Monthly Archives: August 2016
Is there a time when saving for college is a bad idea? With student loan debt repeatedly in the news as one of the country’s biggest financial problems, it’s a question worth asking. And the answer? Maybe.
When Saving for College Is a Bad Idea
For some families the need for college financial aid is clear-cut. When parents have low incomes and few assets, there’s little need to strategize when it comes to applying for financial aid. The same is true at the wealthy end of the spectrum: Parents will likely be expected to pay their children’s college bills in their entirety.
But what about everyone else? The majority of middle-class families, and even many upper-middle-class families, may well qualify for some degree of financial aid. Could saving for college reduce their eligibility for help compared with other families?
In fact, there are perfectly permissible money strategies that can help reduce the amount that colleges will expect a family to contribute to its child’s cost of attendance: tuition and fees, room and board, and books and supplies. Some might call this gaming the college financial aid system; others might consider it smart planning based on knowing how financial-aid formulas count different types of income and assets.
We’ll let you make your own decisions about what you feel is fair and ethical. But before you can do that, you need to know how financial-aid formulas work and what your options are for maximizing your aid award.
Key Income Cutoffs
Schools calculate what families can spend on college using two components: the parents’ income and assets, and the student’s income and assets. When household income is less than $30,000, the family’s expected financial contribution (EFC) toward the cost of attendance is zero, explains Kristen Moon, an independent college counselor and founder of Moon Prep. If someone in the family receives a federal benefit such as welfare, it helps substantiate that the family needs financial aid.
When household income is less than $50,000, some income is counted toward the family’s EFC, but no assets are counted. Bank account balances, plus the value of any stocks, bonds and mutual funds, don’t count in this case. Aid formulas expect parents to contribute 22% to 47% of their income after subtracting an income-protection allowance for taxes and basic living expenses. The formula protects about $6,400 in student income, then expects 50% of a student’s income beyond that to go toward college expenses.
Because financial-aid formulas have so many inputs – including income, assets, family size, parent age and the number of children in college – it is difficult to estimate an upper income limit at which a family would not be eligible for any financial aid, but $180,000 in annual household income is a possible cutoff. However, it is far better to file the Free Application for Federal Student Aid (FAFSA) and see what aid you qualify for than to assume you won’t qualify for any and potentially miss out.
Income and Assets That Reduce Eligibility the Most
Whether assets are held in a student’s, parent’s or grandparent’s name, as well as the type of asset, affects how FAFSA’s formula determines EFC. In addition, student income is treated differently from parental income. By understanding which types of income and assets count against you the most, you can strategize to reduce your EFC and maximize your student’s aid award.
1. Unnecessary Income
Realizing capital gains by selling appreciated assets (such as stocks and bonds), taking retirement account distributions and even withdrawing Roth IRA contributions will hurt you, because these will all be counted as income on the FAFSA, says Mark Kantrowitz, publisher and vice president of strategy at the college scholarship search website Cappex.com. If you can take any of these actions before the tax year that applies to your first FAFSA filing – or postpone them until after your child graduates – you may qualify for more aid.
2. Assets You Aren’t Required to Report
Common mistakes that families make on the FAFSA can hurt their aid. These include listing the family’s principal home as an investment (FAFSA exempts the family’s principal home from its asset calculations) and listing retirement plans as investments (FAFSA doesn’t require you to report the assets in qualified retirement plans such as individual retirement accounts (IRAs), 401(k)s, 403(b)s and pensions).
3. Assets in the Student’s Name
Financial-aid formulas protect a certain amount of parents’ assets depending on the number of parents and their age, but they assume that nearly four times as much of the student’s assets are available than they do the parents’ assets, says Joshua Wilson, partner and chief investment officer at WorthPointe Wealth Management in Dallas.
While the top asset contribution rate for parental savings is 5.64%, the contribution rate for all student assets is 20%. For every $100 a parent has in savings, colleges will expect them to contribute a maximum of $5.64 toward the child’s college costs. For every $100 a student has in savings, colleges will expect them to contribute $20.
In most situations it’s better to have money in the parent’s name than in the child’s name, Wilson says. People often make the mistake of transferring money into the student’s name or leaving new money in the student’s name. “If your child is working to pay for college, make sure they aren’t saving any earnings,” Wilson says. “That savings will only hurt their aid the next time they apply.”
Instead, working students should take money they would have saved and apply it to any student loans they’ve taken out. “Then apply for new loans for the upcoming semester after you’ve depleted your savings account by paying down old loans,” Wilson says. “I know it sounds silly, but having money in your account hurts you.” This also reduces the size of the loan the student will have to repay after graduation.
Other possibilities include having the student contribute to an IRA, which won’t be counted in financial aid calculations, or transferring the student’s savings into a 529 account, which is treated as a parental asset even if it is in the student’s name.
If your family can afford it, another option may be to have the student forgo paid employment in favor of an unpaid professional internship that provides the type of work experience that will help after college. Of course, if the internship happens to pay, just use the strategies outlined here to protect the money.
4. Help From Relatives
A 529 account that a grandparent opens for a student isn’t counted as an asset, “but when the money is withdrawn to pay school expenses, this money is counted as income for the student,” Moon says. “So either way they get you.”
FAFSA considers financial support provided by anyone other than the student’s parents to be untaxed income to the student. The hit to financial-aid qualification from college expense contributions by grandparents or other relatives can therefore be significant. Of course, those contributions are effectively a form of financial aid and do help the student, just perhaps not as much as the adults trying to help would expect.
An alternative is to have grandparents contribute to a 529 that is in the parents’ name. Another option is for the student not to take any distributions from the grandparent-established 529 until after filing the last FAFSA of his or her junior year.
More Ways to Shield Assets
Some families might find the following strategies to be acceptable ways to keep their hard-earned assets instead of being required to contribute them toward the cost of their child’s college education. Others might see them as unethical, though it could be argued that they are no more unethical than taking income tax deductions. All of these strategies follow the rules, so feel free to employ whichever ones you are comfortable with that apply to your situation.
1. Save, Save, Save for Retirement
Experts always recommend that parents save for their own retirement before saving for their children’s college education because while children can borrow to pay for an education, parents can’t borrow (at least not enough) to fund their retirement. But another great reason for parents to put retirement savings first is that the money in a qualified retirement plan, such as a 401(k) or IRA, contributed before the tax year that coincides with your first FAFSA filing (called the base year) will be considered an asset and will not be counted toward your EFC. Contributions you make for the tax year that you report with the FAFSA, however, are considered untaxed income, so last-minute contributions won’t help your child qualify for more aid.
2. Pay Down Debt
If you have assets that colleges will expect you to spend to pay for your child’s college expenses but you’re also carrying debt, you might want to put extra money toward your credit card bills, auto loan and/or mortgage. That way you’re saving money on interest payments and potentially increasing your child’s financial aid eligibility. Even if you end up increasing your offspring’s eligibility for loans rather than grants, the student loans will likely have better terms than your credit cards or auto loans (though perhaps not better terms than your mortgage).
3. Cover Your Life
It’s always a good idea to make sure you have enough life insurance, and even though you have a child who is about to go to college, he or she, as well as younger siblings and your spouse, might still depend on your income or other contributions to running the household. You might want to use some of your savings to increase your life insurance coverage, ideally with an affordable term policy. If something happens to you, the money you spend on premiums will benefit your family more than putting those savings toward college would have.
4. Proceed with Planned Purchases and Upgrade Your Home
Don’t blow money on unnecessary purchases just to whittle down your savings to try to qualify for more aid, as such aid might come in the form of loans, and you might wish you’d held onto your cash instead. But it might make sense to go ahead and buy the new car or get the new roof you actually need sooner rather than later. Personal possessions such as automobiles, furniture, books, computers and jewelry aren’t factored into the FAFSA equation. A new roof might contribute to your home equity, which FAFSA also doesn’t count as long as the home is your primary residence. You could also move to a more expensive home or renovate your existing one. Other items you might consider purchasing are a computer your child can take to college or a used car that your child can drive to school and work.
No one wants to pay more than they have to for anything, and if your child has been an excellent student and you’ve worked hard to help him or her succeed, you probably feel you deserve all the aid you can get as long as you play by the system’s rules. No one would encourage you to voluntarily pay more in taxes than you’re required to by law; they would tell you to take every deduction and use every tax avoidance strategy to which you’re legally entitled. So why are things any different when it comes to qualifying for college financial aid? Does it matter if you are violating the spirit of the rules even if you’re technically complying with them?
That’s up to you. But in one respect financial-aid ethics are crystal clear: “There is a difference between positioning income and assets to maximize aid eligibility – such as saving in the parent’s name instead of the child’s name and paying down debt – and lying about the existence of assets,” Kantrowitz says. “If you lie or mislead on the FAFSA, you can be subjected to a $20,000 fine and up to five years in jail, plus disgorgement of the aid. Moreover, some colleges will expel students who lie on the FAFSA.”
In today’s financial marketplace, a well-maintained portfolio is vital to any investor’s success. As an individual investor, you need to know how to determine an asset allocation that best conforms to your personal investment goals and strategies. In other words, your portfolio should meet your future needs for capital and give you peace of mind. Investors can construct portfolios aligned to their goals and investment strategies by following a systematic approach. Here are some essential steps for taking such an approach.
Step 1: Determining the Appropriate Asset Allocation for You
Ascertaining your individual financial situation and investment goals is the first task in constructing a portfolio. Important items to consider are age, how much time you have to grow your investments, as well as amount of capital to invest and future capital needs. A single college graduate just beginning his or her career needs a different investment strategy than a 55-year-old married person expecting to help pay for a child’s college education and retire in the next decade.
A second factor to consider is your personality and risk tolerance. Are you willing to risk some money for the possibility of greater returns? Everyone would like to reap high returns year after year, but if you can’t sleep at night when your investments take a short-term drop, chances are the high returns from those kinds of assets are not worth the stress.
Clarifying your current situation, your future needs for capital, and your risk tolerance, will determine how your investments should be allocated among different asset classes. The possibility of greater returns comes at the expense of greater risk of losses (a principle known as the risk/return tradeoff) – you don’t want to eliminate risk so much as optimize it for your unique condition and style. For example, the young person who won’t have to depend on his or her investments for income can afford to take greater risks in the quest for high returns. On the other hand, the person nearing retirement needs to focus on protecting his or her assets and drawing income from these assets in a tax-efficient manner.
Conservative Vs. Aggressive Investors
Generally, the more risk you can bear, the more aggressive your portfolio will be, devoting a larger portion to equities and less to bonds and other fixed-income securities. Conversely, the less risk that’s appropriate, the more conservative your portfolio will be. Here are two examples: one for a conservative investor and one for the moderately aggressive investor.
The main goal of a conservative portfolio is to protect its value. The allocation shown above would yield current income from the bonds, and would also provide some long-term capital growth potential from the investment in high-quality equities.
Moderately aggressive portfolio
A moderately aggressive portfolio satisfies an average risk tolerance, attracting those willing to accept more risk in their portfolios in order to achieve a balance of capital growth and income.
Step 2: Achieving the Portfolio Designed in Step 1
Once you’ve determined the right asset allocation, you need to divide your capital between the appropriate asset classes. On a basic level, this is not difficult: equities are equities and bonds are bonds.
But you can further break down the different asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the equity portion between different sectors and market caps, and between domestic and foreign stock. The bond portion might be allocated between those that are short-term and long-term, government versus corporate debt and so forth.
There are several ways you can go about choosing the assets and securities to fulfill your asset allocation strategy (remember to analyze the quality and potential of each investment you buy – not all bonds and stocks are the same):
Stock Picking – Choose stocks that satisfy the level of risk you want to carry in the equity portion of your portfolio – sector, market cap and stock type are factors to consider. Analyze the companies using stock screeners to shortlist potential picks, than carry out more in-depth analysis on each potential purchase to determine its opportunities and risks going forward. This is the most work-intensive means of adding securities to your portfolio, and requires you to regularly monitor price changes in your holdings and stay current on company and industry news.
Bond Picking – When choosing bonds, there are several factors to consider including the coupon, maturity, the bond type and rating, as well as the general interest-rate environment.
Mutual Funds – Mutual funds are available for a wide range of asset classes and allow you to hold stocks and bonds that are professionally researched and picked by fund managers. Of course, fund managers charge a fee for their services, which will detract from your returns. Index funds present another choice; they tend to have lower fees because they mirror an established index and are thus passively managed.
Exchange-Traded Funds (ETFs) – If you prefer not to invest with mutual funds, ETFs can be a viable alternative. ETFs are essentially mutual funds that trade like stocks. They’re similar to mutual funds in that they represent a large basket of stocks – usually grouped by sector, capitalization, country and the like. But they differ in that they’re not actively managed, but instead track a chosen index or other basket of stocks. Because they’re passively managed, ETFs offer cost savings over mutual funds while providing diversification. ETFs also cover a wide range of asset classes and can be useful for rounding out your portfolio.
Step 3: Reassessing Portfolio Weightings
Once you have an established portfolio, you need to analyze and rebalance it periodically, because market movements may cause your initial weightings to change. To assess your portfolio’s actual asset allocation, quantitatively categorize the investments and determine their values’ proportion to the whole.
The other factors that are likely to change over time are your current financial situation, future needs and risk tolerance. If these things change, you may need to adjust your portfolio accordingly. If your risk tolerance has dropped, you may need to reduce the amount of equities held. Or perhaps you’re now ready to take on greater risk and your asset allocation requires that a small proportion of your assets be held in riskier small-cap stocks.
To rebalance, determine which of your positions are overweighted and underweighted. For example, say you are holding 30% of your current assets in small-cap equities, while your asset allocation suggests you should only have 15% of your assets in that class. Rebalancing involves determining how much of this position you need to reduce and allocate to other classes.
Step 4: Rebalancing Strategically
Once you have determined which securities you need to reduce and by how much, decide which underweighted securities you will buy with the proceeds from selling the overweighted securities. To choose your securities, use the approaches discussed in Step 2.
When selling assets to rebalance your portfolio, take a moment to consider the tax implications of readjusting your portfolio. Perhaps your investment in growth stocks has appreciated strongly over the past year, but if you were to sell all of your equity positions to rebalance your portfolio, you may incur significant capital gains taxes. In this case, it might be more beneficial to simply not contribute any new funds to that asset class in the future while continuing to contribute to other asset classes. This will reduce your growth stocks’ weighting in your portfolio over time without incurring capital gains taxes.
At the same time, always consider the outlook of your securities. If you suspect that those same overweighted growth stocks are ominously ready to fall, you may want to sell in spite of the tax implications. Analyst opinions and research reports can be useful tools to help gauge the outlook for your holdings. And tax-loss selling is a strategy you can apply to reduce tax implications.
Remember the Importance of Diversification.
Throughout the entire portfolio construction process, it is vital that you remember to maintain your diversification above all else. It is not enough simply to own securities from each asset class; you must also diversify within each class. Ensure that your holdings within a given asset class are spread across an array of subclasses and industry sectors.
As we mentioned, investors can achieve excellent diversification by using mutual funds and ETFs. These investment vehicles allow individual investors to obtain the economies of scale that large fund managers enjoy, which the average person would not be able to produce with a small amount of money.
Unfortunately, personal finance has not yet become a required subject in high school or college, so you might be fairly clueless about how to manage your money when you’re out in the real world for the first time.
To help you get started, we’ll take a look at eight of the most important things to understand about money if you want to live a comfortable and prosperous life.
If you’re lucky, your parents taught you this skill when you were a kid. If not, keep in mind that the sooner you learn the fine art of delaying gratification, the sooner you’ll find it easy to keep your finances in order. Although you can effortlessly purchase an item on credit the minute you want it, it’s better to wait until you’ve actually saved up the money. Do you really want to pay interest on a pair of jeans or a box of cereal?
If you make a habit of putting all your purchases on credit cards, regardless of whether you can pay your bill in full at the end of the month, you might still be paying for those items in 10 years. If you want to keep your credit cards for the convenience factor or the rewards they offer, make sure to always pay your balance in full when the bill arrives, and don’t carry more cards than you can keep track of.
Take Control of Your Own Financial Future
If you don’t learn to manage your own money, other people will find ways to (mis)manage it for you. Some of these people may be ill-intentioned, like unscrupulous commission-based financial planners. Others may be well-meaning, but may not know what they’re doing, like Grandma Betty who really wants you to buy a house even though you can only afford a treacherous adjustable-rate mortgage.
Instead of relying on others for advice, take charge and read a few basic books on personal finance. Once you’re armed with personal finance knowledge, don’t let anyone catch you off guard – whether it’s a significant other that slowly siphons your bank account or friends who want you to go out and blow tons of money with them every weekend. Understanding how money works is the first step toward making your money work for you.
Know Where Your Money Goes
Once you’ve gone through a few personal finance books, you’ll realize how important it is to make sure your expenses aren’t exceeding your income. The best way to do this is by budgeting. Once you see how your morning java adds up over the course of a month, you’ll realize that making small, manageable changes in your everyday expenses can have just as big of an impact on your financial situation as getting a raise.
In addition, keeping your recurring monthly expenses as low as possible will also save you big bucks over time. If you don’t waste your money on a posh apartment now, you might be able to afford a nice condo or a house before you know it.
Start an Emergency Fund
One of personal finance’s oft-repeated mantras is “pay yourself first.” No matter how much you owe in student loans or credit card debt, and no matter how low your salary may seem, it’s wise to find some amount – any amount – of money in your budget to save in an emergency fund every month.
Having money in savings to use for emergencies can really keep you out of trouble financially and help you sleep better at night. Also, if you get into the habit of saving money and treating it as a non-negotiable monthly “expense,” pretty soon you’ll have more than just emergency money saved up: you’ll have retirement money, vacation money and even money for a home down payment.
Don’t just sock away this money under your mattress; put it in a high-interest online savings account, a certificate of deposit or a money market account. Otherwise, inflation will erode the value of your savings.
Start Saving for Retirement Now
Just as you headed off to kindergarten with your parents’ hope to prepare you for success in a world that seemed eons away, you need to prepare for your retirement well in advance. Because of the way compound interest works, the sooner you start saving, the less principal you’ll have to invest to end up with the amount you need to retire and the sooner you’ll be able to call working an “option” rather than a “necessity.”
Company-sponsored retirement plans are a particularly great choice because you get to put in pre-tax dollars and the contribution limits tend to be high (much more than you can contribute to an individual retirement plan). Also, companies will often match part of your contribution, which is like getting free money.
Get a Grip on Taxes
It’s important to understand how income taxes work even before you get your first paycheck. When a company offers you a starting salary, you need to know how to calculate whether that salary will give you enough money after taxes to meet your financial goals and obligations. Fortunately, there are plenty of online calculators that have taken the dirty work out of determining your own payroll taxes, such as Paycheck City. These calculators will show you your gross pay, how much goes to taxes and how much you’ll be left with, which is also known as net, or take-home pay.
For example, $35,000 a year in New York will leave you with around $26,399 after taxes without exemptions in 2016, or about $2,200 a month. By the same token, if you’re considering leaving one job for another in search of a salary increase, you’ll need to understand how your marginal tax rate will affect your raise and that a salary increase from $35,000 a year to $41,000 a year won’t give you an extra $6,000, or $500 per month – it will only give you an extra $4,144, or $345 per month (again, the amount will vary depending on your state of residence). Also, you’ll be better off in the long run if you learn to prepare your annual tax return yourself, as there is plenty of bad tax advice and misinformation floating around out there.
Guard Your Health
If meeting monthly health insurance premiums seems impossible, what will you do if you have to go to the emergency room, where a single visit for a minor injury like a broken bone can cost thousands of dollars? If you’re uninsured, don’t wait another day to apply for health insurance; it’s easier than you think to wind up in a car accident or trip down the stairs.
You can save money by getting quotes from different insurance providers to find the lowest rates. Also, by taking daily steps now to keep yourself healthy, like eating fruits and vegetables, maintaining a healthy weight, exercising, not smoking, not consuming alcohol in excess, and even driving defensively, you’ll thank yourself down the road when you aren’t paying exorbitant medical bills.
Guard Your Wealth
If you want to make sure that all of your hard-earned money doesn’t vanish, you’ll need to take steps to protect it. If you rent, get renter’s insurance to protect the contents of your place from events like burglary or fire. Disability-income insurance protects your greatest asset – the ability to earn an income – by providing you with a steady income if you ever become unable to work for an extended period of time due to illness or injury.