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College Expenses, 529s, and Tax Credits

John Mason, CFP®

Student loan debt has become the second highest consumer debt category, exceeding $1.5 trillion for over 44 million borrowers in the United States. A student in the 2017 graduating class started his or her career with an average debt of $28,650 (Friedman). Parents advising their children to take on this liability are unknowingly facilitating the first, and perhaps the most devastating, financial planning decision they will ever make. 
It is vitally important to start your child’s financial plan while they are in high school, and the goal should be to have them graduate with minimal (if not zero) student loan debt. 
Excessive student loan debt prevents college graduates from:
1. Saving for retirement - every dollar paid towards loan principal or interest is a dollar that is not growing tax-free in a Roth IRA, Roth 401(k)
2. Establishing an emergency fund
3. Moving out and becoming independent
4. Purchasing a home
5. Purchasing the necessary life and disability insurance to protect their earning potential
The good news is, there are ways to decrease debt for students while still allowing parents to plan for retirement. A proper financial plan will help parents determine if they are on track to pay for college in addition to meeting their own retirement goals. Below are three financial planning ideas for parents to consider, but please speak with your financial advisor before making any decisions or changes to your financial plan. 

1. Use a 529 to pay for college and higher education expenses.

For example, Joe is a freshman at James Madison University and his mom and dad would like to pay for 100% of his college tuition. Let’s assume one semester costs $12,000 and they have the monthly cash flow to accomplish this goal. I would not advise them to write a check or use a credit card to pay tuition directly. Instead, it would make sense for them to fund 3 Virginia 529 plans with $4,000 each. Virginia 529s allow the taxpayer to claim a $4,000 VA tax deduction per account. The $12,000 contributed to a 529 and then immediately distributed to JMU saves the taxpayer $690 ($12,000 * 5.75%) per semester for a total tax savings of $5,520 over 8 semesters. 

2. Determine eligibility for American Opportunity Tax Credit or Lifetime Learning Credit.

The American Opportunity Tax Credit (AOTC) provides up to a $2,500 federal tax credit on $4,000 paid for qualified higher education expenses. Don’t overlook claiming the American Opportunity Credit if 100% of expenses are paid through a 529. Consult with your tax advisor about potentially claiming a portion of a 529 distribution as income, which in turn, would allow the $4,000 expense eligible for one of the education credits. 
The Lifetime Learning Credit (LLC) provides up to $2,000 federal tax credit on $10,000 of qualified higher education expenses. 
Be advised that income limits apply to both the AOTC and LLC. For those that exceed, consider increasing your 401(k) or TSP contributions and maximizing Flexible Spending or Health Savings Accounts to decrease your income to qualify for the credit. If eligible for a credit, consider adjusting W-4 withholdings to increase monthly cash flow.

3. Consider using investments to pay for college.

Without a financial plan, parents may be inclined to keep saving or hoarding investments, because they believe they will never be able to retire. It’s true, you can’t borrow for retirement, but the advisors at Mason & Associates are able to position their clients to reduce 401(k)/TSP contributions, stop saving in Roth IRAs, or dip into their investments to pay the tuition, fees, and other expenses, because they are on track for retirement. 
Helpful Tips:
1. Roth IRA and Traditional IRA distributions are not subject to a 10% penalty if distributed for qualified higher education expenses. 
2. Roth IRA distributions are First-in First-out (FIFO). The first distributions from a Roth IRA are contributions, which can be distributed tax free and penalty free. 
3. 401(k) or TSP loans are available if parents are actively employed. 
4. Non-Qualified accounts can be sold at any time. Positions with long-term capital gains could be sold at favorable long-term capital rates.
5. EE Bonds can still be used, but favorable tax treatment is unlikely. 
Parents aren’t the only ones that should be held accountable for minimizing student loan debt. Students should be held responsible for their future, too. Considerations for students to decrease debt after college:
1. Complete an Associate’s Degree at a community college, then transfer to a participating 4-year college.
2. Work a part-time job. For example, Virginia Tech Dining Services is currently offering $10.50/hour and $1,000 bonus if students work 16 hours/week. That’s almost half a semester of tuition.
3. Take summer classes and graduate a semester, or even a year, early.
4. Attend a public college or university in-state instead of going out-of-state or private.
College planning and debt management is the first step in a young professional’s retirement plan. We encourage parents to review their financial plan to determine what the plan can provide, and to have these conversations with children early to minimize or eliminate student loan debt. Reach out to discuss these options with one of our Financial Advisors. Click the “Contact Us” button below. 
Source: Friedman, Zack. “Student Loan Debt Statistics in 2019: A $1.5 Trillion Crisis.” Forbes. 25 February 2019. 4 September 2019.