This article is part of a paid partnership between Citizens™ and HerMoneyMedia
There’s a dirty little secret about investing for retirement. Accumulating the money – a subject on which countless books, articles, blog posts and tweets have been written – may be the easy part. At least you know what to do: save, invest (in a diversified, low-cost way), repeat. Withdrawing the money in such a way that it helps accomplish your actual goal – providing you with enough money to last the rest of your life – is in many ways the harder part. Well, it turns out the same is true of college, particularly money that you’ve smartly stashed away in a 529 college savings account. Here’s what you need to know.
Grab Those Tax Credits First
Those college bills arrive and you start thinking about pulling out funds. Before you pass GO, and reach into your 529, there are some tax credits that you want to grab first. Atop the list, The American Opportunity Tax Credit which is available to eligible students for their first four years of higher education. It’s worth a maximum $2,500 per student per year – that’s 100% of the first $2,000 in qualified education expenses and another 25% of the next $2,000 in qualified education expenses. And it’s partially refundable, meaning that if the credit brings your tax bill in any particular year down to zero, you can receive up to 40% (or $1,000) as a tax refund. There are income limits that prescribe who is eligible. Your modified adjusted gross income must be $80,000 or less (singles), $160,000 or less (joint filers), to receive the whole thing. Then there’s a phase out and if you make more than $90,000 (singles), $180,000 (joint) you’re not eligible at all.
The American Opportunity Credit is worth more per dollar toward eligible expenses than a 529 distribution, explains College Financing Expert Mark Kantrowitz. But you can only use it for tuition and textbooks. If more than four years have passed and you’re within the income guidelines (which are slightly lower than for the AOC) look to the Lifetime Learning Credit. It’s worth up to 20% of the first $10,000 of qualified educational expenses — or $2,000 per year — per family as opposed to per student.
Scope Out How Much You’ll Need To Borrow Year By Year
As we talked about in the first story this week, the best loans to have are Stafford Loans (also called Direct Loans). Interest rates are low, they’re in the student’s name, they help build credit, no credit check is required, no cosigner and payment options are wide-ranging. But they have annual caps on how much you may receive starting with $5,500 for freshman year, $6,500 for sophomore year, and $7,500 for junior and senior. The goal is to make sure that you have the ability to use every bit of these loans before you wade into other, more expensive waters.
So, how do you do that? Look at what the overall cost of college is going to be. Then, assuming you’re planning on a four-year program, work your way backward from senior year, he says. If you know you’re going to need to borrow $20,000 overall, you’ll hit that by taking the full Stafford in years 4 and 3, then borrowing $5,000 in year 2. You don’t need to borrow freshman year. That’s particularly advantageous if your loans aren’t subsidized, because you’ll have less time for interest to accrue.
Similarly, some private lenders, such as Citizens, may offer multi-year approval options for their loans. “Our standard loan application process will let approved borrowers know if they qualify for multi-year approval, giving them peace of mind to know that they have that amount locked in for future years,” said Christine Roberts, Head of Student Lending at Citizens.
Or, you can look where interest rates are and where you think they’re going to go. If you think they’re going higher, borrowing sooner can make sense. Same is true, if you believe your 529 investments will continue to perform well. (Should you still fill out the FAFSA for a year in which you’re not planning on borrowing? Yes! “Who knows what might happen in a subsequent year,” Kantrowitz says. “You might lose a job because a pandemic appears. You want to establish a baseline of what your income was.”)
Make Sure Your Distributions Are Qualified
Qualified 529 distributions are those that are, for lack of a better word, legit. They include tuition and fees (not just for college but up to $10,000 per year for grades K through 12), books and supplies, computers and internet, and room and board (but only if the student is enrolled at least half time). Travel expenses aren’t included, neither is healthcare, fees for extracurricular activities or college application fees or test prep. You want to steer clear of non-qualified distributions because they can get pricey. Gains are subject to ordinary income tax at the recipient’s rate, plus a 10% penalty. And they’re counted within the tax year that you take them. This argues, Kantrowitz explains, for waiting until November – no later, he says, because they can take a while to arrive – for taking distributions if you can. “The key is that you don’t want to take a distribution now for expenses you’re not entirely sure of.” If you do take out too much? You can recontribute it to any 529 that lists that student as the beneficiary without taxes or penalty. And while you can take a distribution in three main ways – payable to the account owner, the beneficiary or directly to the college – he suggests making it payable to the student is cleanest for qualified distribution purposes.
Consider Ownership Of The Plan
It’s also important to consider who owns the plan. If the parent owns a 529 account, it is treated – for financial aid purposes – as belonging to the student. That’s what you want. Financial aid formulas require less of that money to be used for college toward tuition each year than if someone else owns the account, like a grandparent. Grandparent plans are not reported as assets on the FAFSA. But, once you tap into them and the school knows they exist, it can lower the amount of aid you receive in future years. For that reason, you should consider waiting (if you can) until January 1 of the student’s sophomore year of college to use assets in this account. Note: This is all changing under FAFSA simplification which will be now be going into effect in 2024 -2025. This will impact the FAFSA that will be filed starting in October 2023. At that point, grandparent-owned plans will no longer impact eligibility.
Use Anything Remaining To Repay Student Debt, Help Siblings
After graduation, 529 assets are somewhat fungible. You can use them to repay up to $10,000 in student loans for the beneficiary of the student loan as well as any siblings. You can also change the beneficiary to the parent and repay up to $10,000 of PLUS loans. And of course, you can use the money to pay educational expenses for siblings and other relatives as well.
MORE ON HERMONEY:
- How to Pay for College
- The Silver Linings of Student Debt
- The Best FAFSA Strategies
- More Than One Kid = More Than One College Bill. Let’s Strategize.
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