Avoid this Mistake in your College Financial Planning
Every now and again, I respond to questions asked of another blog site. One of the recent questions posted came from the parent of a junior in High School. The just of the question was concern over costs of college and the impact of borrowing $10,000 from the equity of their home to give to a stock broker and in doing so the impact on the FAFSA form. Now, this blog is not one to give investment advice, so let’s put that on the table up front. And, the examples we talk about are specific, may be hypothetical and probably aren’t the same as what you personally might experience. Best of all, they aren’t a guarantee of future performance or your own success. Having said all that legal stuff, let’s consider some of the issues.
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When you borrow money, you have to pay interest. Let’s assume the interest rate is 5%. So, just to break even, you have to make at least 5% plus the brokers fees for investing the money cause he ain’t gonna do it for nothing. Now, the stock has to go up for you to win, then he has to sell it for you to profit and he gets a fee for selling it. Then you pay taxes in the range of 0% to 35%, depending on your tax bracket and how long you own the stock. That’s if the stock goes up. What if it goes down? OOPs! Now you have to pay back the loan with dollars that you otherwise could have used to pay for college. So far, this is a risky expensive deal.
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Now, let’s look at the impact on the FAFSA form (Free Application for Student Aid). FASFA and is an estimate of the parent’s and/or student’s ability to pay for post secondary education. It generates something called the Effective Family Contribution, EFC, which is the U.S. government’s attempt to determine how much a family can afford for college and any eligibility for student aid from either the state or federal government or the schools themselves. Parents have to declare lots of assets. Home equity isn’t one of them. So, putting money into a brokerage account usually raises their Effective Family Contribution. It could be as high as 25% of the account value. That could raise their EFC by $2500. That means reducing their College Aid by $2500/year. Sounding worse as we go. Now, let’s say they are fortunate enough to make a profit and they sell it. The gain is considered income and causes the income part of the FAFSA to go up or as they make a profit but don’t sell it, the whole value of the account is causing their effective family contribution to go up $0.25 for every $1 they make. What that could mean is they have to make a 30% return each year to offset the cost of the interest and the impact on the FAFSA score. Do you know any place that can guarantee 30%/year without any risk? If so please let me know.
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Action Time.
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Planning for college is a complex progress. Sometimes we have the best of intentions but shoot ourselves in the foot. For this person, that appears to be the case. A couple of options are available. One would be to make use of some of the various cost calculators that various sites offer and input the data with and without the money in the brokerage account and see what the EFC turns out to be. If there is an increase in the EFC, calculate that into the return you would have to make including the interest charge just to break even. That offers a reasonable picture as to the risk. If the return is pretty high, an alternative may be to use the equity to pay the college bill and pay the loan off over time. This doesn’t impact the FAFSA or any student aid and may offer some tax deductions, based on their personal situation. If your path is somewhat muddy, I would look forward to hearing about your circumstances and seeing how I might be of assistance.
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Examples presented in material are meant for illustrative and or informational purposes only, and not indicative of any specific investment product. Individual circumstances will vary. Please see your investment and/or tax professional regarding education planning.
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Coach Rossitto
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The opinions voiced in this material are for general information and are not intended to provide specific advice or recommendations for any individual.
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