Monthly Archives: October 2014

Student Debt: Know Before You Apply

As the college application season approaches, it’s important to remember one of the big reasons you want your child to attend college: Because of the opportunities for a better adult life that college provides. Whether that means career, intellectual, social, or another form of engagement and success, college is considered by many to be a key piece.

In order to ensure that future success, it’s important to avoid creating a situation that makes those goals difficult, if not impossible, to attain. I’m talking about large sums of student debt.

Here are some facts about student debt*:

  • 35% of households age 20-40 have student loan payments of at least $250/month
  • 71% of students graduating in 2012 had student debt
  • Among college graduates, 1 in 9 from public colleges and 1 in 11 from private colleges defaults on federal student loans. This means they will have extreme difficulty buying a home or even getting a car loan or reasonable interest rate on a credit card.
  • Perhaps most surprising, student debt hits across the economic spectrum. Although borrowing is highest among graduates from families in the lowest income quartile (77% graduate with debt), 50% of students from families in the highest income quartile graduated with student loan debt.
  • For the school year just ended, students attending Oregon colleges and their parents borrowed over $1.3 billion. And that’s just in the form of student loans; it does not include credit card balances or home equity or other types of loans.

So do yourself and your student a favor and look at your finances before you start looking at schools. Have a candid conversation about what each of you can pay and what you can reasonably borrow, and let that inform your school selection process. College should be a pathway to a better future, not a more difficult one.

* From Pew Research Center Baccalaureate and Beyond, National Postsecondary Student Aid Study, and The Oregonian’s analysis of federal student loan data (9/25/14)

Morningstar 529 Plan Ratings

Investment analyst Morningstar released their annual rating of 529 plans this week. Morningstar rates 529 plans on the same 5 criteria it uses in its mutual fund ratings:

  • People–Are the managers and researchers directing the plan’s investments skilled and well-supported?
  • Process–Are the strategies sensible and are past successes likely to be repeated? Are the asset-allocation and fund selection for the age-based options based on solid research and implemented well?
  • Parent–Is the program manager a good caretaker of college savers’ capital? Is the state managing the plan professionally?
  • Performance–Has the plan delivered strong risk-adjusted performance, and is it likely to continue?
  • Price–Are the investment options a good value?

The top ratings are “medalists”– gold, silver and bronze. Others are “neutral;” the fifth category is “negative.”

Only 4 plans received Gold ratings:

  • Maryland College Investment Plan
  • Alaska’s T Rowe Price College Savings Plan
  • Nevada’s Vanguard 529 College Savings Plan
  • Utah Educational Savings Plan

These plans are considered by Morningstar’s analysts to be “the most appealing to college savers, with reasonable fees, strong investment options, and capable oversight.”

Plans receiving negative ratings were South Dakota’s CollegeAccess 529 (“egregious fees”), Arizona’s IvyFunds InvestEd 529 Plan (“Elsewhere, college savers can find plenty of stronger, more stable, and less-expensive options to choose from”), and Kansas’ Schwab 529 College Savings Plan (“some of the most expensive options among direct-sold plans”).

Oregon’s plan received a Neutral rating. Morningstar describes Neutral as “not seriously flawed, but in Morningstar’s view, they’re unlikely to outperform over a full market cycle. College savers who choose a Neutral-rated plan should expect returns near their peer-group norms over the long term–a reasonable outcome.” Oregon’s tax break for contributions helps make the plan a more reasonable option for in-state savers.

More details on the ratings, other plans, and Morningstar’s methodology here.

And just a reminder: You can invest in any state’s 529 plan, and you can pay for any college with that investment.

Matching 529 distributions to qualified expenses

So Junior is off to college and now it’s time to start paying the bills. For those who have done a good job putting money away in a 529 account, it’s important that you time your distributions in the same year as your expenses. It’s time to learn about two forms: the 1099-Q and the 1098-T.

The 1099-Q reports your withdrawals from a qualified tuition program such as a 529 or Coverdell ESA in a calendar year. The 1099-Q goes to the person who received the withdrawals. So if the withdrawal went to you, the parent, then you will receive the 1099-Q. If the withdrawal went to the student, then the student will receive the 1099-Q. (See my previous post about why you would want withdrawals going to either the student or parent.)

The 1098-T is provided by the college and details qualified tuition and related expenses for the year. The 1098-T is issued to the student, regardless of who pays the tuition. Check with your school to see what exactly is on the 1098-T. Typically room and board expenses, even if paid to the school, are not, though those are qualified higher education expenses.

IMPORTANT: The 1098-T can show either amounts billed or amounts paid. If the amount is in Box 1, then it’s the amount paid. If it’s in Box 2, it’s the amount billed. Your distributions can only be used for amounts paid. So if you receive a bill in December that is due in January, wait until January to take the distribution from your 529 account. If your withdrawals exceed your expenses paid, then you’ll be subject to tax and the 10% penalty.

Many schools offer the opportunity to prepay all four years of tuition in order to lock in current rates. This can be a good deal, but beware the consequences of withdrawing the full amount from your 529 plan. Most schools still only credit you each year’s tuition expense annually, even if you prepay. If that is the case, then you need to come up with other money to prepay the tuition and then reimburse yourself annually from the 529 plan. Otherwise, you might pay  a 10% penalty to achieve a 7% savings. Check with your school if they make this offer.

And don’t forget, you can’t double-dip on tax benefits. What that means is, if you plan to take the American Opportunity or Hope tax credit, you need to pay some of your qualifying expenses with cash flow, not 529 plans. You can’t use tax-advantaged funds to pay for something and then also take a tax deduction for the payment. Here is more info on the AOTC and Hope tax credits.