Spend College Savings Wisely

Most parents who have managed to save for their children's college educations have that money stashed in a combination of different accounts.

And while saving the money seemed like the tough part, it turns out that spending the money also takes some planning.

Financial advisor Ray Martin explained on The Saturday Early Show the best way to use that money now that your child is in school.

Chances are, Martin says, parents have college savings in a combination of different places, such as mutual funds, bonds, a 529 plan and an education IRA. If you want to qualify for financial aid or reap tax savings, the order in which you tap these funds counts.

Financial Aid

As hard as you try, you'll probably still need help paying for college; a majority of students use some form of financial aid. All students are eligible for federal loans - the most common form of aid - but individual schools determine how large of a loan students can receive based on the parents' and student's earnings and savings.

Loan officers re-evaluate a student's need each year. Students are expected to contribute 35 percent of their money toward college costs while parents are only expected to contribute 5.6 percent of their assets each year.

The Lowdown: Martin says the more money that's in the student's name, the less financial aid you will receive. If you need federal loans to pay the bills, spend any and all student money first. Coverdell education saving accounts, formerly known as education IRAs, and custodial accounts are both considered student assets.

Taxes

Martin explains that many families, based on their annual incomes, will qualify for tax credits when they spend money on education. For instance, the Hope credit allows you to claim a tax credit of $1,500 once you pay $2,000 in tuition and fees. But, Martin says, the government does not want you "double dipping" and receiving two tax savings on the same chunk of change. So that $2,000 has to come from money in a taxable account. Money earned in a 529 plan, for instance, is tax-free. If you use $2,000 from that plan to pay your bills, you are ineligible for the tax credit.

The Lowdown: Martin says this is a case where you can have your cake and eat it, too. If you qualify for a tax credit, make sure to spend your first $2,000 from a taxable account (mutual fund, savings account, custodial account) and then feel free to draw the rest of the money from a 529 plan.

Martin says there's a new tax credit this year available to couples earning under $130,000 or singles under $65,000. You can claim $3,000 in education expenses even if you don't itemize your taxes.

Smart Spending

So now that you understand the impact of savings and spending on financial aid and taxes, how do you apply that knowledge to best spend your hard-earned savings? Martin suggests tapping your resources by using the following guidelines:

• Spend Children's Money First: According to a Charles Schwab & Co. survey released this week, the concept of kids pitching in is not foreign to parents. The survey found that 79 percent of people believe students should have to work to help pay for their education. This also makes financial sense, Martin says. As discussed above, the fewer assets your child has, the more financial aid you can receive. Also, if your student sells appreciated stock from a trust or mutual fund, he will pay a lower capital gains tax than an adult would on the same amount of profit. Thus, the money in his fund goes further than the same amount of appreciated stock in your fund.

  Finally, while no parent wants to send their child off into the world with debt, the reality is a 22-year-old college graduate has more time to pay off debts and save for retirement than 55-year-old parents. You may want your child to begin "adult" life with a small nest egg but as Martin says, "Get over it." You simply can't base financial decisions on emotion.

• Coverdell Education Savings Accounts: These are very similar to the Roth IRA; money withdrawn from a Coverdell ESA is tax-free. The money in an ESA is considered the child's assets and will count against you for financial aid so you may want to spend it early. Martin says you should remember that because you are already receiving a tax break from this account, you can't use money withdrawn from the ESA toward an education tax credit.
• Bonds: Thanks to low interest rates, bonds have a low rate of return right now. Martin says it might be smart to spend this money and allow other investments to grow. Also, the earnings on savings bonds purchased after 1989 are tax-free when used toward education. (Again, income restrictions apply.)
• 529 Plans: These savings plans have become very popular. Parents have amassed $34.6 billion in 529s. Like the ESA, money withdrawn from the 529 can't be used toward an education tax credit because its earnings are tax-free. Martin says it makes sense to allow this money to grow as long as possible before spending it. However, you've saved this money specifically for your child's education and now, he says, is the time to spend it.
• Other Savings/Stocks: Finally, Martin recommends spending your savings in generic/general accounts. Martin suggests having stock you intend to sell and use to finance college. Gift that stock to your student instead. When the child sells the stock to pay for college, he or she will pay a lower capital gains tax and there will be more earnings to spend on that student's education.

A Last Resort

At all costs, Martin says avoid dipping into your 401(K) or other retirement plan to pay for college. Not only will you pay an early-withdrawal penalty, it may not be as easy as you think to replace these funds. You can obtain loans for college, but you can't obtain loans for retirement.

Help!

It's lovely to talk about how to spend the money you've saved, but what if you haven't managed to save for college? Or, your savings have been ravished by the bust market? Martin has some last-minute strategies for you:

• Ask Again: Once your student's school of choice has made a financial aid offer, go back and ask them for more assistance. A 2001 survey found that nearly half of all appeals result in higher financial aid awards.
• Check Extended Payment Plans: Over 3,500 universities offer plans that allow you to pay for tuition in monthly installments instead of a lump sum at the beginning of a semester. Typically, outside companies organize this service for a university and charge an annual fee of about $50.
• Consider Home Equity Loans: Parents with more equity in their home (such as a small mortgage) qualify for less financial aid. So, if you are trying to receive more aid, get a home equity loan and put that money into an annuity or life insurance. These "retirement savings vehicles" won't count against you in the financial aid formula. Martin says to beware of agents who want to charge high fees for this kind of "equity shifting."