Even as college tuition continues to rise, more and more American families are paying less out of pocket than in previous years. During the 2015-16 academic year, grants and scholarships paid the largest portion of college expenses — 34 percent, compared to 30 percent the year before.
In addition to grants and scholarships, parent income and savings provided for 29 percent of costs. Student resources chipped in for 12 percent, and loans covered another 20 percent. On average, households paid $23,688, slightly less than in 2014-15.
Parental and student income and assets have a big impact on the student’s eligibility for financial aid. For parents, the most significant factor is income, followed by assets held in a 529 college savings plan, Coverdell ESA savings and taxable savings and investment accounts.
However, here is an important point for high-net worth families: Even if you don’t expect your student to qualify for financial aid, you should submit a Free Application for Federal Student Aid (FAFSA) application every year in order for your student to be eligible to receive a federally subsidized student loan.
If you use invested funds to help pay college expenses, be aware of any taxable events triggered by withdrawals. For example:
- Withdrawals from traditional IRA and 401(k) accounts are taxed as ordinary income
- Withdrawals of contributions from a Roth IRA are tax free, but withdrawals that represent earnings are taxed as ordinary income
- Assets taken from taxable accounts may be subject to capital gains taxes
We believe you should try to exhaust other resources before paying for college expenses with funds allocated to retirement savings accounts.
A 529 college savings plan can offer numerous advantages for parents or grandparents helping to cover a student’s tuition. You can open multiple 529 accounts — one for each child or grandchild, and it doesn’t matter if different accounts name the same individual as beneficiary. Following are a few of the 529’s benefits:
- Assets in the account remain under the control of the account owner
- However, for the purpose of removing assets from the owner’s estate, 529 contributions are considered a gift to the account beneficiary
- Contributions earn interest tax free
- Withdrawals made to pay for qualified college expenses are tax free
- Withdrawals for any other reason also are tax free, with the exception of the portion considered earned interest, which will be taxed as income plus a 10% tax penalty
- Distributions from a grandparent-owned 529 are considered student income
The content provided here is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice. Contact us at firstname.lastname@example.org or call us at (952) 460-3260 to schedule a time to discuss your financial situation and the potential role of investments in your financial strategy.