College-bound Money: It’s How You Play the Game

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For parents and their children preparing for college, there are new rules and tax laws about college funding and financial aid eligibility that could have a big impact how those students and their parents fare financially. Even more complicated, those rules are changing every year. If parents and their dependent students learn how to make the right moves in the college financing game, the average family could potentially lower college costs by thousands of dollars over the four year period their child is in college. Win or lose – it’s how you play the game.

The federal Higher Education Reconciliation Act a.k.a. Deficit Reduction Act of 2005 brings about changes in college financial planning that are beginning right now. One of the most touted modifications is in the 529 college savings plan, where college-bound students and their parents supposedly get financial incentives for putting money into a 529 plan.

All of that money is then specifically earmarked for college. An example is where parents would transfer money from a custodial account (Uniform Transfer to Minors Act -- in the child’s name but with parental oversight) into a 529 plan. For some families, the move makes sense. For others, taking advantage of this single option could cause some adverse tax and financial aid implications.

Before you start transferring your money to save for college, consider:

Is the 529 plan right for you?

1) Depending on your existing assets, such as stocks or mutual funds, you could be paying a large tax bill if you convert the funds to a 529 account. Determine the amount of untaxed gains before selling stocks or mutual funds, because they will now be taxed if you transfer the funds. In addition, the money in a 529 plan will now be treated as a parental asset. Considering your tax bracket, this could become an expensive issue.

2) All of the growth in a 529 plan is tax-free when used for college. Although the money gets invested like any other mutual fund, there are higher fees charged, limitations on moving money within the plan, and that money can only be used for your student’s education.

3) Keeping your money out of a 529 and in your own name means much more flexibility and freedom in deciding how you choose to make use of your money. Your individually-owned assets can be used in a number of ways, like setting it aside for retirement, family emergencies, or college planning on your own terms. Once the money is in a 529 plan, the feds control how your money can be used – for college – that’s it.

Is it beneficial to have a custodial account set up for your student?

1) Many families have set up custodial accounts, intended specifically for college. The most commonly held assets are cash, stocks, and mutual funds, and the custodian has a great degree of control and flexibility in how those assets are managed and used.

2) Custodial accounts may also be used for certain expenses prior to college; therefore, the overall asset values of the account may be reduced by paying those allowable expenses. Because money is already spent before the college years, the custodial account shows less value, making it possible to apply for more financial aid.

3) The account assets will revert to the child when they reach the age of majority (18 to 21 years old), so if you want to maintain control of the money, make your decisions before that time.

How do the federal tax laws impact college planning?

1) Taxpayers in the lowest tax brackets may be able to take advantage of the zero dividend and capital gains law. On May 17, 2006 President Bush signed the “Tax Increase Prevention and Reconciliation Act of 2005” (TIPRA) into law for tax years 2008 through 2010.

2) TIPRA also made some changes to the “kiddie tax” laws. The “kiddie tax” laws set limits on the maximum investment income a child can receive ($1,700) before the excess is taxed at the parents’ rate.

3) TIPRA currently states that teens will have to pay taxes on excess investment income received only after the age of 18. The new law, raising the age limit, has an impact on how custodial accounts can be managed and when they can be liquidated for college.

Is there anything I can take advantage of now?

1) The Free Application for Federal Student Aid, FAFSA, is available to all students, and is used most often as the starting point in the financial aid. The most recent version of the FAFSA (released on 6/7/06) has a loophole that may increase available aid. The FAFSA says that education accounts (including 529 plans) owned by the student should not be reported on the application form. The form gives the appearance that these asset values will be excluded in their entirety from the financial aid calculation, so that again, on paper, your look more eligible for financial aid.

2) Will this loophole be eliminated in the final version of the FAFSA? It’s a roll of the dice.

Is there an appropriate time to start positioning your financial resources for college?

1) With a student going to college in 2007, tax data is used from 2006. Deciding where to put assets and in whose name must be determined long before the student starts applying for college.

2) Get an early start on putting the college financing pieces together. You will maximize your opportunities to save money by starting at least two years before the student will be entering college.

Remember, it’s not always the plan you choose, but how you play the game.

Michael J. Lopata is a CPA and Certified College Planning Specialist and a member of the NICCP (National Institute of Certified College Planners). He is available for public speaking or consulting. His college planning philosophy: “For every family there is a solution. I help uncover the options.”    


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Michael Lopata
Education Path
404 591-2451
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