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How Student Loans Impact Your Credit

How Student Loans Impact Your Credit

If you’ve finished college within the last few years, chances are you’re paying off your student loans. What happens with your student loans now that they’ve entered repayment status will have a significant impact. This can be positive or negative on your credit history and credit score.

It’s payback time on your student loans

When you left school, you enjoyed a grace period of six to nine months before you had to begin repaying your student loans. But they were there all along. Once the grace period was over, the reality hits. How is it now affecting your ability to get other credit?

One way to find out is to pull a copy of your credit report. There are three major credit reporting agencies, or credit bureaus. They are, Experian, Equifax, and Trans Union. You should get a copy of your credit report from each one. Keep in mind, though, that while institutions making student loans are required to report the date of disbursement, balance due, and current status of your loans to a credit bureau. They’re not currently required to report the information to all three, although many do.

If you’re repaying your student loans on time, then that is actually helping you establish a good credit history. But if you’re seriously delinquent or in default on your loans, this can seriously undermining your efforts to get other credit.

What’s your credit score?

Your credit report contains information about any credit you have. Including credit cards, car loans, and student loans. The credit bureau may use this information to generate a credit score. A credit score statistically compares information about you to the credit performance of a base sample of consumers with similar profiles. The higher your credit score, the more likely you are to be a good credit risk. Thus, the better your chances of obtaining credit at a favorable interest rate.

Many different factors are used to determine your credit score. Some of these factors carry more weight than others. Significant weight is given to factors describing:

  • Your payment history, including whether you’ve paid your obligations on time, and how long any delinquencies have lasted
  • New credit, including how many inquires or applications for credit you’ve made, and how recently you’ve made them
  • Your outstanding debt, including the amounts you owe on your accounts, the different types of accounts you have, and how close your balances are to the account limits
  • Your credit history, including how long you’ve had credit, how long specific accounts have been open, and how long it has been since you’ve used each account

Student loans and your credit score

Always make your student loan payments on time. Otherwise, your credit score will be negatively affected. To improve your credit score, it’s also important to make sure that any positive repayment history is correctly reported by all three credit bureaus, especially if your credit history is sparse. If you find that your student loans aren’t being reported correctly to all three major credit bureaus, ask your lender to do so.

But even when it’s there for all to see, a large student loan debt may impact a factor prospective creditors scrutinize closely. They will look to your debt-to-income ratio. A large student loan debt may especially hurt your chances of getting new credit if you’re in a low-paying job, and a prospective creditor feels your budget is stretched too thin to make room for the payments any new credit will require.

Moreover, if your principal balances haven’t changed much, or if they’re getting larger, it may look to a prospective lender like you’re not making much progress on paying down the debt you already have.

Getting the monkey off your back

Like many people, you may have put off buying a house or a car because you’re overburdened with student loan debt. So what can you do to improve your situation? Here are some suggestions to consider:

  • Pay off your student loan debt as fast as possible. Doing so will reduce your debt-to-income ratio, even if your income doesn’t increase.
  • If you’re struggling to repay your student loans and are considering asking for a forbearance, ask your lender instead to allow you to make interest-only payments. Your principal balance may not go down, but it won’t go up, either.
  • Ask your lender about a graduated repayment option. In this arrangement, the term of your student loan remains the same, but your payments are smaller in the beginning years and larger in the later years. Lowering your payments in the early years may improve your debt-to-income ratio. Larger payments later may not adversely affect you if your income increases as well.
  • If you’re really strapped, explore extended or income-sensitive repayment options. Extended repayment options extend the term you have to repay your loans. Over the longer term, you’ll pay a greater amount of interest, but your monthly payments will be smaller, thus improving your debt-to-income ratio. Income-sensitive plans tie your monthly payment to your level of income. The lower your income is, the lower your payment. This also may improve your debt-to-income ratio.
  • If you have several student loans, consider consolidating them through a student loan consolidation program. This won’t reduce your total debt, but a larger loan may offer a longer repayment term or a better interest rate. While you’ll pay more total interest over the course of a longer term, you’ll also lower your monthly payment. This in turn will lower your debt-to-income ratio.

If you’re in default on your student loans, don’t ignore them. They aren’t going to go away. Student loans generally cannot be discharged even in bankruptcy. Ask your lender about loan rehabilitation programs . Successful completion of such programs can remove default status notations on your credit reports.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

How Student Loans Impact Your Credit

How Student Loans Impact Your Credit

If you’ve finished college within the last few years, chances are you’re paying off your student loans. What happens with your student loans now that they’ve entered repayment status ,will have a significant impact. This can be positive or negative on your credit history and credit score.

It’s payback time

When you left school, you enjoyed a grace period of six to nine months before you had to begin repaying your student loans. But they were there all along, sleeping like an 800-pound gorilla in the corner of the room. Once the grace period was over, the gorilla woke up. How is he now affecting your ability to get other credit?

One way to find out is to pull a copy of your credit report. There are three major credit reporting agencies, or credit bureaus. There is Experian, Equifax, and Trans Union and you should get a copy of your credit report from each one. Keep in mind, though, that while institutions making student loans are required to report the date of disbursement, balance due, and current status of your loans to a credit bureau, they’re not currently required to report the information to all three, although many do.

If you’re repaying your student loans on time, then the gorilla is behaving nicely, and is actually helping you establish a good credit history. But if you’re seriously delinquent or in default on your loans, the gorilla will turn into King Kong. Terrorizing the neighborhood and seriously undermining your efforts to get other credit.

What’s your credit score?

Your credit report contains information about any credit you have, including credit cards, car loans, and student loans. The credit bureau may use this information to generate a credit score. This score statistically compares information about you to the credit performance of a base sample of consumers with similar profiles. The higher your credit score, the more likely you are to be a good credit risk. And, the better your chances of obtaining credit at a favorable interest rate.

Many different factors are used to determine your credit score. Some of these factors carry more weight than others. Significant weight is given to factors describing:

  • Your payment history, including whether you’ve paid your obligations on time, and how long any delinquencies have lasted
  • New credit, including how many inquires or applications for credit you’ve made, and how recently you’ve made themYour outstanding debt, including the amounts you owe on your accounts, the different types of accounts you have (e.g., credit cards, installment loans), and how close your balances are to the account limits
  • Your credit history, including how long you’ve had credit, how long specific accounts have been open, and how long it has been since you’ve used each account

Student loans and your credit score

Always make your student loan payments on time. Otherwise, your credit score will be negatively affected. To improve your credit score, it’s also important to make sure that any positive repayment history is correctly reported by all three credit bureaus. Especially if your credit history is sparse. If you find that your student loans aren’t being reported correctly to all three major credit bureaus, ask your lender to do so.

But even when it’s there for all to see, a large student loan debt may impact a factor prospective creditors scrutinize closely: your debt-to-income ratio. A large student loan debt may especially hurt your chances of getting new credit if you’re in a low-paying job. As well, a prospective creditor feels your budget is stretched too thin to make room for the payments any new credit will require.

Moreover, if your principal balances haven’t changed much, or if they’re getting larger, it may look to a prospective lender like you’re not making much progress on paying down the debt you already have.

Getting the monkey off your back

Like many people, you may have put off buying a house or a car because you’re overburdened with student loan debt. So what can you do to improve your situation? Here are some suggestions to consider:

Pay off your student loan debt as fast as possible. Doing so will reduce your debt-to-income ratio, even if your income doesn’t increase.If you’re struggling to repay your student loans and are considering asking for a forbearance, ask your lender instead to allow you to make interest-only payments. Your principal balance may not go down, but it won’t go up, either.

The Repayment Option

Ask your lender about a graduated repayment option. In this arrangement, the term of your student loan remains the same. However, your payments are smaller in the beginning years and larger in the later years. Lowering your payments in the early years may improve your debt-to-income ratio. Larger payments later may not adversely affect you if your income increases as well.

If you’re really strapped, explore extended or income-sensitive repayment options. Extended repayment options extend the term you have to repay your loans. Over the longer term, you’ll pay a greater amount of interest, but your monthly payments will be smaller. Thus, this will improve your debt-to-income ratio. Income-sensitive plans tie your monthly payment to your level of income. The lower your income, the lower your payment. This also may improve your debt-to-income ratio.

Loan consolidation program

If you have several student loans, consider consolidating them through a student loan consolidation program. This won’t reduce your total debt, but a larger loan may offer a longer repayment term or a better interest rate. While you’ll pay more total interest over the course of a longer term, you’ll also lower your monthly payment. Which in turn will lower your debt-to-income ratio.

If you’re in default on your student loans, don’t ignore them–they aren’t going to go away. Student loans generally cannot be discharged even in bankruptcy. Ask your lender about loan rehabilitation programs; successful completion of such programs can remove default status notations on your credit reports.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

How to Choose the Best 529 Plan for You

How to Choose the Best 529 Plan for You

When selecting the best 529 college savings plan, the choice should be personalized to your family’s specific situation. With so many 529 plans to choose from, you’ll need to ask a lot of questions in order to select the best plan for you.

Compare the 529 plans offered by different states

If you’re interested in joining a college savings plan, you should consider all of your options. Compare the plans offered by different states in terms of:

  • Flexibility
  • Tax considerations
  • Investment selection
  • Contribution rules
  • Costs and fees

Any state that offers a 529 plan can provide you with a free packet of information that describes the program and its rules. You can also check out a plan’s website. Keep in mind that some states allow nonresidents to join their plans, and others don’t. The vast majority of states that offer college savings plans allow nonresidents to participate.

Consider the 529 plan’s account ownership and beneficiary designation rules

When comparing 529 plans, keep plan flexibility in mind. Particularly with respect to account ownership and beneficiary designation rules. These rules may vary from state to state. A college savings plan can be an expensive undertaking. And your child’s education is certainly important to you. As an account owner, you’ll want to make sure the account works the way you want it to work.

Generally, the account owner retains ownership and a certain amount of control over the college savings plan account. For example, he or she can change the beneficiary of the account or terminate the account and receive a refund of contributions. Keep in mind that if you terminate the account, you’ll typically receive back only a portion of your earnings, if any. A penalty will generally apply, unless you terminate the account because the beneficiary has died or is disabled. Here are some questions to ask when researching various plans:

  • Am I able to own the account jointly with my spouse or another person?
  • Can a trust or other entity be an account owner?
  • Can I name a successor owner when I open the account? If not, what happens to the account when I die?
  • Must the account owner be a state resident? Must the beneficiary be a state resident?
  • What happens if the account owner or beneficiary later moves out of state?
  • Are account statements issued only to the account owner or also to the beneficiary?
  • Can I view the account on-line?
  • If I terminate the account, how much of my contributions and earnings will I get back, and will I pay a penalty?

Tax considerations

Some individuals favor a college savings plans over other college savings vehicles because of the federal (sometimes state) tax advantages associated with 529 plans. Let’s face it–we all want to keep our taxes to a minimum. No matter which college savings plan you join, all qualified withdrawals will be free of federal income tax. But things differ at the state level.

Some states exempt a college savings plan’s earnings from income tax if used to pay qualified higher education expenses. Some states may also let you deduct on your state income tax return some or all of your plan contributions in a given year. Other states offer no such income tax benefits. Since state tax benefits can vary widely, compare the tax benefits. Look at your own state’s 529 plan first and research the state tax benefits available. Especially if you’re thinking about moving to another state in the near future. Also, keep in mind that states may limit their tax benefits to individuals who participate in the in-state 529 plan only.

Consider any state gift tax issues regarding contributions. Learn if there are state penalties for withdrawals that are not used for permitted education expenses. The following questions can help you determine what tax advantages each state offers:

  • Can I claim a deduction on my state income tax return for my contributions to the college savings plan?
  • Is my deduction recaptured into income if later withdrawals are not used for qualified education purposes?
  • Is there a limitation or cap placed on the amount of my state income tax deduction? If so, what is it?
  • If a withdrawal from the college savings plan is used to pay qualified education expenses, are the 529 plan’s earnings exempt from state income tax?
  • Must I join my own state’s 529 plan to get its tax benefits?

Number and type of investment vehicles offered

If you’re interested in opening a college savings plan account, you should consider the number and type of investment vehicles offered by each plan. Since some investors are more comfortable with risk than others, investment choice is important. Investment choice may also be important if you’re a sophisticated investor who wants to maximize return.

The 529 plans in some states may restrict you to a certain portfolio based on the beneficiary’s age. Some 529 plans provide you with an extensive menu of investment options,. Others offer only one or two portfolios. Some states also allow you to change your investment choice when you change the beneficiary or once per calendar year.

You may want to look at the past investment performance of a particular portfolio and compare it with other portfolios in different 529 plans. You should also think about the reputation of the plan manager. Here are some investment-related questions to ask:

  • How many investment options does the college savings plan provide?
  • Are there age-based asset allocation approaches offered? If so, can I select a portfolio other than one designed to match the age of my designated beneficiary?
  • If the college savings plan offers more than one investment option, can I spread a contribution among the options without opening multiple accounts?
  • Who manages the 529 plan’s investments, and how solid is that company’s reputation?
  • Can I choose one investment portfolio with today’s contribution, and a different portfolio with future contributions?
  • Will the 529 plan let me switch my account from one portfolio to another portfolio?
  • When does the investment manager’s contract with the plan end? What happens to my account if the state changes investment managers?

Contribution rules for 529 Plans

Although we all have different financial situations, money is important to each of us. To ensure that you select a college savings plan that best matches your financial means, you should investigate the contribution rules of each plan. Most 529 plans have maximum contribution limits of $300,000 and up. But if money is tight for you, you might want to avoid 529 plans that require a high annual plan contribution. Find out the answers to the following questions:

  • What’s the maximum contribution limit for the 529 plan?
  • What’s the minimum amount I must contribute to establish the college savings plan?
  • Is there a required annual contributions? If so, how much?
  • Can someone other than the account owner make 529 plan contributions?
  • Are the contribution limits different if I am a resident of the state or a nonresident?

Costs and fees

Since 529 plan costs and fees can really add up and take a sizable bite out of your funds, you should consider the expenses associated with each plan. Sometimes, nonresidents joining a plan must pay higher broker’s fees or higher annual account fees. There might be a tax break for residents, so look into that. Then, compare the overall costs of different plans. Consider the following questions:

  • Are residents and nonresidents treated differently in terms of 529 plan costs and fees?
  • Is there an application fee, beneficiary substitution fee, or account owner substitution fee?
  • What other fees and costs are there, and what are the amounts?
  • Will my fees be less if I contribute through payroll deduction or automatic deduction from my checking account?
  • Is there a fee to do a rollover to another state’s plan?
  • Is there a penalization if I move my account out of the 529 plan within a short time after I open the account? How short a time?
  • Is there a fee if I terminate the account?
  • Do I pay fees separately? Will the fees be deducted from my account?

Do you need help deciding the best 529 plan for your situation?

Choosing a 529 plan that works best for you doesn’t have to be confusing. Let our financial experts help you make the best decision for your current financial situation and future goals. Contact us today for a complimentary consultation!

The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

The Best Ways to Save for College

The Best Ways to Save for College

 

In the college savings game, all strategies aren’t created equal. The best savings vehicles offer special tax advantages if the funds are used to pay for college. Tax-advantaged strategies are important because over time, you can potentially accumulate more money with a tax-advantaged investment compared to a taxable investment. Ideally, though, you’ll want to choose a savings vehicle that offers you the best combination of tax advantages, financial aid benefits, and flexibility, while meeting your overall investment needs.

 

529 plans

Since their creation in 1996, 529 plans have become to college savings what 401(k) plans are to retirement savings–an indispensable tool for helping you amass money for your child’s or grandchild’s college education. That’s because 529 plans offer a unique combination of benefits unmatched in the college savings world.

There are two types of 529 plans–college savings plans and prepaid tuition plans. Though each is governed under Section 529 of the Internal Revenue Code (hence the name “529” plans), college savings plans and prepaid tuition plans are very different college savings vehicles. There are typically fees associated with opening and maintaining each type of account.

529 plans: college savings plans

A 529 college savings plan is a tax-advantaged college savings vehicle that lets you save money for college in an individual investment account. Some plans let you enroll directly, while others require that you go through a financial professional.

The details of college savings plans vary by state, but the basics are the same. You’ll need to fill out an application, where you’ll name a beneficiary and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be in cash.

529 college savings plans offer a unique combination of features that no other college savings vehicle can match:

  • Federal tax advantages: Contributions to your account grow tax deferred and are completely tax free if the money is used to pay the beneficiary’s qualified education expenses. The earnings portion of any withdrawal not used for college expenses is taxed at the recipient’s rate and subject to a 10 percent federal penalty.
  • State tax advantages: Many states offer income tax incentives for state residents, such as a tax deduction for contributions or a tax exemption for qualified withdrawals. However, be aware that some states limit their tax deduction to contributions made to the in-state 529 plan only.
  • High contribution limits: Most college savings plans have lifetime maximum contribution limits over $300,000.
  • Unlimited participation: Anyone can open a 529 college savings plan account, regardless of income level.
  • Professional money management: College savings plans are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.
  • Flexibility: Under federal rules, you can change the beneficiary of your account to a qualified family member at any time without penalty. And you can rollover the money in your 529 plan account to a different 529 plan once per year without income tax or penalty implications.
  • Wide use of funds: Money in a 529 college savings plan can be used at any college in the United States or abroad that’s accredited by the U.S. Department of Education and, depending on the individual plan, for graduate school.
  • Accelerated gifting: 529 plans offer an excellent estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s college education. Individuals can make a lump-sum gift to a 529 plan of up to $70,000 ($140,000 for married couples) and avoid federal gift tax, provided a special election is made to treat the gift as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.
  • Variety: Currently, there are over 50 different college savings plans to choose from because many states offer more than one plan. You can join any state’s college savings plan.

But college savings plans have drawbacks too. You relinquish some control of your money. Returns aren’t guaranteed–you roll the dice with the investment portfolios you’ve chosen, and your account may gain or lose money.

529 plans: prepaid tuition plans

Prepaid tuition plans are distant cousins to college savings plans–their federal tax treatment is the same, but just about everything else is different. A prepaid tuition plan is a tax-advantaged college savings vehicle that lets you pay tuition expenses at participating colleges at today’s prices for use in the future. Prepaid tuition plans can be run either by states or colleges. For state-run plans, you prepay tuition at one or more state colleges; for college-run plans, you prepay tuition at the participating college(s).

As with 529 college savings plans, you’ll need to fill out an application and name a beneficiary. But instead of choosing an investment portfolio, you purchase an amount of tuition credits or units (which you can then do again periodically), subject to plan rules and limits. Typically, the tuition credits or units are guaranteed to be worth a certain amount of tuition in the future, no matter how much college costs may increase between now and then. As such, prepaid tuition plans provide some measure of security over rising college prices.

  • Federal and state tax advantages: The federal and state tax advantages given to prepaid tuition plans are the same as for college savings plans.
  • Other similarities to college savings plans: Prepaid tuition plans are open to people of all income levels, and they offer flexibility in terms of changing the beneficiary or rolling over to another 529 plan once per year, as well as accelerated gifting.

Prepaid tuition plans have some limitations, though, compared to college savings plans. One major drawback is that your child is generally limited to your own state’s prepaid tuition plan, and then your child is limited to the colleges that participate in that plan. If your child attends a different college, prepaid plans differ on how much money you’ll get back. Also, some prepaid plans have been forced to reduce benefits after enrollment due to investment returns that have not kept pace with the plan’s offered benefits. Even with these limitations, some college investors appreciate the peace of mind that comes with not worrying about college inflation each year by locking in college costs today.

Coverdell education savings accounts

A Coverdell education savings account (Coverdell ESA) is a tax-advantaged education savings vehicle that lets you save money for college, as well as for elementary and secondary school (K-12) at public, private, or religious schools. Here’s how it works:

  • Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account. The beneficiary must be under age 18 when the account is established (unless he or she is a child with special needs).
  • Contribution rules: You (or someone else) make contributions to the account, subject to the maximum annual limit of $2,000. This means that the total amount contributed for a particular beneficiary in a given year can’t exceed $2,000, even if the money comes from different people. Contributions can be made up until April 15 of the year following the tax year for which the contribution is being made.
  • Investing contributions: You invest your contributions as you wish (e.g., stocks, bonds, mutual funds, certificates of deposit)–you have sole control over your investments.
  • Tax treatment: Contributions to your account grow tax deferred, which means you don’t pay income taxes on the account’s earnings (if any) each year. Money withdrawn to pay college or K-12 expenses (called a qualified withdrawal) is completely tax free at the federal level(and typically at the state level too). If the money isn’t used for college or K-12 expenses (called a nonqualified withdrawal), the earnings portion of the withdrawal will be taxed at the beneficiary’s tax rate and subject to a 10 percent federal penalty.
  • Rollovers and termination of account: Funds in a Coverdell ESA can be rolled over without penalty into another Coverdell ESA for a qualifying family member. Also, any funds remaining in a Coverdell ESA must be distributed to the beneficiary when he or she reaches age 30 (unless the beneficiary is a person with special needs).

Unfortunately, not everyone can open a Coverdell ESA–your ability to contribute depends on your income. To make a full contribution, single filers must have a modified adjusted gross income (MAGI) of less than $95,000, and joint filers must have a MAGI of less than $190,000. And with an annual maximum contribution limit of $2,000, a Coverdell ESA probably can’t go it alone in meeting today’s college costs.

Custodial accounts

Before 529 plans and Coverdell ESAs, there were custodial accounts. A custodial account allows your child to hold assets–under the watchful eye of a designated custodian–that he or she ordinarily wouldn’t be allowed to hold in his or her own name. The assets can then be used to pay for college or anything else that benefits your child (e.g., summer camp, braces, hockey lessons, a computer). Here’s how a custodial account works:

  • Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account.
  • Custodian: You also designate a custodian to manage and invest the account’s assets. The custodian can be you, a friend, a relative, or a financial institution. The assets in the account are controlled by the custodian.
  • Assets: You (or someone else) contribute assets to the account. The type of assets you can contribute depends on whether your state has enacted the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). Examples of assets typically contributed are stocks, bonds, mutual funds, and real property.
  • Tax treatment: Earnings, interest, and capital gains generated from assets in the account are taxed every year to your child. Assuming your child is in a lower tax bracket than you, you’ll reap some tax savings compared to if you had held the assets in your name. But this opportunity is very limited because of special rules, called the “kiddie tax” rules, that apply when a child has unearned income. Under these rules, children are generally taxed at their parents’ tax rate on any unearned income over a certain amount. Currently, this amount is $2,000 (the first $1,000 is tax free and the next $1,000 is taxed at the child’s rate). The kiddie tax rules apply to: (1) those under age 18, (2) those age 18 whose earned income doesn’t exceed one-half of their support, and (3) those ages 19 to 23 who are full-time students and whose earned income doesn’t exceed one-half of their support.

A custodial account provides the opportunity for some tax savings, but the kiddie tax sharply reduces the overall effectiveness of custodial accounts as a tax-advantaged college savings strategy. And there are other drawbacks. All gifts to a custodial account are irrevocable. Also, when your child reaches the age of majority (as defined by state law, typically 18 or 21), the account terminates and your child gains full control of all the assets in the account. Some children may not be able to handle this responsibility, or might decide not to spend the money for college.

U.S. savings bonds

Series EE and Series I bonds are types of savings bonds issued by the federal government that offer a special tax benefit for college savers. The bonds can be easily purchased from most neighborhood banks and savings institutions, or directly from the federal government. They are available in face values ranging from $50 to $10,000. You may purchase the bond in electronic form at face value or in paper form at half its face value.

If the bond is used to pay qualified education expenses and you meet income limits (as well as a few other minor requirements), the bond’s earnings are exempt from federal income tax. The bond’s earnings are always exempt from state and local tax.

In 2013, to be able to exclude all of the bond interest from federal income tax, married couples must have a modified adjusted gross income of $112,050 or less at the time the bonds are redeemed (cashed in), and individuals must have an income of $74,700 or less. A partial exemption of interest is allowed for people with incomes slightly above these levels.

The bonds are backed by the full faith and credit of the federal government, so they are a relatively safe investment. They offer a modest yield, and Series I bonds offer an added measure of protection against inflation by paying you both a fixed interest rate for the life of the bond (like a Series EE bond) and a variable interest rate that’s adjusted twice a year for inflation. However, there is a limit on the amount of bonds you can buy in one year, as well as a minimum waiting period before you can redeem the bonds, with a penalty for early redemption.

Financial aid impact

Your college saving decisions impact the financial aid process. Come financial aid time, your family’s income and assets are run through a formula at both the federal level and the college (institutional) level to determine how much money your family should be expected to contribute to college costs before you receive any financial aid. This number is referred to as the expected family contribution, or EFC.

In the federal calculation, your child’s assets are treated differently than your assets. Your child must contribute 20 percent of his or her assets each year, while you must contribute 5.6 percent of your assets.

For example, $10,000 in your child’s bank account would equal an expected contribution of $2,000 from your child ($10,000 x 0.20), but the same $10,000 in your bank account would equal an expected $560 contribution from you ($10,000 x 0.056).

Under the federal rules, an UTMA/UGMA custodial account is classified as a student asset. By contrast, 529 plans and Coverdell ESAs are considered parental assets if the parent is the account owner or for student-owned or UTMA/UGMA-owned 529 accounts. Accounts owned by grandparents aren’t counted as a parent asset. And distributions (withdrawals) from 529 plans and Coverdell ESAs that are used to pay the beneficiary’s qualified education expenses are not classified as parent or student income on the federal government’s aid form, which means that some or all of the money is not counted again when it’s withdrawn. Other investments you may own in your name, such as mutual funds, stocks, U.S. savings bonds (e.g., Series EE and Series I), certificates of deposit, and real estate, are also classified as parental assets.

Regarding institutional aid, colleges are generally a bit stricter than the federal government in assessing a family’s assets and their ability to pay college costs. Most use a standard financial aid application that considers assets the federal government does not, for example, home equity. Typically, though, colleges treat 529 plans, Coverdell accounts, and UTMA/UGMA custodial accounts the same as the federal government, with the caveat that distributions from 529 plans and Coverdell accounts are often counted again as available income.

Are you looking to take the first steps for college saving?

If you would like to find out more, or have questions regarding college planning, our team is here to help you. Contact us today for a consultation.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

529 Plans and Financial Aid Eligibility

529 Plans and Financial Aid Eligibility


If you’re thinking about joining a 529 plan, or if you’ve already opened an account, you might be concerned about how 529 funds will affect your child’s chances of receiving financial aid. Of all the areas related to 529 plans, financial aid is perhaps the most uncertain, and the one most likely to change in the future. But here’s where things stand now.

First, why should you be concerned?

The financial aid process is all about assessing what a family can afford to pay for college and trying to fill the gap. To do this, the institutions that offer financial aid examine a family’s income and assets to determine how much a family should be expected to contribute before receiving financial aid. Financial aid formulas weigh assets differently, depending on whether they are owned by the parent or the child. So, it’s important to know how your college savings plan account or your prepaid tuition plan account will be classified, because this will affect the amount of your child’s financial aid award.

A general word about financial aid

Financial aid is money given to a student to help that student pay for college or graduate school. This money can consist of one or more of the following:

  • A loan (which must be repaid in the future)
  • A grant (which doesn’t need to be repaid)
  • A scholarship
  • A work-study job (where the student gets a part-time job either on campus or in the community and earns money for tuition)

The typical financial aid package contains all of these types of aid. Obviously, grants are more favorable than loans because they don’t need to be repaid. However, over the past few decades, the percentage of loans in the average aid package has been steadily increasing, while the percentage of grants has been steadily decreasing. This trend puts into perspective what qualifying for more financial aid can mean. There are no guarantees that a larger financial aid award will consist of favorable grants and scholarships–your child may simply get (and have to pay back) more loans.

The two main sources of financial aid are the federal government and colleges. In determining a student’s financial need, the federal government uses a formula known as the federal methodology, while colleges use a formula known as the institutional methodology. The treatment of your 529 plan may differ, depending on the formula used.

How is your child’s financial need determined?

Though the federal government and colleges use different formulas to assess financial need, the basic process is the same. You and your child fill out a financial aid application by listing your current assets and income (exactly what assets must be listed will depend on the formula used). The federal application is known as the FAFSA (Free Application for Federal Student Aid); colleges generally use an application known as the PROFILE.

Your family’s asset and income information is run through a specific formula to determine your expected family contribution (EFC). The EFC represents the amount of money that your family is considered to have available to put toward college costs for that year. The federal government uses its EFC figure in distributing federal aid; a college uses its EFC figure in distributing its own private aid. The difference between your EFC and the cost of attendance (COA) at your child’s college equals your child’s financial need. The COA generally includes tuition, fees, room and board, books, supplies, transportation, and personal expenses. It’s important to remember that the amount of your child’s financial need will vary, depending on the cost of a particular school.

The results of your FAFSA are sent to every college that your child applies to. Every college that accepts a student will then attempt to craft a financial aid package to meet that student’s financial need. In addition to the federal EFC figure, the college has its own EFC figure to work with. Eventually, the financial aid administrator will create an aid package made up of loans, grants, scholarships, and work-study jobs. Some of the aid will be from federal programs (e.g., Stafford Loan, Perkins Loan, Pell Grant), and the rest will be from the college’s own endowment funds. Keep in mind that colleges aren’t obligated to meet all of your child’s financial need. If they don’t, you’re responsible for the shortfall.

The federal methodology and 529 plans

Now let’s see how a 529 account will affect federal financial aid. Under the federal methodology, 529 plans–both college savings plans and prepaid tuition plans–are considered an asset of the parent, if the parent is the account owner.

So, if you’re the parent and the account owner of a 529 plan, you must list the value of the account as an asset on the FAFSA. Under the federal formula, a parent’s assets are assessed (or counted) at a rate of no more than 5.6 percent. This means that every year, the federal government treats 5.6 percent of a parent’s assets as available to help pay college costs. By contrast, student assets are currently assessed at a rate of 20 percent.

There are two points to keep in mind regarding the classification of 529 plans as a parental asset:

  • A parent is required to list a 529 plan as an asset only if he or she is the account owner of the plan. If a grandparent, other relative, or friend is the account owner, then the 529 plan doesn’t need to be listed on the FAFSA. Similarly, if the student is considered the account owner (as may be the case with a “custodial 529 account,” which results when UGMA/UTMA assets are transferred to an existing 529 account), then the 529 plan doesn’t need to be listed on the FAFSA.
  • If your adjusted gross income is less than $50,000 and you meet a few other requirements, the federal government doesn’t count any of your assets in determining your EFC. So, your 529 plan wouldn’t affect financial aid eligibility at all.

Distributions (withdrawals) from a 529 plan that are used to pay the beneficiary’s qualified education expenses aren’t classified as either parent or student income on the FAFSA.

The federal methodology and other college savings options

How do other college savings options fare under the federal system? Coverdell education savings accounts, mutual funds, and U.S. savings bonds (e.g., Series EE and Series I) owned by a parent are considered parental assets and counted at a rate of 5.6 percent. However, UGMA/UTMA custodial accounts and trusts are considered student assets. Under the federal methodology, student assets are assessed at a rate of 20 percent in calculating the EFC.

Also, distributions (withdrawals) from a Coverdell ESA that are used to pay qualified education expenses are treated the same as distributions from a 529 plan–they aren’t counted as either parent or student income on the FAFSA, so they don’t reduce financial aid eligibility.

One final point to note is that the federal government excludes some assets entirely from consideration in the financial aid process. These assets include all retirement accounts (e.g., traditional IRAs, Roth IRAs, employer-sponsored retirement plans), cash value life insurance, home equity, and annuities.

The institutional methodology and 529 plans

When distributing aid from their own endowment funds, colleges aren’t required to use the federal methodology. As noted, most colleges use the PROFILE application (a few colleges use their own individual application). Generally speaking, the PROFILE digs a bit deeper into your family finances than the FAFSA.

Regarding 529 plans, the PROFILE treats both college savings plans and prepaid tuition plans as a parental asset. And once funds are withdrawn, colleges generally treat the entire amount (contributions plus earnings) from either type of plan as student income.

If you have more questions regarding 529 plans, contact us today! Our team is here to help you make wise decisions for your financial future.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in the issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.