Creative College Financing Isn't Always the Best Option for Parents of Three by Howard Hook, CFP®, CPA As published in The Star-Ledger, "Get With the Plan," November 24, 2013 Paul, 50, and Kayla, 46, need help in making a huge decision with their cash. The Middlesex County couple has three children — a college freshman, a 16-year-old and an 8-year-old. Their freshman has $100,000 in his name, and it’s stopping him from receiving financial aid. Paul and Kayla paid the $25,000 cost for the first year of college from their savings account. The couple is considering an unusual way to protect their student money from financial aid formulas. They’re considering buying a home in their son’s name — using the $100,000 in his accounts — so he might be eligible for future aid. They’d add $150,000 to their freshman’s account, then purchase a $250,000 home. Another possibility would be to buy a larger home for themselves as an investment, and stick with their student’s ineligibility for financial aid. "We lost a lot of money in the stock market a few years back, therefore, we have no investments currently and are earning a mere one percent in savings and checking accounts," Kayla says. "It seems foolish to leave this amount of money in a low-interest bearing account, and we would rather put it towards a future investment such as real estate." Paul and Kayla, whose names have been changed, have saved $1 million in 401(k) plans, $75,000 in IRAs, $250,000 in checking and $150,000 in savings. Their three kids have a total of $215,000, including the $100,000 in their oldest child’s name. The Star-Ledger asked Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton, to help Paul and Kayla see the big picture. "Like most people, Paul and Kayla have goals that conflict with one another," Hook says. "Saving for retirement, paying for college for their three children, and buying a bigger home are all goals that are competing for their investment dollars." Hook has several concerns about using their student’s assets and their assets to buy a home for their student. Converting liquid assets in a bank account to a non-liquid asset such as real estate could increase their risk of losing money, especially in the short term, he says. Plus, their annual expenses will increase, causing more withdrawals from the remaining cash accounts. In addition, the contribution being made by Paul and Kayla would be considered a gift. Hook says a gift tax return would be due, even though it’s unlikely they’d owe gift tax because individuals are allowed to make lifetime gifts of $5.25 million. After all that, there’s no guarantee the move would result in their son qualifying for aid. "This may depend upon whether the property is considered a primary residence or an investment for their son," Hook says. The idea of upgrading their own home, though, is a different consideration. Hook says this should be a lifestyle decision and not based solely on an investment idea. "A primary residence is considered a ‘use’ asset and should not be counted as part of one’s investment portfolio," he says. "We have run a retirement projection showing that if they were to sell their existing home and use the proceeds to buy a (larger) home, they would be able to meet their college savings and retirement savings goals." Buying a bigger house would probably increase their monthly expenses, particularly real estate taxes and utilities, Hook says. He says their income may not be enough to support the increases in expenses unless they made up the shortfall with money from their savings accounts. Turning to college, Hook recommends that Paul and Kayla pay for their children’s college educations using the children’s assets, and supplement any remaining amounts with their own assets. He says they should segregate the amounts they expect to need from their other assets. In total, he calculates they will need $150,000 from their own assets to supplement the money in the children’s names. Once college starts for each child, Hook suggests the children’s assets be depleted first. "Because children’s assets count more towards financial aid than parent’s assets, depleting the child’s assets first reduces the Estimated Family Contribution (EFC) calculation for financial aid purposes," he says. He says the assets earmarked for college should be invested differently for each child. The funds for the child already in college should remain in a money market account, he says. For the 16-year-old, Hook says, they should leave the equivalent of the first two years of tuition in a money market account, and the balance could be invested in CDs maturing the spring prior to the year the funds are needed. The strategy for their 8-year-old, who has a time horizon of 10 years, should be different. These assets should be invested in both the stock market and the bond market, Hook says. He suggests they open a custodial 529 Plan and fund it with the $45,000 in his name so they can take advantage of tax-free growth and professional portfolio management. "We recommend investing the assets in an age-weighted portfolio, which takes into consideration the age of the future students and invests the assets more and more conservatively as the child approaches college age," Hook says. Hook says Paul and Kayla will need to use $80,000 from their own assets for the 8-year-old, and these funds should also be a 529 Plan, but in a different account. That’s because if the funds are added to the custodial account, they’d lose control of the money. After setting aside the $150,000 of their own assets for college, Hook says, they should keep $30,000, or six months of expenses, in an emergency fund. That leaves $220,000 that should be invested in a well-diversified portfolio, Hook says. "It is important for Paul and Kayla to build their investment portfolio outside of retirement accounts," he says. "Retirement accounts such as 401(k) and IRA accounts are very tax-efficient during the accumulation phase of someone’s life. However, they are very tax-inefficient once withdrawals are needed since every dollar coming out of the plan is subject to income tax." Hook says the final piece to the planning is how all these moves affect their ability to retire. Hook assumed a retirement age for Paul’s of 67, at which time he would collect full Social Security. Hook says assuming all his recommendations for their cash accounts, his projections show, assuming a 5.5 percent growth rate on their assets, they would have enough liquid assets for retirement through and beyond Paul’s age 90.