A recent AP article that ran in today’s Oregonian highlights how growing student loan debt increases income inequality in the US. Helping your student to make informed decisions about how much to spend and how much to borrow for college is one of the best things you as a parent can do to ensure that your child is on the path to a financially secure adulthood.
Given the lower contribution limit—$2000 annually per beneficiary—many people wonder why anyone would bother with a Coverdell ESA, compared with a 529 plan. Here’s a quick overview; maybe you’ll find that a Coverdell ESA should be part of your college savings planning as well.
Coverdell ESAs work a lot like Roth IRAs and 529 plans: You contribute after-tax money to them, and future withdrawals are tax-free. Like 529 plan withdrawals, Coverdell ESA withdrawals are not counted as income in aid formulas. So, what’s different? Several things:
- Qualifying expenses: Funds in Coverdell ESAs can be used for K-12 expenses, in addition to college expenses. For K-12 expenses, a qualifying school is any elementary or secondary school as defined under applicable state laws—which may include home schooling. If you have a child in private school, or intend to send one to private school, a Coverdell ESA can be a big help. Likewise if you intend to home school, you may be able to use a Coverdell ESA to cover some of the costs you incur.
- Investment choices: Coverdell ESAs are self-directed investments. That means you open the account and you choose the investments. Many custodians, including Schwab, USAA, State Street Bank, Scottrade, TD Ameritrade, Capital One and more, offer low-cost Coverdell ESAs.
- Income limits: Joint filers need MAGI below $190,000 in order to contribute to a Coverdell ESA. If your income is above that threshold, you can gift money to your child who can then open the account.
- Beneficiary changes: Coverdell ESAs let you change the beneficiary to any other family member who is under age 30.
Donors and custodians may impose restrictions or rules so if you think a Coverdell ESA might be a good fit for your family, be sure to read all the fine print before investing.
Congratulations! You got accepted into several schools, and each offered you some financial aid. When you compare the offers, it’s important to make apples-to-apples comparisons. The first thing to figure out is, did you get funded aid or unfunded aid?
Funded aid consists of grants and scholarships. Funded aid reduces the cost of going to college. Unfunded aid is loans and work-study. Unfunded aid provides ways to get the money to attend college. Funded aid is far more valuable. Many times an aid offer will include both types of aid.
Offer in hand, you can determine your total cost to attend a school. Total cost is:
Direct costs of attending, including
- Tuition & mandatory fees
- Room and board
- Books and supplies
Plus other costs, including
- Transportation to and from your school
- Dorm needs and décor
- Sports or event tickets, memberships, etc.
- Funded aid
So let’s say a school’s direct costs are $46,000, other costs total $2,500, and you got an aid package including a $15,000 scholarship and $5,500 in a Stafford loan. Your total cost is $46,000 + $2,500 – $15,000 = $33,500. Don’t subtract the Stafford loan from your cost of attendance because you still have to pay for it. And remember: you can turn down a portion of your aid offer without impacting the rest. You’re not required to take the loan that the school offers.
Most of us will be lucky to save enough in 529 plans to cover the cost of college tuition, let alone room, board and/or any of the other expenses that might qualify. Here is a quick rundown of what expenses qualify with a 529 savings plan:
- Room and board: This is easy to figure out if your student lives on campus. Off campus is actually pretty straightforward too. Generally, you can’t claim more than the cost of living on campus, or an “estimated off-campus amount” that the school publishes. If you spend more than that amount, it’s not qualified so you can’t use your 529 plan funds to pay for it.
- Computers and Internet access: It used to be that computers were only covered if your school specifically required one. Now you can use your 529 funds to pay for a computer, Internet access and relevant software regardless of school.
- Just because you need it, doesn’t make it a cost of attending school. Toiletries, extra-long sheets, and transportation to and from school all fall under the “not qualified” heading. Nor are loan repayments, fraternity or sorority dues, or tickets to sports events.
There are some gray areas too. Is your student’s on-campus health insurance part of the fees, or are they required to purchase it separately? If it’s a cost of attending, then it could be a qualified expense.
The above applies to 529 savings plans. If you have a prepaid plan (which are only offered by a limited number of states; Oregon is not one of them), then the list of qualified expenses is quite a bit shorter. Generally these are limited to tuition and mandatory fees and exclude room, board and books.
The American Opportunity Tax Credit and Lifetime Learning Credit each have different definitions of qualified expenses too. Assuming that you’ll pay some of your expenses with 529 funds and you may be eligible for the AOTC or LLC, it’s important to know which expenses are eligible for which so that you can coordinate your claims because you can’t take either of the credits for an expense that was paid by your 529 plan funds.
Divorced parents tend to have a number of questions about aid issues and college applications in general. Let’s start with the basics: Do both parents’ incomes count? And what about new spouses’?
As is so often the case, the answer is different depending on the aid form. The FAFSA is simple so let’s start there. The FAFSA only counts the custodial parent’s income and assets in its formula. The custodial parent is the one with whom the student lived the most in the past 12 months, regardless of who provides support. Of course, any support that the custodial parent receives from the other parent is included on the FAFSA. Note that “custodial parent” in this case is not necessarily the same as custody in divorce parlance. Although a divorce may specify equal, 50% custody, the FAFSA is looking for the parent with whom the student has his primary residence.
The CSS PROFILE, on the other hand, requests data from both parents.
What happens if a parent remarries? As applicable, the new spouse’s income and assets count too. Which is to say, if the custodial parent remarries, the spouse’s data is included on the FAFSA, but not in the case of a non-custodial parent. The CSS PROFILE would count the new spouse’s income and assets regardless of custody. Neither the schools to which your student is applying nor the federal government are party to your prenuptial agreement, so specifying in a prenup that your new spouse is not liable for college expenses does not change this.
Several of us weigh in on how to prioritize college and retirement savings in a recent New York Times article here.