College planning is a difficult and time consuming process that, even when successful, must start years before the education itself begins. There are many pitfalls along the way but here are three mistakes many people make when planning to pay for their children’s college education:
1) Not watching investment risk
Saving for college expenses for children is nothing like retirement planning. Retirement savings are plotted out over a 20-40 year period, meaning that market fluctuations can be reduced over time. Retirement expenses, meanwhile, can be combined with other forms of income like Social Security, to produce a complete picture.
College savings, meanwhile, do not have nearly so long to accumulate returns, typically 10-15 in the best scenarios. What is saved for college, however, will usually be exhausted over a 2-5 year time frame. What this difference in timeline means is that your client can’t afford to ride out any temporary hiccups in the investment markets.
In the early stages of college savings, it’s acceptable to include higher risk investments so long as clients have a decade or more before the money is needed. However, as their children enter high school and college appears closer on the horizon, less volatile assets should be considered.
2) Taking a loan against their 401(k)
On occasion, clients may want to take a loan against their 401(k) to pay for their child’s college education. This is problematic for a number of reasons, but there are two major concerns that clients should be aware of.
First, depending on the rules of the client’s 401(k) plan, taking out a loan may disqualify clients from company matching programs. Second, clients may also have to repay loans that are taken out against their 401(k) within 60 days of a layoff or if they leave the company. The outstanding loan balance would be considered income if not repaid and would impact the client’s Expected Family Contribution, possibly reducing the student’s college finance package.
3) Ignoring Educational Tax Breaks
A large number of generous tax breaks are available to middle-class America and meant for college financial planning. Some of the biggest tax breaks that frequently go unused are the Hope Scholarship and the Lifetime Learning Credit, each of which can be worth $1,500-$2,000.
The IRS also prohibits individuals from using two tax credits on the same education expenses. Clients who tap into the 529 plans could disqualify themselves for credits like the American Opportunity Credit, worth up to $2,500. To avoid this potential issue, clients shouldn’t tap into 529 plans until they pay the $4,000 in qualified education expenses first.
Saving for continually rising college expenses is a difficult task. Many parents, themselves burdened at one point with student loan debt, try very hard to help their children avoid a similar situation. Prudent financial advisors will council parents on making sure they continue to save for their own retirement alongside saving for their children’s education. Life will often get in the way of a good plan, but making sure to avoid the most common mistakes is a great place to begin.