Want to finance your child’s college education without going broke or sacrificing your own retirement security? Then planning ahead is critical.
At minimum, begin planning one-and-a-half years before your child’s senior year in high school – though the day they’re born is even better! Why? For financial aid, your ability to pay for college next year is based on your financial situation last year. In other words, in 2015, the government will estimate what you’ll contribute to college in 2016 based on your 2014 tax return.
And you need time to find and fund the best college savings plan. Conventional college savings include 529 plans, UGMA’s and UTMA’s but they aren’t your only option. Here are seven critical questions to ask when determining the best way to fund a college education:
1. Do you have full control over how and when the money is used? With limited exceptions, you can only withdraw money from a 529 Plan for eligible college expenses without incurring taxes and penalties. With UGMAs and UTMAs, you lose all control the day your child legally becomes an adult.
2. Will the funds count against you in applying for federal student aid? Funds in your 529 Plan are counted as your asset, and UGMAs and UTMAs are counted as your child’s assets. Either will likely penalize you in applying for need-based aid.
3. If your child earns a full scholarship or doesn’t go to college, can you use the money elsewhere? 529 Plan funds must be used for qualified post-secondary education expenses. If not, you’ll pay income tax on your gains, plus a 10% penalty if you take money out before you turn 59½. UGMAs and UTMAs can be used for whatever your child wants once they reach legal age – whether you approve or not!
4. Can you use the plan beyond college? If you don’t use up 529 Plan money for college expenses, you face taxes and penalties. UGMAs and UTMAs money is not yours to use at all. As soon as your child reaches legal age, they have complete control of that money.
5. Are there tax benefits? You may get a state income tax deduction for 529 Plan contributions, depending on where you live and the plan you choose. Gains in UGMAs and UTMAs will be taxed at your child’s tax rate instead of yours.
6. Can your plan finish funding itself if you die prematurely? In all conventional college savings plans, your child has only the funds you managed to save before your death – which may not cover college expenses when the time comes.
7. Is growth of your money guaranteed? Since the money in 529 Plans, UGMAs and UTMAs is typically invested in stocks, bonds, and mutual funds, the answer is “no.”
Is there a better alternative? Yes. Certain dividend-paying whole life insurance policies (like the supercharged policies I describe in The Bank On Yourself Revolution: Fire Your Banker, Bypass Wall Street, and Take Control of Your Own Financial Future) build cash value that grows by a guaranteed amount every year and never goes backwards when markets crash. And that cash value does not count against you when you apply for student aid.
Pamela Yellen is Founder of BankOnYourself. She is a financial investigator and the author of two New York Times best-selling books, including her latest, The Bank On Yourself Revolution: Fire Your Banker, Bypass Wall Street, and Take Control of Your Own Financial Future.
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