College Financial Planners and Financial Aid—Do They Have a ...


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  • My name is ____________________, and today I am going to present concepts and ideas that will help you reduce the overall cost of private school and college, and to hopefully provide you more money for retirement.
  • In the time we have today, we arent going discuss things you can hear about at the school financial aid night, nor are we going to discuss ways to game that system to have you qualify for more aid. And we aren’t going to discuss scholarship searchs, other than ones you can find right across the dining room table from you. What we will discuss is real solutions to this problem, using the tax code, debt restructuring….any practical tools we can to reduce this cost.
  • Before we start, I would like to have you partake in a three question quiz, designed to help you begin to think creatively….from a tax point of view. Lets discuss the case of this top student, someone who has lots of “financial need” as far as paying for college, someone who has narrowed her choices down to two. School A and B are her top choices, and they are offering her a combination of need based and merit scholarships, such that the net cost of attendance is just about the same. The only difference is that one school specifically allocates their scholarship for tuition and fees, and the other does not. So how could this make a $6000 or more difference to the family? We will talk about that.
  • Take a look at this list….and make a mental note of anything that you see here that is normally tax-deductible.
  • And what building would you say this is a picture of…..I know what you might be thinking….but think like a taxpayer.
  • In order for you to get the maximum value out of this seminar, its important you understand the terms I will be using…so lets take a look at the tax forms I passed out for you and point out where each of these items appear (Discuss each item on the list and where it appears on the 1040)
  • And lets make sure we have a full understanding of what each of the major educational tax incentives are. The scholarship exclusion allows that scholarships for tuition and fees are not taxable income Educational reimbursement plans allow employers to exclude up to $5,250 of educational expenses of their employees 529 plans are savings tools that allow monies saved for college to grow and be expended for college related costs on a tax deferred basis Up to $2500 of student loan interest can be income tax deducted, assuming your income falls within certain criteria Up to $4000 of college tuition is income tax deductible, again, assuming your income falls within certain ranges These two credits can reduce your income taxes by up to $2,000 annually as long as your income is not too high The tutition related benefits cannot be “double dipped” on the same expenses….so if you claim the full hope credit, you also cant claim the tuition deduction for the same student.
  • Paying for education really costs you more than you think because it is paid with AFTER-TAX dollars! Depending on which tax bracket you are in, the amount you must EARN to pay for school is a good deal more because you must first pay the IRS…before you pay the college or independent school. The goal is to implement tax strategies that minimize or eliminate the tax cost ($190,000 - $118,000 = $72,000 in taxes) so that you end up paying just the education cost of ($118,000). The money that you would normally pay in taxes ($72,000), you now can save for retirement. By the way, the small print says that the average 4 year public school is $13,900 per year, but it is taking the average student 5 years to complete a degree in a public university. Private university….$29,500 annually for 4 years.
  • Lets see what this commitment to educating your children could cost you in retirement nest egg. Lets assume that we have a couple who is 42, planned their children 4 years apart, and the first one is entering college right now. Remember we are assuming they are attending the average private school, which costs $29,500. Lets further assume that education costs rise by 5% annually, and that if the children had not attended college, the dollars would have been managed to return 8% annually with taxes deferred until the parents turned 65. The cost to their retirement nest egg……around one and a quarter million dollars. So assuming one were to draw 5% of that nest egg annually for retirement, paying for this education would reduce retirement income by $62,500 per year.
  • And for those whose children attend independent school, lets extend those numbers out further. Assume our couple is now 4 years younger and starting their 14 year old at a private high school that costs $23,500 annually…..both children attend. Assume that inflation occurs at 5% and applies to both the private school and the college expenses. All the other assumptions stay the same……..and the bottom line is, that paying for these educations puts this couple down over $2.5 million at retirement. Please understand, we are not advocating that paying for the right kind of education does not have value. We view it as an investment in the future, just as you do…..just as you view your home, your 401(k) plan. But if you could take a significant bite out of these costs…..lets say you could obtain what we would call in this case a “tax scholarship” for 10% or more of that ultimate cost….. Just by taking two simple steps, would you consider it? Lets see.
  • Income shifting and the gifting of appreciated assets are two effective ways to reduce the after-tax cost of education, because these strategies shift the tax burden from the parent’s tax bracket to the child’s lower tax bracket. Parents that own a business can shift income to their child because they can hire the child through the business and pay the child instead of taking the income out of the business in their tax bracket. Parents that do not own their own business cannot shift income to their children, but all parents can gift personal assets to their children regardless of whether they work for someone else or are self-employed.
  • This slide illustrates the concept of income shifting and the gifting of assets from parents to children. The goal is to shift income from the parent’s tax bracket to the child’s typically lower tax bracket, and then offset, or eliminate, the tax by using the child’s standard deduction which is worth up to $4,850 for the 2004 tax year.
  • This is an example of how income shifting works. The parent hires the child through a business and pays them $4,850. The child will then be taxed on this income, but the child gets a standard deduction on their tax return of up to $4,850. So the child’s taxable income of $4,850 is reduced to zero after the standard deduction is applied, and the child’s federal tax is $0. If the parent would have taken the $4,850 as income, instead of paying the child, the parent would have paid $1,600 in federal tax (33% of $4,850). Therefore, the parent has saved $1,600.
  • Over four years of private high school this basic strategy would shift a total of $19,400 of income to the child, and the child would pay no federal tax. The parents would avoid paying $1,600 in federal taxes each year for four years, for a total savings of $6,400. If we assume that the tax savings from each year went into an account that earned a hypothetical compounded annual return of 8%, the $6,400 would actually be worth $7,209 at the end of high school, and $9, 808 four years later at the end of college.
  • In reality, at an adjusted gross income of $130,000 or more, our client will get no Hope Credit, no Lifetime Learning Credit, no Higher Education Tax deduction, and they won’t qualify for any need-based financial aid at the average four year private college. Moreover, the money that is already set aside for college is not usually in 529 College Savings Plans or Education Savings accounts. The money is in the parent’s names or the child’s UTMA account, and they will likely have a capital gain problem when they liquidate the account to pay for college.
  • Another idea might be to consider redoing your mortgage to an interest only mortgage. Consider this hypothetical example. Lets say you are 15 years into your mortgage (currently $150,000), and planning to move in 5 years. In a conventional mortgage, over the next 5 years, you pay off $20,000 more of the principal. But when it comes time to sell, what did you earn on the $20,000? Zero….you just get $20,000 more back at closing…but no interest. If that is the case, why not consider going interest only, and either investing the additional cash flow or putting it toward college.
  • College Financial Planners and Financial Aid—Do They Have a ...

    1. 1. The following is a presentation prepared for NASFAA’s 2006 Conference in Seattle, WA July 5-8, 2006
    2. 2. College Financial Planners and Financial Aid - Do They Have a Role to Play?
    3. 3. Presenters <ul><li>John Pearson, CPA, CCPS </li></ul><ul><li>Tax and Educational Strategies </li></ul><ul><li>Norwalk, Connecticut </li></ul><ul><li>Mick Endersbe, CHFC, MS </li></ul><ul><li>President </li></ul><ul><li>College Planning University, LLC </li></ul><ul><li>Lakeville, Minnesota </li></ul>
    4. 4. Apply Here For Your Tax Scholarship!! John Pearson, CPA, CCPS Tax and Education Strategies 17 Pumpkin Lane Norwalk, CT 06851 203-984-2518
    5. 5. Today’s Goal <ul><li>Not to retread paths of student loans and government grants </li></ul><ul><li>No 529 savings plans </li></ul><ul><li>Not to “game” the financial aid system </li></ul><ul><li>Not to search for obscure scholarships </li></ul><ul><li>Seek practical solutions using tax, debt, consultative, and cash flow management to reduce the after-tax cost of college </li></ul>
    6. 6. Warm-up Quiz <ul><li>Desirable student with significant financial need applies to six colleges, with two top choices. </li></ul><ul><li>School “A” offers her a full scholarship for tuition and fees…her other top choice offers her $$ that leaves a nearly identical COA for family to fund. </li></ul><ul><li>She declines School “A”’s offer in favor of School “B” on a financial basis. Her parents state that even though the net COA were almost exactly the same, School “A’s” offer would have cost them $6,000-$7,000 more!! </li></ul><ul><li>How could this be? </li></ul>
    7. 7. Which of these student expenses are federal income tax deductible? <ul><li>Music lessons </li></ul><ul><li>SAT preparation courses </li></ul><ul><li>Sports training </li></ul><ul><li>Student abroad travel </li></ul><ul><li>Educational consultant fees </li></ul><ul><li>Weddings </li></ul><ul><li>Tutoring </li></ul><ul><li>Technology (computers, cell phones, etc.) </li></ul>
    8. 8. What is this building?
    9. 9. Important Terms <ul><li>Adjusted Gross Income </li></ul><ul><li>Tax Deduction </li></ul><ul><li>Tax Credit </li></ul><ul><li>Exemption </li></ul><ul><li>Standard Deduction </li></ul><ul><li>Alternative Minimum Tax </li></ul><ul><li>Education Tax Incentives </li></ul><ul><li>Tax Bracket </li></ul>
    10. 10. Current Tax Incentives For Education <ul><li>Scholarship Exclusion </li></ul><ul><li>Educational reimbursement plan </li></ul><ul><li>529/Prepaid tuition plan </li></ul><ul><li>Student loan interest deduction </li></ul><ul><li>Tuition deduction (expiring) </li></ul><ul><li>Hope and Lifetime Learning Credit </li></ul>
    11. 11. So Who Are We Talking About? <ul><li>Middle and upper middle class America </li></ul><ul><li>Living in areas w/ above average cost of living and median incomes </li></ul><ul><li>The “house rich/cash poor” who don’t get need based aid </li></ul>
    12. 12. And What Are Their Problems? <ul><li>College prices rising beyond inflation rate </li></ul><ul><li>Parents have saved little if anything </li></ul><ul><li>Parents already have high debt levels </li></ul><ul><li>Students facing debt from college/credit cards </li></ul><ul><li>Graduation rates are extending </li></ul>
    13. 13. As If That Weren’t Enough! <ul><li>Rising energy and health care cost </li></ul><ul><li>Beginning of demographic shift of jobs to Asia </li></ul><ul><li>Tax incentives for education are inadequate </li></ul><ul><li>Education cost is shooting holes in Boomers biggest goal... Retirement </li></ul>
    14. 14. So How Are The Boomers Doing It? <ul><li>Paying out of cash flow </li></ul><ul><li>Using up savings/reducing retirement contributions </li></ul><ul><li>Obtaining scholarships </li></ul><ul><li>Going to the grandparents </li></ul><ul><li>Students are working more hours </li></ul><ul><li>But mostly, both parents and students are borrowing </li></ul>
    15. 15. * Assumes 28% bracket Federal and 5% State Tax The average annual cost of year public college is $13,800, Private university is $29,500 Source: Harris Insight Funds To Pay For One Child’s College, You Need To Earn For 5 Years of Average Public University $111,000 For 4 Years of Average Private University $190,000
    16. 16. How paying for education impacts retirement <ul><li>Assume parents age 44, children 18 and 14, both attending private college 4 years </li></ul><ul><li>Initial cost is $25,000 after aid, 5% inflation </li></ul><ul><li>Assets invested at 8% compound </li></ul><ul><li>At age 65, parents retirement pool is </li></ul><ul><li>reduced by: </li></ul>$846,426
    17. 17. And what if those children attend private high school <ul><li>Parents begin at age 40 with students 14 and 10, both attend private school beginning in grade 9. </li></ul><ul><li>Annual Cost is $20,000, 5% inflation </li></ul><ul><li>8% investment assumption </li></ul><ul><li>Private college follows at 5% inflation </li></ul><ul><li>Retirement savings would decline at age 65 by </li></ul>$1,767,668
    18. 18. An EFC Scenario <ul><li>AGI of $76,000 </li></ul><ul><ul><li>Wages $75K (Wife earns $50K, Husband $25K) </li></ul></ul><ul><li>Parents have $30K in cash/savings </li></ul><ul><li>Kids are 18 and 14 </li></ul><ul><ul><li>Older child has $3K of summer earnings, $5K assets </li></ul></ul><ul><ul><li>Younger child has $5K of assets </li></ul></ul><ul><li>$150K of home equity </li></ul><ul><li>Claimed the Hope Credit of $1500 </li></ul>
    19. 19. And the EFC is……? <ul><li>Under the Federal Methodology the parents EFC is $12,304 </li></ul><ul><li>Under the Institutional Methodology the parents EFC is $14,917 </li></ul><ul><li>Source: College Board Online Financial Aid Estimator </li></ul>
    20. 20. Adding Some Wages… <ul><li>If AGI bumps to $101,000… </li></ul><ul><ul><li>Wages split $75,000/$25,000 </li></ul></ul><ul><ul><li>Everything else stays the same </li></ul></ul><ul><li>EFC jumps to $22,567/$22,544 </li></ul><ul><li>AGI at $126,000 (Split $75,000/$50,000) </li></ul><ul><li>EFC becomes $33,278/$31,998 </li></ul><ul><li>Source: College Board Online Financial Aid Estimator </li></ul>
    21. 21. “ Shifting and Gifting” <ul><li>Shifting </li></ul><ul><li>Move earned income from the parent to the child </li></ul><ul><li>Best done if family has a family business or farm </li></ul><ul><li>Taxed in a lower bracket of the child </li></ul><ul><li>Gifting </li></ul><ul><li>Use appreciated assets like stock </li></ul><ul><li>Student uses stock sale proceeds to pay for college </li></ul><ul><li>Gains taxed at lower bracket </li></ul>
    22. 22. Private School Years Tax deductions $5,000 standard deduction Child <ul><li>Parent’s </li></ul><ul><li>personal assets </li></ul><ul><li>compensation </li></ul><ul><li>from business </li></ul>It’s time to pay for private school . Gift assets and/or pay child <ul><li>Child is taxed on: </li></ul><ul><li>Earned income </li></ul><ul><li>Unearned income </li></ul>
    23. 23. Private High School Child’s Earned Income $5,000 Child’s Std. Deduction ($5,000) Federal Tax due $ 0 Parent’s Tax Savings Earned Income $5,000 33% fed/state tax rate $1,650 Tax that parent’s avoided $1,650
    24. 24. Private High School Tax Savings Income shifted $ 5,000/year Four years $20,000 Child’s Tax $ 0 Parent’s Tax Avoided $ 6,600 ($1,650/yr/4yrs) Tax savings + 8% return $ 7,500 ($1,650/yr/4yrs/@8%) At End of College $ 10,200
    25. 25. The Reality of Paying for College <ul><li>At AGI of $130,000 + (joint return) </li></ul><ul><li>No Hope Credit </li></ul><ul><li>No Lifetime Learning Credit </li></ul><ul><li>No Need-Based Financial Aid (rare exceptions) </li></ul>
    26. 26. Enter the Tax Scholarship <ul><li>Direct wages from family business to child </li></ul><ul><li>Transfer appreciated property to child </li></ul><ul><li>Total should be enough to have child provide more than ½ their own support </li></ul>Result: Student gets exemption, education credits and their own standard deduction!!!
    27. 27. Example College Years 1-2 <ul><li>Student selects private college - $33,000 cost </li></ul><ul><li>Parents pay child $13,000 out of family business for office and marketing work </li></ul><ul><li>Gift $22,000 of low-basis stock to child </li></ul><ul><li>Child uses cash to pay for college </li></ul><ul><li>If not transferred to child, parent’s federal tax on all this income approx $6,500 </li></ul><ul><li>Childs tax on the same income is $0 </li></ul>
    28. 28. In College Years 3 and 4 <ul><li>Give student a raise to $17,000 of wages </li></ul><ul><li>Transfer stock to the child as before </li></ul><ul><li>Parent’s tax burden if income was left with them would be $7,500 </li></ul><ul><li>Child’s tax? $0 </li></ul>
    29. 29. Tax Scholarship Summary <ul><li>Total college tax savings per child? $28,000 </li></ul><ul><li>If student attended private school, per my example $6,600 additional saved </li></ul><ul><li>If invested, total savings total approximately $40,000….per child </li></ul>
    30. 30. Should I restructure mortgage? <ul><li>Real estate market in region is slowing </li></ul><ul><li>Is paying down your mortgage such a great idea in this environment if you are cash poor? </li></ul><ul><li>What are you earning on the paydown? </li></ul>
    31. 31. Why Can’t I Just Borrow Against My House? Beware The AMT!!
    32. 32. Common Questions <ul><li>If my child isn’t my dependent, are they no longer covered under my benefits? </li></ul><ul><li>In your example, you didn’t include state taxes on the child, and what about Social Security Taxes? </li></ul>
    33. 33. Common Questions <ul><li>What kind of work could my child possibly do to justify such a large wage? </li></ul><ul><li>What other things could I pay for using this concept? </li></ul>
    34. 34. Getting The Word Out <ul><li>Public relations-national and local media </li></ul><ul><li>Local, regional and national seminars </li></ul><ul><li>Making contacts at independent schools </li></ul><ul><li>Developing relationships with the Financial Aid and Admissions community </li></ul><ul><ul><li>Asking colleges and universities to consider providing this kind of education…to parents!! </li></ul></ul><ul><ul><li>Parent enrichment at orientation or scheduled high school visit days </li></ul></ul><ul><ul><li>High Schools are “off limits” due to “non-profit” rules. </li></ul></ul>
    35. 35. Why should we bother? <ul><li>Marketing value is tremendous </li></ul><ul><li>Existing clients appreciate the value added </li></ul><ul><li>Potential new clients have never heard these type of ideas…..from anyone </li></ul><ul><li>Even if they don’t act on them, they appreciate being told that they have choices !! </li></ul><ul><li>If they do act on them, made the education more affordable!! </li></ul>
    36. 36. What are your questions? John F. Pearson CPA CCPS Tax and Educational Strategies 17 Pumpkin Lane Norwalk, Connecticut 06851 203-984-2518
    37. 38. Presenter <ul><li>Mick Endersbe, CHFC, MS </li></ul><ul><li>President </li></ul><ul><li>College Planning University, LLC </li></ul><ul><li>Lakeville, Minnesota </li></ul>
    38. 39. Traditional College Planning <ul><li>Data-based assumptions are made </li></ul><ul><ul><li>Time Frames </li></ul></ul><ul><ul><li>Risk Tolerance </li></ul></ul><ul><ul><li>Rate of Return </li></ul></ul><ul><ul><li>Inflation </li></ul></ul><ul><ul><li>Savings vehicle </li></ul></ul>
    39. 40. The Problem with Data - Inflation <ul><li>“ In each of the past four years, tuition has increased by 10 percent or more.” </li></ul><ul><ul><li>Minnesota State Colleges and Universities News Release, October 20, 2004 </li></ul></ul><ul><li>“ The Minnesota State Colleges and Universities Board of Trustees has capped tuition increases at 7 percent in the coming year. The decision comes after the trustees endured a barrage of student complaints about rising college costs during recent budget discussions. The cap is a hardship for at least 20 of the system's institutions that have already budgeted for tuition increases higher than that.” </li></ul><ul><ul><li>Minnesota Public Radio, July 21, 2005 </li></ul></ul>
    40. 41. The Problem with Data – Rate of Return
    41. 42. The Problem with Data - Saving
    42. 43. The Problem with Data – My Family Child’s Name Carley Libbey Age 9 9 Years until college 9 9 Current college cost $27,969 $27,969 Current savings $10,000 $10,000 Assumed rate/return 9% 9% Assumed inflation rate 7% 7% Current monthly savings $500 $500 Addit’l monthly needed $797 $797
    43. 44. The Problem with Data – Moving targets
    44. 45. The Problem with Data – We’ll go public. <ul><li>Family Scenario </li></ul><ul><li>College University of MN TC $16,344 </li></ul><ul><li>Income $70,000 </li></ul><ul><li>Assets (home and IRA NA) $50,000 </li></ul><ul><li>Number of Children 2 </li></ul><ul><li>Ages 17 14 </li></ul><ul><li>EFC $9,375 </li></ul><ul><li>State Grant $0 </li></ul><ul><li>Pell Grant $0 </li></ul><ul><li>Stafford Loan $2,625 </li></ul><ul><li>Parent Responsibility $13,719 </li></ul><ul><li>x 4 years = over $55,000 </li></ul>
    45. 46. A Sample Client - Executive <ul><li>$340,000 annual income </li></ul><ul><li>$600,000 in investments </li></ul><ul><li>$300,000 in home equity </li></ul><ul><li>48 years old </li></ul><ul><li>4 talented, hardworking kids </li></ul><ul><li>Wants his kids to have the opportunity to attend Elite schools </li></ul><ul><li>“ The elite colleges are running about $44,000 per year. How did you plan to pay for college?” “That’s why you’re here.” </li></ul>
    46. 47. Tell me about Sara <ul><li>“ Is there a particular school that you or Sara are interested in?” “Why?” </li></ul><ul><li>“ How did you think you would pay for XYZ?” </li></ul><ul><ul><li>Well, we’ve done some….. $60,000 </li></ul></ul><ul><ul><li>We were hoping we would get some help from the college. </li></ul></ul><ul><ul><li>She’s a B plus student with a 29 on her ACT, debater </li></ul></ul><ul><li>“ Would you send her if she didn’t get aid?” </li></ul><ul><ul><li>Because she won’t - nor will any of the executive’s kids </li></ul></ul>
    47. 48. Our Solution Total Scholarship Student Loan Student Work Redirect monthly savings Investments 60k/4 Cash Flow Cost $ 46,500 ( Over-funded by $58,000) $36,500 (Short $7500) $ 10,000? (merit) $ 0(need-based) $ 2,500 $ 2,500 $ 3,000 $ 3,000 $ 6,000 $ 6,000 $15,000 $15,000 $10,000 $10,000 $32,000(private) $44,000 (Elite)
    48. 49. Real College Financial Planning <ul><li>Done in the context of overall financial planning </li></ul><ul><li>Complex, moving parts </li></ul><ul><li>Investment expertise </li></ul><ul><li>Tax expertise </li></ul><ul><li>Financial aid expertise? </li></ul><ul><li>Like all consultants, must be skilled at asking questions. </li></ul>
    49. 50. Do you want their involvement? If so, what would you like them to do?