficient withdrawals while maximizing financial aid benefits.
Coverdell Education Savings Account
Coverdell Educational Savings Accounts (ESA) can be used for qualified education expenses. Unlike the 529 Plan, which must be used specifically for higher education, the ESA can be used to fund education expenses at any age up to and including college. When withdrawn, the ESA distribution is reported under the student’s tax ID. This may be beneficial from a tax perspective. However, since the funds are owned by the student, this can have a greater impact on financial aid eligibility.
Know more: You must withdraw all assets from an ESA before the beneficiary reaches age 30, unless there is a special-needs situation. If there is not, you are required by the IRS to redeem the entire account within 30 days of the beneficiary reaching age 30. This amount may be subject to a tax on earnings and a 10% penalty for non-qualified distributions. To avoid this tax and penalty, you may be able roll over an ESA to an immediate family member under the age of 30 or rollover to a 529 Plan.
The 529 College Savings Plan is a popular savings vehicle for college. While Janus Henderson does not offer the 529 College Savings Plan, it’s important to know how it's taxed. In general, withdrawals used to pay for qualified higher education expenses are free from federal tax. If you are using your official state sponsored plan, distributions may also be free from state income tax as well. If you are not a resident of the state that sponsors your plan, you should check with that state or a tax advisor to review the tax treatment of your withdrawal. With the 529 Plan, most owners can choose who is taxed: the account owner or the beneficiary. Assuming distributions are qualified, it shouldn't matter who is responsible for the tax reporting. However, if taking non-qualified distributions, having this option could help you strategize.
Know more: Be careful not to withdraw too much. Certain education tax credits taken on your tax return may reduce the amount of qualified distributions you can withdraw from the 529 Plan. Talk to your tax advisor to learn more.
Custodial Account (UGMA/UTMA)
Custodial accounts, legally known as either Uniform Gift to Minors Accounts or Uniform Transfer to Minors Accounts, depending on your state’s laws, are not tax-deferred. Assets can be used at any time and for any reason as long as they are used for the benefit of the child. Investment earnings are taxable at the child's rate, which depends on age and income.
Know more: Since Custodial assets can be withdrawn at any time without penalty, consider tapping the account after draining any assets from an ESA or 529 Plan to maximize their tax benefits for college and reduce the likelihood of penalties.
IRA Accounts can be used to fund qualified higher education expenses incurred by the IRA participant, the participant’s spouse and any child or grandchild of the participant or the participant’s spouse. While it can be done without penalty, distributions may still be taxable as ordinary income, so beware before implementing this strategy.
Know more: Assets in your IRA are not included in the calculation to determine your expected family contribution and so using this type of account to fund college can help maximize financial aid. However, keep in mind that by distributing assets that are earmarked for your retirement, you might be losing out on potential tax-deferred growth over the long term. To learn more about your specific situation, contact a tax professional.
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