[From Ramit: Yesterday, Todd wrote about what to do before you file your taxes.
Today, this article is specifically for college students. I know, I know. You feel guilty because your parents are paying thousands every semester while you’re busy napping all day and trying to spit game at the girl next door. And failing.
Your parents may be able to save on taxes if they follow some of the instructions below. Take a look and send them this article.]
Guest post by Todd Doerr
I’ve coached many families who already have college students or will soon have at least one child in college. There are ways to successfully navigate the waters of paying for college. In this article, I will share a game plan with you, the parents, to make your life easier and to help your student get off to a strong start in the real world. I will also provide you with some tax-savings ideas that may speed up your progress even faster.
Let’s first look into the financial future of your college student once they graduate.
As you are probably aware, the typical college graduate has both credit card and student loan debt. Recent graduates have an average of over $19,000 of student loans and over $3000 of credit card debt. The typical graduate degree student leaves with $24,000 to over $100,000 of student loans.
So, your college graduate begins the new season in their life and the snowball builds….
Then, your graduate buys the new car (take it from someone who bought the new car one month after walking the stage – it happens a lot). Another $300 per month in payments out the door.
Then, your graduate rents the nice apartment as they are sick and tired of dorm life or the college apartment. Oh yea, that nice apartment makes the college furniture look nasty. New furniture on the MasterCard – PRICELESS.
Then, your graduate starts making payments on the student loans (sure, the interest rate might be fairly low, but the payment still stinks). Potentially hundreds more of outflow each month.
Then, all of their friends start to get married and everyone starts dropping serious cash on wedding gifts, parties, travel, dresses, and tuxes. The numbers here really add up when you multiply by the number of friends.
Maybe it’s none of these events – maybe they spend $300 per month eating out. Maybe it’s buying cool gadgets. I’ve coached many clients in their 20’s. Their stories are different, but the result is generally the same. The debt adds up quickly and the minimum monthly debt payments grow substantially.
The good news is that the snowball does not have to claim your graduate. They can thrive financially if they live off a budget, get out of consumer debt, and avoid going into additional student loan debt.
The best financial coaching advice that I can share with you, the parents:
Help your child graduate with as little or no debt as possible.
Why? Because when they are free of consumer debt and student loans, they can really begin to thrive financially and to build a hopeful future for themselves.
Let’s say your graduate didn’t have that “normal” student loan payment, the “normal” MasterCard payment, those 2 payments could can easily add up to several hundred dollars per month. Instead, he or she invested $300 per month from age 25 to age 65 in a retirement account earning 8% per year. At age 65, they could have approximately $1 Million in retirement savings. Obviously the cost of living will go up, so it won’t feel as big. But it gets them off to a great start towards retirement savings.
Winning with College Expenses
Here is the overall game plan I share with my clients. It does take some work, but it is truly worth it to follow as many of the strategies as possible.
- Save-Save-Save. If you have time before one of your children heads off to school, save aggressively with an Education Savings Account (ESA) or a 529 College Account, or even just a high-yield savings account. My favorite resource for these 529 and ESA plans is www.SavingForCollege.com. If you are just a couple of years away, I would avoid investing in 529’s or ESA’s as the value could go down if invested in stock mutual funds. I would stick with a high-yield savings account in that case.
- Proactive Scholarship Hunting. Get proactive and diligent about applying for scholarships and grants, even if your student is midway through college. Don’t give up!
- It’s possible to find thousand of dollars in scholarships and grants. I recommend Ramit’s postings on these topics. He really knows how to win in this area.
- Hire a scholarship coach. I send some of my clients to a productive scholarship coach. She consistently helps her clients find $10,000 to over $40,000 of scholarship and grant money.
- Cash Flow College. As a family, do everything you can to pay for college with cash and to avoid borrowing and credit cards. Here are some ideas to get you started:
- Part-time jobs for your student, or even yourself. Part-time jobs are a great way for students to develop life and time management skills. They are not forever, and can provide a significant boost for college expenses.
- Drive used cars. This can really boost your monthly savings. It’s not just a lower payment (or no payment at all if you a big bargain) – older vehicles also depreciate more slowly than newer vehicles.
- Maximize as many tax strategies as possible for parents. I will cover this in detail later. This step alone can put money in your pocket each year.
- Become a bargain hunter on everything. Buy used textbooks, used computers, used furniture, etc.
- Hold off on expensive vacations. This could save $1000’s over 4 years in college.
- Sell things. Have a massive yard sale. Sell the motorcycle. Sell the piano that no one plays anymore.
- As a last resort, Student Loans. I’m not going to slam you for taking a student loan, but let’s work REALLY hard on all of the other steps before we start taking these on. The benefits can be substantial.
- Avoid borrowing or withdrawing from your 401k or IRA’s for college expenses. Even though you can withdraw or borrow money penalty free in specific scenarios from some retirement accounts, you are putting your financial future and retirement at risk.
- Avoid borrowing on your home to pay for college. Borrowing against your home puts your home at risk, especially in today’s crazy real estate market where people end up upside down on their mortgages.
Review Tax Savings Ideas
Make sure you research every possible income tax savings opportunity – this could save lots of dollars every year of college. By making tax-smart moves, you can free up more money to pay cash for college.
Here is a list to review that may help to boost your plan. Some are best handled by your personal tax accountant.
- Maximize your Hope and Lifetime Credits. These are great credits if you qualify – see IRS Publication 970 for details. The Hope Credit may only be claimed for 2 tax years per child and can only apply to the first 2 years of post-secondary education.
- Deduct Student Loan Interest. If you are already making student loan payments, you may qualify to deduct a certain amount of interest paid on student loans. See Publication 970 for limitations.
- Continue to Keep Your Student as a “Dependent”. This assumes that you continue to provide at least one-half of their support. Refer to Exemptions in the Form 1040 Instructions.
- Hire your student. If you are self-employed or own your own business, hire your child to perform bona-fide work at a reasonable salary. Keep records of time worked, duties, etc. You can deduct their wages as a business expense. This is a more complex strategy that probably would best be handled by your personal tax accountant.
- Buy-off campus housing. This is for wealthy parents only. I recommend that you do not consider this option unless your primary residence is paid for (no mortgage), you have a substantial emergency fund, you have no consumer debt, and have accumulated a large retirement account (Yes, I know this advice is very conservative). You can “hire” your child to be the property manager. You can also potentially deduct the housing property taxes on your Schedule A. This strategy requires a clear game plan – take your time and don’t rush in. Once again, this one is best handled by your personal tax accountant.
- Make sure your student has health insurance coverage. This is not a tax strategy, but important enough to mention as a “protect yourself from a financial blow-up” strategy. One serious trip to the hospital could set you back from $5,000 to $20,000 or more without health insurance on your student.
Tomorrow’s article will outline a financial game plan for the newly engaged and the newly married.
Todd Doerr is a personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at firstname.lastname@example.org or at www.taxmakeover.com.[Update] 1. See the two other articles Todd wrote:
- What to do before you file your taxes this year
- What to do, tax-wise, if you’re recently engaged or married
2. Then check out his eBook, The 2008 Tax Makeover Guide
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