College Funding Strategies

Retirement Asset Sustainment


The Federal Perkins Loan (FPL) is in the student's name; he or she will be entitled to the student-loan interest deduction. A FAFSA form needs to be filed; the loan will be part of the award letter from the college. FPLs are low-interest, need-based loans with a five percent fixed rate. Students are eligible for up to $4,000 per year if undergraduate and $6,000 if graduate. The interest is subsidized by the Federal government until nine months after the student leaves college. The college determines which students will receive this loan and the amount.

Non-Need-Based College Loans

FUSL: A FAFSA form must be filed and the student must file a financial aid application. The loan amount, interest rate and repayment terms are the same as for an FSSL, except that the interest is not subsidized by the Federal government while the student is in college. Repayment does not start until six months after the student leaves college.

Federal PLUS loans: Parents' Loans for Undergraduate Students ( PLUS ) are available only to parents or step-parents; a legal guardian will need permission from the school. These loans are not available to grandparents. A FAFSA form needs to be filed before applying. The amount available to a borrower is limited to the cost of attendance, less any financial aid awarded to the student. For loans disbursed before July 1, 2006, the interest rate is variable and adjusted once a year, on July 1; the interest rate on the repayment is capped at nine percent. A three percent origination fee and a one percent insurance premium are taken from the loan proceeds. For loans disbursed after July 1, 2006, the interest rate is fixed at 8.5 percent; discounts on the rate may be available if the payments are made automatically from a checking account.

PLUS loans are 10-year loans, but may be consolidated into one loan and repaid over a 30-year period after the child leaves school. The loan balance is forgiven on the death or disability of the signatory parent.

If a parent is not creditworthy and cannot obtain a PLUS loan, the student can borrow an additional $4,000 per year in FUSLs for the first year of college, and $5,000 for the second, third, fourth and fifth years of college (the limit for an independent student).

Saving for College

Sec. 529 plans: A Sec. 529 plan is a specific type of college savings plan. It is a tax-deferred way to save for college, by putting money into an account that, when used for qualified college costs, would be exempt from tax on its earnings. There are some restrictions on the amount that can be invested; a financial adviser or a college planning specialist should be consulted for information on the best options for investing in these plans.

Are Sec. 529 plans the best option for college savings? The advantages include tax-deferred savings and tax-free distributions for college; in addition, contributions are completed gifts. There are tax benefits to investing in some state plans and, for high-income individuals, there are no income limits banning their investment in such plans. As for disadvantages, the account can lose money, investment selections are limited, state Medicaid agencies may require that plan assets be used to pay for medical and long-term care expenses before Medicaid payments start and, if plan amounts are not used for a qualified distribution, there is a 10 percent penalty on the earnings, and the earnings become taxable.

Other Options

Are there other cost-efficient ways to fund college and retirement at the same time? There are several opportunities available to an investor that allow funds to be used for either college or retirement, depending on need.

Regular or Roth IRA: The advantage of using an IRA is that the funds are tax-deferred and can be distributed and used for college costs penalty-free (the holder is still taxed on the ordinary income, however). The disadvantage is that the amount contributed is limited to $4,000 per year (for 2007), provided the contributor has earned at least that much for the year. Also, if IRA funds are used for college, they are no longer available for retirement. If a student has earned income, a possible strategy is for the student to open an IRA and take an IRA deduction against that income. This strategy is not recommended if the student is eligible for financial aid.

Coverdell ESAs: Under Sec. 530, Coverdell education savings accounts (ESAs) are exempt from taxes if the amounts are used for QHEEs. The disadvantages are that a limited amount can be contributed each year ($2,000), contributions cannot be made after the beneficiary reaches age 18, the funds must be used before the beneficiary reaches age 30, contributions are phased out based on the contributor's AGI (starting at $95,000 for an individual, $190,000 if filing jointly), and a 10 percent penalty is imposed on excess distributions over qualified expense amounts.

Mutual funds: The major advantage of using a mutual fund instead of a Sec. 529 plan is the flexibility of the fund's use. It can be used for either college or retirement, with no penalty for distributing the funds. If a child receives a scholarship, grant or financial aid, the balance can be kept in the mutual fund and used for the child's post-college needs. Other advantages include higher potential for investment performance, greater investment choices and lower fees. The major disadvantages are that distributions potentially result in capital gains, and dividends and capital gains earned each year are currently taxable. Market risk is also an obvious disadvantage.

Life insurance/annuities: Investing in a permanent life insurance policy, a group universal life insurance policy or an annuity is another way to fund retirement and (in the case of insurance policies) ensure that insurance needs are covered with the same investment dollars. College planning comes into play with these types of investments, as these policies allow for loans or withdrawals.

Secs. 401(k) and 403(b): The strategy of last resort is to borrow from retirement accounts to fund college costs. Secs. 401(k) and 403(b) plans allow loans from the contributor's account that usually need to be repaid over five years.

The funding dilemma between college and retirement is one of the most difficult for a parent. Proper planning and long-term thinking should be involved when parents sit down to discuss the options, given their financial and personal circumstances and needs. The general consensus is that parents should not sacrifice retirement savings for college. Once funds are used to pay for college, they no longer can work and grow. Not fully funding retirement is a risky strategy that should be done only after consideration of the severe long-term consequences.