Money Maven: Paying for your child’s college

By Sheryl Rowling

SAN DIEGO —  Q: My daughter is starting college. She doesn’t have much of a college fund. How do we pay the bills?

A: There are several ways to pay for your children’s college expenses. Your basic choices are: 1-Pay the costs out of your own savings and investments. 2-Encourage grandparents (and other family members) to make gifts. 3- Obtain a student loan. 4-Obtain a bank loan. 5-Borrow against insurance policies 6-Borrow against retirement accounts. 7-Withdraw money from retirement accounts.

Paying out of savings: Although your daughter doesn’t have adequate savings, maybe you do. Paying for college expenses out of your monthly cash flow or savings or a combination of both may be the simplest solution. If you have investments that have appreciated, like stocks or mutual funds, consider giving them to your daughter and having her sell them to pay tuition. If you sell the stocks or mutual funds, you will pay capital gains taxes. If your daughter sells them, because she has a lower tax bracket, she may pay no or little taxes on the gain.

Gifts: You may be able to encourage grandparents or other relatives to pitch in on college expenses. If someone other than you pays your daughter’s college expenses, the person making the payments is generally subject to the gift tax, to the extent the gift is more than $14,000 per year ($28,000 in the case of married couples). However, if the other person pays your daughter’s tuition directly to the school, there’s an unlimited exclusion from gift tax. The unlimited gift tax exclusion applies only to direct tuition costs. There’s no exclusion (beyond the normal $14,000 annual exclusion) for dormitory fees, books, supplies, etc.

Student Loans: You and/or your daughter may qualify for student loans, such as Stafford loans. Depending on your family income and assets, you may qualify for subsidized loans, offering beneficial terms and reduced interest rates. Even if family income is high, certain college loans are still available. Some student loans contain a provision that all or part of the loan will be cancelled if the student does qualifying work for a certain period of time, for example, as a doctor for a public hospital in a rural area. In this case, the student won’t have to report any income if the loan is canceled and she performs the required services.

Bank Loans: Commercial bank loans can be considered when looking for college funding alternatives. However, absent the deduction for qualified education loan interest, interest on loans used to pay college expenses is non-deductible personal interest. A deductible option is a home equity loan. Home equity loans, or lines or credit, are generally easy to obtain and offer attractive interest rates. Assuming that the interest is “qualified residence interest,” it is deductible for income tax purposes. Interest deducted as qualified residence interest cannot be deducted as education loan interest.

Insurance Policy Loans: Life insurance policies with built-up cash surrender value may be a source of cash. Such policies may allow loans against the cash surrender value. Care should be taken to comply with policy requirements. If the policy lapses, the loan will be treated as a distribution and tax may apply.

Retirement Plan Loans: Many company retirement plans permit participants to borrow cash. This may be an appealing alternative to a bank loan, especially if your other debt burden is high. However, unless you qualify for the deduction for education loan interest, there’s no deduction for the personal interest paid. Also, to avoid treatment as a withdrawal, the loan must meet strict requirements.

Retirement Plan Withdrawals: IRAs and qualified retirement plans may be your largest cash resource. You can pull money out of your IRA at any time to pay college costs without incurring the 10% early withdrawal penalty that usually applies to withdrawals from an IRA before age 591/2. However, the distributions will be subject to ordinary income tax. Some qualified plans either don’t permit withdrawals or restrict them. For example, a 401(k) plan may allow distributions for college funding. However, these withdrawals will be subject to income tax as well as a 10% penalty tax if they are made before the participant reaches age 59 1/2.

Not all of the above alternatives may be used in the same year, and using some of them may reduce other amounts available. So, it takes planning to determine which should be used in any given situation. Be sure to consult your tax or financial advisor for advice!

*
Rowling is a certified public accountant, personal finance specialist, and principal of Rowling & Associates. She may be contacted via sheryl.rowling@sdjewishworld.com