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How to pay for college with a 529

Your clients have been saving in their 529 plans getting ready for that day when their student goes off to college. Well, the day has finally come. What now?! What do parents need to think about? What about tax considerations and cash flow?

Some tips for families when it comes time to pay the bill…

1) Families need to know their due dates!

Most colleges have early August due dates for the fall semester and December or early January due dates for spring. They are probably communicating reminders with the student who may not always do the best job of reminding the parents…the ones paying the bill! Make sure they stay in the loop.

2)  Who is getting the funds?

529 plans can disburse money either directly to the institution, directly to the owner, or directly to the beneficiary (the student). When an owner logs in to their 529 plan online, they can request a withdrawal and indicate the party receiving the funds.

Allow enough time between the request and the due date. Sometimes it can take 10 days for the funds to get to where they are going. The owner of the 529 can be the recipient of the withdrawal when they need to reimburse covered expenses (like books) that they paid out of pocket.

3)  Should families use up 529 funds first?

Many parents will make the mistake of using their 529 money to pay all the expenses until it is all gone. They will then turn to loans to cover the remainder.

Maybe the first three years are paid using 529 money, and then the fourth year comes and the family is looking at loans. This is a mistake.

Federal student loans (Stafford) have the lowest interest rates and best repayment options, but they are capped at a certain amount each year: $5,500 freshman year, $6,500 sophomore year, $7,500 junior and each year after in undergraduate education. We call them “use it or lose it” loans.

Here’s an example. A family has saved $100,000 in their 529 plan. (Good for them!) The school costs $30,000 per year. They use 529 money to pay the first year, the second year, and the third year. They are forced to take out $20,000 in loans during the last year. Because the federal loan is capped at $7,500, they will be forced to get loans without the favorable interest rate.

A better way is to use the maximum federal loan available each year. The total loan amount remains the same; however, the result in terms of repayment is much better.

4)  Don’t forget cash flow funding.

When a student is at home, they aren’t free, right? Every month families pay for the cost of them living at home. When they go to school, some of these costs end. Parents can use that unspent money to make payments for college.

Many colleges will accept a payment plan spread out over the semester. Take advantage of it. Families want to avoid parent loans at all costs so cash flow funding can fill the gaps.

Also, consider flowing funds through the 529 while in college. Many states, like Ohio, allow for a state tax deduction on the first $2,000. Colorado allows for an unlimited state income tax deduction! It’s a no brainer! Might as well.

5)  Use tax credits but don’t double dip.

The American Opportunity Tax Credit (AOTC) equals 100% of a student’s first $2,000 in qualified education expenses plus 25% of the next $2,000 for a possible total credit on their taxes of $2,500. This total credit applies per student. (It is subject to maximum income and other rules to be aware of.)

Parents cannot claim qualified education expenses under the AOTC using investment growth from their 529 savings or Coverdell Education Savings Account. The exact details can be tricky so always consult a CPA for advice. In general, the best idea is to use non-529 money for AOTC qualified expenses.

If their income is below the phase out limits, they should spend $4,000 of their own money (if they can) on qualified expenses to take advantage of the $2,500 tax credit each year.

So, your client made it…they’re sending their student off to college. Remind them to stay on top of those deadlines, know who they want to pay, understand how to take advantage of federal student loans and cash flow/payment plans, and don’t forget those tax credits. Carefully planning all four years and how they are going to pay for them can give them the financial edge.

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