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COLLEGE

Feb. 1, 2006
Are you ready for that first bill?

Are you ready for that first bill?

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CONGRATULATIONS! Your oldest child just fulfilled her lifelong dream and got into Harvard University. Can you write a check today for $45,000? That’s the cost of just one year at an elite college such as Harvard. That means you will need to shell out $180,000 for four years. But, wait - the College Board has discovered that about 47 percent of college students now take five years to graduate from college. At many private universities, that fifth year is costing at least $35,000 for a total five-year college expense of $175,000. And that’s just for starters. You did want your child to go to graduate school, right? As a single parent or the main income earner in your family, you can use some powerful tools to afford your three largest future expenses: retirement, your child’s wedding, and your child’s college education.

Last year college costs increased 11 percent, and college costs are rising at two to three times the rate of inflation. What is a woman dentist to do? The crisis facing you and most dentists is a current cash flow problem. You might choose to pay for college without sacrificing your current lifestyle and discover later that you have a retirement shortfall. The key to building a successful financial future - a solid net worth - is to save for retirement as soon as possible and set aside money for college only after maximizing your retirement savings. Remember, there are many ways to pay for college - including washing dishes - but no one will pay for your retirement except you.

If you are tempted to put your child’s ­education needs in front of your retirement needs, consider how this strategy might affect your net worth. Let’s assume your child is going to attend a private college with a total cost of $140,000 and you hope to retire in 20 years. Paying that $140,000 yourself will rob your retirement of $448,994 - and this scenario assumes you have only one child in college and you earn only 6 percent per year on your retirement investments. If your retirement fund is earning a higher rate of return, then your retirement account will take an even larger hit.

How much do colleges expect me to pay?

You or your child might qualify for financial aid such as merit aid despite your income. Even so, that might just mean partial aid. To calculate how much need-based aid you might qualify for, colleges will run the numbers and determine how much money they think you should pay out of pocket for tuition, room, and board. This is called your expected family contribution, or EFC. I guarantee it will be a lot higher than what you think you can afford. Most families have no idea how colleges figure their contribution amount, but you can predict your EFC and even change its value when armed with an understanding of the basics and the help of a Certified College Planning Specialist, or CCPS.

Methodology: Your EFC is calculated once a year and is calculated using either the Federal Methodology or the Institutional Methodology. The Federal Methodology is used by all accredited schools as a way to determine how much federal money may be given by the school to cover the student’s cost of attendance, or COA. The Institutional Methodology is used by some private schools and is stricter because it counts more assets than the Federal Methodology.

Financial need: The difference between a school’s COA, your EFC, and any student resources (such as private, local scholarships, 529 plans, cash from grandparents) is the amount of financial need the school thinks your child deserves. As you can see, student resources reduce financial need on a dollar-for-dollar basis.

The calculation: Student and parent income and assets are assessed when calculating the EFC. It’s a complicated formula. To simplify, let’s say the school expects a student to use almost 50 percent of his income and 35 percent of his assets to contribute toward college expenses. The school expects the parents to contribute 47 percent of their income and 5.6 percent of their assets toward the COA. Again, this is a gross oversimplification; the college does make some allowances for living expenses, taxes, and some types of assets.

Living allowance: The living allowance the college grants you in the EFC calculation is the amount of money the college thinks your family needs to live on per year. Consequently, the college does not expect you to use this cash to pay for college. Before you breathe a sigh of relief, however, realize the living allowance for a family of four for 2005 is only $21,330.

Nonassessable assets and income: These do exist and often include annuities, life insurance, retirement accounts, personal items, the family’s main personal residence, sibling assets, student loan proceeds, rollover pensions, and nonmonetary gifts. Again, this is a complex area and the Institutional Methodology does assess some of the above items and can choose to change what it will and will not assess each year.

Assets and earnings: The EFC is calculated on the current year’s assets and earnings. So, the upcoming 2006-07 school year’s EFC will be based on your Dec. 31, 2005, income and assets. The college collects these numbers on the Free Application for Federal Student Aid, or FAFSA, which you should turn in as soon as possible after the beginning of January every year.

Divorced parents and EFC: Schools have the right to calculate the EFC based on your income and assets as well as your ex-spouse’s. If your husband has custody of the children, the schools may assess your assets and expect you to contribute money toward their college educations. If you have custody of the children, your child’s EFC may not be as low as you think it should be. Once the schools look at your husband’s income, they might expect him to pay for some college bills. Therefore, seek the advice of a Certified College Planning Specialist to discuss your specific situation.

So, it’s August and your child’s dream college determined your EFC exceeds his or her tuition. In other words, you received no free money, your son or daughter received little scholarship money, and you have the bill for the first semester of college. How do you scrape together enough cash to pay it?

You can slide some earned income over to your children to create an education fund from your tax savings. This is a lengthy topic that is best addressed in another article. For now, know that during college years, you can use this strategy if the logic still applies. Now that your child is college-age, you also have some more advanced strategies that will help you pay for college using the least amount of cash.

Section 529 plans: Let’s start with the basic question I often hear, “Should I put money into a 529 plan?” It depends, and it is not always the best way to go. If you have a low EFC and are on the cusp of qualifying for need-based financial aid from the schools, then 529 plans are probably not your best investment vehicles. If you have a high EFC and will never qualify for need-based aid, then 529 plans cannot hurt your aid package, so 529 plans might be good for you to set aside money for college.

What is a 529 plan? These are qualified tuition programs designed to help families save for post-secondary education. They may be either prepaid tuition or savings programs.

In a prepaid tuition program, each state determines how much you need to contribute to the plan each year to guarantee that future tuition is covered, despite inflation. Read the fine print carefully. If your child decides not to attend the state school you have a prepaid tuition account with, you can use the money at another school. Nevertheless, that can be costly. Expect to see the prepaid tuition programs under scrutiny during the next few months as more of these state plans are becoming bankrupt.

In a savings-type program, the money is typically invested in a variety of mutual funds held in a state-owned trust. Although there is no tax deduction for money put into the plan, the assets grow tax-free. Each state has different regulations regarding these accounts, and some offer a state income tax deduction for contributions. If set up by a parent, the parent retains ownership of the account but designates a beneficiary for whom the money is to be used. There are no income limitations on who can contribute, and most anyone can contribute on behalf of a beneficiary, though beware of gift tax limitations. A special election exists so one can fund the plan in one lump sum, but treat it as if it were made during a five-year period, thus giving you the flexibility to contribute up to $55,000 gift tax-free.

Tip: You may change beneficiaries on the account (for instance, if one child decides not to go to college), and you can even use the money for your own higher education.

Whose asset is it? According to the Department of Education, the 529 savings plan is an asset of the parent and should be assessed at 5.6 percent instead of the student’s 35 percent assessment rate. There is a growing trend for private colleges using the Institutional Methodology to consider the 529 plan a resource of the student - meaning a dollar-for-dollar ­reduction in the student’s financial aid package. If your child could have qualified for financial aid, the 529 plan just cost you a lot of free money from the school.

Is the withdrawal really tax-free? Not necessarily. One of the biggest misconceptions about 529 plans is that all withdrawals are tax-free when, in fact, only the return of your contributions, or basis, is tax-free. All earnings distributed in excess of that year’s qualified educational expenses are subject to taxation. A specialist should be consulted to ensure your withdrawals are actually tax-free and the tax-free portion of the qualified withdrawals is scheduled to expire at the end of 2010. ­(Congress is already considering a bill that would make current 529 plan provisions permanent.) Most nonqualified distributions are subject to federal taxes as well as a 10 percent penalty.

Tip: To learn more about specific state plans as well as any state tax benefits you may receive for setting up a 529 plan, visit www.savingforcollege.com.

Section 127 plans: Open a section 127 plan if you can. A Section 127 plan is a qualified employer educational assistance plan that allows you, as an employer, to give up to $5,250 per year, per employee, in tax-free educational assistance. Here’s what the excitement is about:

Discrimination: Although you cannot discriminate in favor of highly compensated employees or their dependents, by nature of the definition of a qualified plan, you may discriminate according to classification. Therefore, you can choose to offer educational assistance to only part-time employees - and the only part-timers just happen to be your children.

Benefit limitation: You may only offer more than 5 percent of total ­educational ­assistance to dependents in a situation where the dependent is 21 or older, an actual employee of the dental practice, and not claimed as a dependent on a parent’s tax return.

Tip: Consider using a Section 127 plan for the final two years of your child’s undergraduate education as well as for graduate school. For every year you use the plan, your practice receives a deduction for the educational assistance, thereby reducing your taxable income.

Grandparent gifts: An increasing number of grandparents are choosing to help their grandchildren pay for college. Because college funding is such a complex issue, it is important for grandparents to be a part of your education plan.

Inheritance from grandparents: I have quite a few clients who want to use inheritance money their children received from a grandparent to pay for college. This makes sense because it is probable the grandparent set aside this money specifically for education and, as women, we often feel an emotional need to use money in the way our parents intended. On the other hand, this money might be earning such a high rate of return that it would be wise to keep the inheritance account intact and either pay for college using cheaper money or consider purposefully taking out a low-interest college loan and using this money to pay off the loan at your own convenience.

Outright gifts from grandparents: Beware of the advantages and disadvantages grandparent gifting might have on your education plan. For instance, if grandparents send money directly to the school, their gift will not reduce their annual $11,000 gift-tax exclusion, which is an advantage to them. The money, however, reduces the child’s financial aid on a dollar-for-dollar basis.

Tip: A cash gift from a grandparent is assessable whereas a gift of a car or computer is not. Also, a loan from a grandparent is not assessable and, after college years, the grandparent could choose to forgive the loan if so desired. A simple change in the manner in which a grandparent gives a graduation gift can dramatically change the value of your EFC.

Loans: Numerous federal and private college loans exist solely to help you and your child pay for college expenses. There are loans you can take out in your name, such as PLUS loans, and loans your child can take out in his or her name, such as Stafford loans. Because of the July 1, 2005, rate increase and the next one on July 1, other means of financing might be more desirable than federal loans.

Home equity line of credit/mortgage ­refinance: Always consider using a home equity line of credit to pay for college. If interest rates are low, consider taking out a line of credit even if you did not already have one. Most of the time you will be able to deduct the interest paid on Schedule A of your tax return, and you will avoid paying the higher student loan interest rates. Another option is a mortgage refinance. Such a refinancing might free up some cash by reducing your monthly mortgage payment and give you the flexibility to take out the home equity line of credit you need.

Insurance loans: Another way to find some cash to pay for college is to borrow against the cash value of your life policy. Although it must be carefully done so it won’t terminate the policy, you might be able to use the money on a tax-deferred basis and have a guarantee against repayment in the event of a child’s death or disability. There are high cash value policies that you might want to consider while your child is young, in anticipation of such policy loans later.

Other options: Don’t forget to investigate merit-based, athletic, or talent-based ­scholarships, as well as local scholarships offered by ­community organizations. A high income does not preclude you from ­pursuing financial aid for your children. Your circumstance gives you numerous strategies to plan and pay for college.

To learn how to minimize your EFC or ask other questions, contact a Certified College Planning Specialist who can begin helping you with this type of planning from the time your child is born, at www.niccp.com. If you have children in high school and do not have an education plan, it is not too late to start. Ideally, you should begin creating a plan no later than the fall of your child’s junior year in high school.

In-house Day Care

Are your children younger than 5 and you’re wondering how to pay for their day care or nanny expenses? A few years ago, I opened an in-office day care for my team members and myself. Together, we ran it for three years. Here are some of the things we learned:

Tax credit: If your children are in day care to enable you to work, then you can take the Child and Dependent Care Credit. You can even claim this credit if you paid for day camps for your children. For 2005, you may claim a credit (reducing your taxes dollar-for-dollar) of 20 percent of qualifying child care expenses, up to a maximum of $3,000 for one child or $6,000 for two or more qualifying children. The children must be younger than 13 and you must be the custodial parent. Expenses should be prorated if you worked for only some months of the year.

NANNY: A nanny should be paid as a household employee. The IRS requests you file for a taxpayer ID number, withhold FICA taxes on each check, give the nanny a W2 for the year, and then report this employee on Schedule H of your 1040. When filing the personal tax return, you will be asked to pay any federal unemployment expenses for this employee. You can still claim the aforementioned tax credit for these expenses.

In-office day care: The most cost-effective way for you to pay for day care expenses could be to bring the day care under the roof of your dental practice. You can deduct money spent on rent, utilities, improvements, etc. Also, you can pay the nanny as either an independent contractor or an employee and thus deduct the full cost of her salary. If you open up the day care to your team’s children, then you reduce the cost of your own day care (they are now helping you split the cost of a nanny) and save your staff money as well - they can pay for their portion of the in-office day care using pretax dollars. (They will still be able to claim the ­aforementioned credit, but with some limitations).

Operating an in-office day care: Check your state’s regulations to determine whether you need a license for operations (in the state of Georgia, a day care with fewer than seven children need not apply). Also, consider having your team members on the board of directors. In our office, all of us voted on each decision and my team members enjoyed having ownership in running a portion of our business. Team members often begin to think differently about raises and benefits you offer them when they must make decisions about raises and benefits to offer the nanny. They see how these decisions affect their bottom line just as they affect the profit of your dental practice.

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Kate Willeford Haile, CPA, CCPS
Willeford Haile is a partner with Willeford Haile CPA, PC, specializing in dental accounting, retirement, tax, financial planning, education funding, and practice transition services since 1975. Reach her at [email protected] or (770) 552-8500. She is also available for speaking engagements.