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 There are dozens of great articles and publications about college planning geared toward affluent families. Many of these are sponsored by financial firms that hope to capitalize on the popularity of Section 529 plans, life insurance plans and Coverdell IRAs and other investment vehicles. These are all appropriate for their intended target market. But these same articles would cause the average middle-income family to make costly mistakes. If I was the editor of any of these publications, I would add the pretext: "IF YOU ARE PLANNING TO APPLY FOR FINANCIAL AID, THE FOLLOWING ADVICE DOES NOT APPLY."
The fact is that the large majority of middle-income families who send kids to college will benefit more by the various financial aid programs than the tax-driven savings mechanisms promoted by the financial industry. Now with the passage of the new 2003 tax laws, I think that a following warning message is needed for these planning articles: "THIS ARTICLE WAS BASED ON TAX PRESUMPTIONS BEFORE 2003 WHICH ARE NOW OUT-OF-DATE".
At this point a middle income American family following the advice given in a typical college planning article might save a few hundred dollars in taxes, but the conventional advice would cost the family thousands of dollars in missed financial aid benefits! In addition, the new tax laws simply make many of the older tax-saving strategies built into most college savings plans obsolete. Many families should revisit their college saving strategy in conjunction with the rest of their financial planning strategies to see if they still make sense.
I am certainly not advocating a "don't bother to save" approach or implying that families should unfairly take advantage of the financial aid system. Rather, I advocate a common sense approach that places proportionate weighting on anticipated taxes and anticipated financial aid. In addition, I suggest that families should consider the basics of sound overall financial management in college planning.
First, implementing a college planning strategy does not make sense if you have not proven success with your commitment to pay off credit card debt. College planning should not be separated from overall financial planning simply because we, as parents, value our commitment to our kids' security higher than our commitment to our own financial security. It simply won't work.
Before tackling any more intricate college planning, ask yourself these very basic financial planning questions:
1) Does the family have at least a couple of month's worth of financial resources tucked away in a bank account or money market for emergencies?
2) Does each parent have at least a few thousand dollars protected in cash value life insurance?
3) Do the kids have at least a little money in Uniform Trust to Minors accounts? If the answer is "no" then your financial planning does not need to be any more complicated at this point than to just cover the basics. Revisit the college planning issue at a later date.
With the huge incidence of divorce in our society, it simply does not make sense to consider financial planning without acknowledging the impact of family law. Like it or not, we must bluntly recognize who holds the purse strings and who has the legal clout in each family unit. Advisers need to strongly warn clients about how harsh family law can be when it comes to college planning.
If you expect to receive financial aid, do not use Section 529 plans. If you do, expect to lose $1 in financial aid for every $1 you have in the Section 529 plan.
If you do use 529 plans, watch out for internal fees, taxes for out-of-state users and sunset provisions that terminate these plans in 2011. (Sunset provisions in the current tax laws were previously thought to be a remote possibility but now tax advisers increasingly see a real risk in this changing economy).
Consider UTMA custodial accounts for modest assets - perhaps up to $20,000 per child. The first $750 of gains is tax free and the next $750 is taxed at only 5% if the child is over 14. (Even if your child is under 14, it may take a few years until you build up sizable taxable gains in the account. Keep in mind than on an average year a typical mutual fund account valued at $10,000 has taxable gains less than $750).
If you expect financial aid to be the largest part of college funding, it is best to keep savings in regular accounts in the parents' names. The new tax law makes it more appealing than ever to invest in stocks, bonds and mutual funds.
About the Author - College Savings Strategies for Middle Income Families
Tony Novak, MBA, MT, is an accountant, writer and financial adviser based in the Philadelphia area. He is the author of "Small Business Benefit Handbook" and a Registered Investment Adviser since 1983. He provides tax and financial planning consultations nationwide by telephone on an hourly basis in conjunction with the work of accountants, attorneys and financial advisers. Over the past 20 years he has responded to tens of thousands of consumer questions posed by telephone, e-mail and on the radio. His articles on financial planning topics are distributed through syndication in publications throughout the nation. Tony can be reached at (877) 529-1112 or through www.tonynovak.com. |
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