Planning Ahead for College Finances

Forbidden Drive
Forbidden Drive

I would like to supplement our 529 college savings accounts by opening an account – either investment or Roth IRA – in order to diversify savings vehicles for our kids to use for education or anything else, but I was concerned that having money in their names would limit their chances to qualify for financial aid. So, this question has been bouncing around in my head for a while: who’s name should the kids assets be under? Parent or child?

The answer: parents.

FAFSA FAFSA FAFSA

It’s recommended that all parents with kids in college complete the Free Application for Federal Student Aid (FAFSA) form every year to determine eligibility for financial aid. In this process, all parent and student assets are taken into account and magically calculated to determine your EFC: Estimated Family Contribution. The game here is to get your EFC as low as possible. 

Looking at assets, they are weighted differently. Assets in the child’s name — including a savings account, trust fund, or brokerage account — will count more heavily against the financial aid award than assets in a parent’s name.

Here’s a summary of how a family’s assets are weighted in calculating the Estimated Family Contribution.

FAFSA Chart.png

  • Student assets: 20%; these include savings and investment accounts and real estate
  • Student income: 50% (don’t work too hard, kids!)
  • Parents’ assets: 2.6% – 5.6%; these include savings and investment accounts, real estate, etc., and is based on a sliding scale
  • Parents’ income: 22-47%; based on a sliding scale

*Not included here is gifts used towards tuition – these can count for 50% – 100%.

Student Income and Assets

A student’s savings account can have a big impact on the EFC, but there is an income protection allowance of $6400 (as of this writing in May 2019).

It is advised to have a parent as the owner of a child’s 529 account with the child as the beneficiary so the account is considered a parent’s asset (weighted up to 5.6% vs student asset at 20%) and therefore more favorable in the eyes of FAFSA. There are other nuances around using 529s that should be considered, like what defines education-related expenses, accounts owned by grandparents, etc.

Parents’ Income and Assets 

The biggest impact in the financial aid equation is parents’ income. While no one typically wants to lower their income intentionally,  here are a few things you can do to limit it during college tuition payment times:

  • Avoid large dividends, capital gains, distributions from a mutual fund or withdrawals from a retirement account – any income reported on Form 1040
  • Defer your work bonus (if you can)

Your income is calculated based on your two years of income before the start of the academic year, so start minimizing your income after January 1 of your child’s sophomore year of high school.

As for typical assets in the FAFSA equation:

  • Home equity in a primary home does not count as an asset, but equity in a second home or investment property does count
  • The cash values of whole life insurance policies and annuities are not considered in the FAFSA calculation
  • The value of a family business is not counted on FAFSA if more than 50% is owned and controlled by your family and has less than 100 full-time employees.
  • Parents’ 401(k), Roth IRA and traditional IRAs are not counted in calculating your EFC. (You can withdraw from a Roth IRA penalty-free to pay for college, but the amount you withdraw is considered untaxed income on the FAFSA.)

In Summary

There are quite a few resources out there with more detail and tips on reducing your EFC, like on Road2College. This is also discussed in the context of post-retirement income and FAFSA in this ChooseFI interview with Root of Good.

Separately, the College Scholarship Service (CSS) form is used to determine your eligibility for non-government financial aid, such as a school scholarship and grants. The considerations for CSS differ from FAFSA.

With this, we realized that our two 529 accounts were already set-up in our names with each individual child as the beneficiary (my father-in-law set these up and is way ahead of me here), so we’re set there and will continue to contribute to these accounts to take advantage of the tax savings.

We have also opened Vanguard investment accounts for each child for the occasional deposit when their traditional savings accounts reach a certain threshold. Soon enough, these will be invested in VTSAX.

I hope that compiling what I’ve learned here has helped demystify this a bit – it’s helped us to dig in and learn more about this even though we’re still seven years away. It’s good just to keep the rules of the game in mind as we continue to save and invest.

Digging out of a financial hole: 18 months into our financial independence journey and 2019 goals

not climbing ropes

Looking back at our 2018 goals, we accomplished all but one-ish:

Wins are fun, so I’ll start there. In 2018, all three of our properties have increased in value! According to both RedFin and Zillow, they’re up. That’s a satisfying – and easy – lift in net worth on Personal Capital. But there are some big variations in values between those two and I’m going to look into why. Expect a post on that.

So, the hole. I feel like it’s been slow progress on debt reduction, but looking at the past 18 months since we’ve started down this path, we’ve reduced our debt by $42,901. That comes to $2,383 per month. That’s a lot of money! This includes our consumer debt, home equity line of credit and mortgages. All of our optimizing has really paid off – it  truly is the aggregation of marginal gains.

jan 2018 debt reduction review

Keeping up the momentum in 2019:

  • We’ve just consolidated our final two credit cards into one 0%, $0 transfer fee card – it’s under $15k, so we’ll knock that out quickly.
  • Then ramp up the HELOC payments and transfer some of the balance to a 0% APR to ease the interest being charged (>$200/month – UGH).
  • The car payments are 1-2%, so we’ll let those loans run their course. These monthly payments will avalanche to …
  • Increase payments on the lowest of the three mortgages; I will re-map the payment schedule once we’re at this point.

All too often though, we (probably me) fall off the FI wagon and succumb to big spends. Some we plan on, others are not planned. Planned on:

  • 2018 Income Taxes: With the changes in tax laws, we think we’ll be paying around $3k. This wasn’t planned on, but now we know, so I’m calling it planned. This was due to the new property tax deduction cap of $10k.
  • Summer Camps: we enrolled before November to take advantage of the early bird discount (saves $30 per week; with 2 kids for 8 weeks, that’s a savings of $480)
  • Finish exterior painting: about $800 remains
  • Little League: travel team + regular season = >$1000. The payments are spread out, but still, it’s a lot of money for a kids sport and that doesn’t include equipment!
  • Monthly expenses for after-school childcare and music lessons will remain the same through June.

I wonder what large unplanned spends we had in the past 18 months? I’m sure there are many – look for that post in the near future!

What is a Health Savings Account (HSA)

The future of health care is unknown.

With the HSA contribution limits increasing in 2019 and on the heels of ChooseFI’s recent episode (finally) focusing on this, I thought it was time to refresh.

What’s changing with HSAs?

  • In 2018, individuals can contribute up to $3,450; this is going up to $3,500 in 2019.
  • In 2018, families can contribute up to $6,900; this is going up to $7,000 in 2019.

We are on my husband’s HSA plan because his employer contributes $2,000 per year into the HSA. This is amazing. His employer was just acquired by another firm; so fingers-crossed that this benefit remains in place.

Why are HSAs fantastic?

It’s the triple tax savings.

  • Your HSA contributions are 100% tax deductible or pre-tax if made by payroll deduction.
  • Your withdrawals to pay for qualified medical expenses, including dental and vision, are tax-free.
  • The interest earned on your account is tax-free.

Finally, the best part, you keep it. It’s not like an FSA where you use it or lose it. Your HSA contributions can stay in your account and continue to grow tax-deferred year over year without limit. And the account stays with you if you change employers.

Using Your HSA

HSA dollars can be used to help pay your health insurance deductible and qualified medical expenses, including those not covered by the health insurance, like dental and vision care. They can also be used to pay health insurance premiums when you’re between jobs, as well as for long-term care premiums and Medicare premiums.

Non-qualified medical expenses withdrawn before the age of 65 are taxed at your income-tax rate, plus 20%. Ouch. Avoid that.

After the age of 65, you can withdraw from your HSA funds and be taxed at your income rate.

Our FI Family Plan

Continue to max out our HSA. We hope to retire prior to the age of 65.  But health care is a huge concern and unknown. Not knowing the state of health care and what coverage will be available to us, this will serve as a safety net for medical costs. Otherwise, I’d like to hold onto it – and all my health care expense receipts – and withdraw tax-free, whenever I want.

I love this simple calculator!

Travel Hacking from Philadelphia: Our Next Steps

Fresh off our first travel rewards trip, I am planning our strategy for our next travel hack.

Our first travel rewards trip was to the Bahamas.

We used Chase Ultimate Rewards and Chase SW miles to fly from Philadelphia to Nassau (with 1 stop in FL). From Nassau, we caught a puddle jumper to Eleuthera Island and VRBO’d a house on the beach. Yeah, we still spent money, but a ton less ($3,480 less) than full price. Traveling with two energetic young boys for multiple days, we definitely prefer the space, kitchen and privacy of a home versus a hotel room.

Other expenses included a car we rented from the home owners, the $5 per gallon gas and eating out; taxes are 12% and a 15% gratuity is typically added. Not complaining, just the facts.

bahamas
Stand-Up Paddle Boarding at Sunset, Bahamas, Nov 2018

It was our first time there and a great trip. We all swam, snorkeled and stand-up paddle-boarded from the house at least once a day.  The kids had plenty of space inside and out and, after a long day of sight-seeing and beach hopping, we enjoyed our own private showing of the sunset on our beach each night with drinks in hand and a beach fire. Definitely a great vacation and even better knowing we saved so much on flights.

So moving on to our next trip … or trips. I’m exploring two tactics:

  1. We know we want to keep up with Southwest Air miles because of their low redemption threshold and abundance of domestic flights from PHL to friends we want to see in Denver and Dallas. With that, my husband will open and use a Chase Southwest Air card to take advantage of the 60k mile bonus (which is 10k more than the bonuses offered via my referral) and build on the base of miles we already have.
    Goal: Denver Ski Trip in December 2019 plus a guys weekend in Dallas at some time. The flights from Philly to both cities are direct on SW Air.
  2. I am going to segue from the Southwest Air card to a Chase British Airways card and take advantage of the 100k bonus offer. Philadelphia is our nearest airport and it’s a hub for American Airlines. I finally believe what I’ve been told: you can transfer British Air Avios miles to American Airline miles. Goal: International family vacation in 2020. 

I’m a bit concerned about spreading ourselves too thin with the spend thresholds required for the bonus miles and companion tickets. I suppose I could analyze the heck out of our spend and map out what this will really look like, but I haven’t. I’ll say I’m 88% sure this plan will achieve these goals.

A takeaway here is to follow a path that works for you. This doesn’t follow any path as discussed in the FI community. I had to look at what made sense for our family, our goals and, most importantly, what works with our closest airport, PHL.

Why You Should Care About Expense Ratios

Think small

While I understand the basics of what expense ratios are – fees, so the lower the better – I have a hard time explaining what they are and their impact on your money. I’m not a financial professional, so this may be over simplifying. And please, someone, correct me if I’m way off.

I’m going to pretend I’m explaining this to someone who doesn’t want to understand investments, but perhaps should (mom!).

The first official definition I see is from Morningstar:

The expense ratio is the annual fee that all funds or ETFs charge their shareholders. It expresses the percentage of assets deducted each fiscal year for fund expenses, including 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund.

What?! Am I supposed to know what 12b-1 fees are? The first line says it best: it’s the annual fee charged to shareholder. That’s you, the account holder.

But I don’t see it on my statement. How am I paying this fee? 

Nothing is free. Your investments are managed by people and companies that are in business to make money. Mutual funds and exchange-traded funds (ETFs) bundle their fees into this “expense ratio.” You’re not going to see this as a line item on a statement of your account transactions, but they have an impact on your investment returns.

What are these expense ratio fees for? 

There are different costs with managing different funds and these costs are paid for (at least partly) through the expense ratio fees. These may include paying the fund manager, custodial services, record keeping, legal, marketing, auditing, accounting, etc. Basically, paying the machine that keeps the firm running.

Do I have to pay this? 

Yes, but you have some control in how much you choose to pay.

How much are we talking and how will it impact me? 

Expense ratio fees can range from 0.01% to 2.5%. To any retail shopper, this sounds like small potatoes, but over time, these rates can have a big impact. I searched for a calculator for this example, but found the results varied, so take this just as an example. I used the SEC’s Tool for Comparing Mutual Funds. 

Say you invest $10,000. Assume an average annual gain of a 10% over 20 years:

  • With 0.91% expense ratio = $11,241 in costs; Balance = $56,034
  • With 0.04% expense ratio = $536 in costs; Balance = $66,739

That’s over a $10,000 difference! This is a really simplified example with no additional contributions and without consideration for a host of other factors. But you can control this $10k difference and it only takes a few minutes.

So, what can I do?

Let’s look at your retirement account and see where it’s invested. With Vanguard, I can easily see the expense ratio by fund. Since my IRA is a mash up of multiple 401k roll-overs, my account was invested across over 10 different funds. I have gradually sold them, in order of highest expense ratio, purchasing low cost index funds instead (VTSAX). I’m down to these six (look at that Fidelity at 0.01%!):

I don’t sell them all at once because there’s a $50 fee for making more than one of these transactions within 60 days. And since I’m no good at math, I’m not going to calculate the impact of these waiting periods, I’m just avoiding the $50 hit.

To trade the high expense ratio funds for lower expense ratio funds, I follow the steps from my Vanguard account: 1) buy and sell and 2)  Trade an ETF or stock. I trade “all” of the high expense account. Once that transaction goes through, it will be held in my money market fund until I add it to my VTSAX fund.

I tried to keep this simple, but it’s not a very simple subject for the non-fiscally minded. And I know I don’t know anything – I’m just scratching the surface here.