Perhaps the ugliest road bump that lies in wait for parents headed toward retirement is college planning. The very word "tuition" can strike fear into the hearts of even the most savvy retirement savers, especially those with kids in high school. Just at the point when parents see their retirement accounts finally starting to show some tangible growth, they are hit with tuition bills that can easily equal or exceed the rest of their debt combined. And while much attention and advice has been devoted to planning for college, far less emphasis has been placed on helping families actually pay for college when they don't have years and years to save for it.
Even parents who do not have long-term savings for their children's educations have a number of weapons they can use against the tuition monster. The effective coordination of some or all of these alternatives can make a substantial difference in the overall education bill that is ultimately presented to them. While several of these techniques are fairly common, there are some lesser-known strategies that can greatly benefit parents as well.
- Education tax credits – The American opportunity tax credit and lifetime learning credit are two federal tax credits that can provide help to parents seeking relief from college expenses.
- Student loans – Loans may be the most common remedy for college costs. Their potential deductibility makes them more palatable as well. It may be more financially sound to have Junior take on the debt for his own schooling, but make sure to discuss this option with a financial advisor before letting your child shoulder this debt. (To learn more about loans, see Getting A Loan Without Your Parents and Pay For A College Education With Retirement Funds.)
- Scholarships – Financial aid that isn't a loan is the best way help of all, needless to say. Ensure that you and your kids are aware of all the options available to you and make sure that your children apply for any and all applicable grants.
- Asset shifting – A critical issue to explore when applying for financial aid is shifting assets to avoid excess taxes and increased interest payments. In some cases, shifting assets to grandparents or other trusted family members can allow you to reduce the amount of the assets that you must claim as your own. And while the FAFSA (Free Application for Federal Student Aid) exempts IRAs, tax-deferred retirement plans, annuities and cash-value life insurance from being counted as assets, it requires borrowers to include prior year qualified plan contributions in their Adjusted Gross Income. Shifting funds from a custodial account to a 529 plan can improve the chances for financial aid as well, as the College Cost Savings Act of 2007 stipulates that 529 plans that are owned by a third party do not count as assets on the FAFSA. Finally, gifting appreciated assets that you may have will allow for a step-up in cost basis when the student sells the asset and will also reduce your declarable assets. (For related reading, see Choosing The Right Type Of 529 Plan.)
- Hiring children for your business – Parents who own businesses should hire their kids as employees. This allows the students to not only earn income that can be used to pay for college expenses, but could potentially make them eligible for the earned income credit and possibly other credits as well. To qualify for the earned income credit, students must be at least 25 years old and can no longer be claimed as a dependent even though they are away at school. If they are younger than 25 years, it may be necessary to compute the parents' tax return both with and without the children as dependents to see which way is more beneficial. To learn more about this credit, click here for IRS information.
Understanding the myriad variables that enter into effective college planning and how they interact with each other can be difficult without a written comprehensive financial plan, or at least a college funding plan. Parents will need to see how much tuition will be covered by loans, how much can be paid with savings and how much the student needs to earn in order to get a clear picture of where they currently stand. Estimating tax credits and deductions may also be helpful. A fairly accurate cash flow analysis can be run here, because both the time frame and projected expenses are fairly defined.
Knowing exactly how college funding will affect retirement planning is critical, and a comprehensive financial plan can also clearly illustrate this issue. Delaying retirement for a few years in order to pay for college may be necessary, and parents need to know what impact tuition may have on their future plans. (To read more about college vs. retirement payments, read Outside-the-Box Financial Strategies to Pay for College and Tax-Smart Ways To Help Your Kids/Grandkids Pay For College. Grandparents should read Seniors: Before You Co-sign That Student Loan.)
The Bottom Line
Using every resource available to you will help to ease the burden of college planning, but knowing how to effectively coordinate those resources is of utmost importance. It is never too late to begin planning for your student's future, even if it is less than a year away. Consult with a financial planner or college planner in order to find out what resources are available for you.