In part one of this blog, we explored some of the reasons why using a 401k/403b loan to pay for college can be a risky strategy. In part two, we will talk about some of the additional challenges of that strategy and some alternative options.

The Five Year Repayment Period and Paying for College

The main benefit of borrowing is that the borrower can reduce the individual payment amounts by making more payments over time. People who borrow do so because either they do not earn income fast enough or do not have enough money left after they pay their other bills to meet the expense with current income. The five year repayment period on a 401k/403b loan is short for a loan, and these loans do not significantly reduce the size of the payments the borrower needs to make.

Most companies allow their employees who use retirement plans like 401ks and 403bs to borrow from these accounts to pay for things that occur before the employee retires. These are not considered withdrawals, and the employee pays the loan back, with interest, over a short period of time. Employees like the idea of “borrowing from myself and paying myself back” and the ease of setting these loans up. However, a 401k/403b loan is a risky college finance strategy that does not always work. In part one of this blog, we’ll look at a few of the reasons why.

How do 401k/403b loans work?

Employees who want to set up a 401k/403b loan contact their 401k/403b manager. The manager sets the repayment terms, which include a five year repayment period (ten years if the loan is to purchase a primary home) and the interest rate. Employees pay the loan back through payroll deduction over 60 months.

Parents often tell College Coach’s Saving for College experts that all, or a large part, of their plan to pay for college involves loans or withdrawals from their 401ks or 403bs. We try to help them find an alternative college finance strategy, as using these accounts to pay for college can be expensive and ruin a parent’s retirement security.

A brief reminder: what is a traditional 401k/403b?

When you fund a traditional 401k or 403b, you allow your employer to take some of your paycheck and deposit it in your retirement account. You don’t have to pay taxes on the income that you save. This is called pre-tax salary deferral. You invest the deposit in assets that you hope will grow in value, and you do not have to pay tax on interest, dividends, or capital gains that are earned within the account. This is called tax-deferred growth. When you do withdraw funds from your traditional 401k or 403b, you must pay income tax on those funds.

It seems hard to pick up a newspaper these days without running into advice from College Coach finance expert, Robert Weinerman!

In an article in this weekend’s Wall Street Journal entitled “August Is Time for a Financial Reboot,” Robert shares his insight for parents of high schoolers on early college financial planning, including scholarship searches, financial aid calculations, and asset allocation for college savings.

And in today’s US News and World Report, Robert offers his perspective on recent student loan legislation in an article entitled “New Student Loan Deal Good, and Bad, for Borrowers.” 

A guest post by Lisa Oppenheimer

Call it the “Scarlet H.”

The “H?” “For Helicopter Parent.”

The dreaded label hovers over all parents as we try to help (and yes, over help) our children, but never more than when our progeny apply to college. That’s when we become, well…crazy. Legends abound about parents writing essays, berating admissions officers, and, in one particularly creative urban legend, applying to schools on our offspring’s behalf (I’m told by a reliable source that the last one is more or less impossible, but you never know). 

Did you invest in a prepaid tuition plan? Is your child about to go off to college? Congratulations if you answered yes to both of these questions! You probably got a great rate of return and have some of your son’s or daughter’s tuition already paid. And here’s some more good news: all that investment growth you got from paying for college in the past will be tax free to you when you use the Plan to pay for college today. All prepaid tuition plans are 529 plans (except the Massachusetts Prepaid Plan, which derives its tax-free status from another section of the federal tax code) and share all of the tax benefits of 529 savings plans.

Unfortunately, using your prepaid tuition plan is not as simple as writing a check to the college. You’ll want to take some steps now so that you use the plan properly when the bill comes due.

College Coach learned today that the Department of Education (DoE) is changing the way the Free Application for Federal Student Aid (the FAFSA) defines a student’s family. Starting with the 2014-2015 FAFSA, which becomes available on January 1, 2014, students will be required to provide information about the adults in their custodial household without regards for marital status or gender. You can read the DoE’s announcement of these pending changes here: http://www.ed.gov/news/press-releases/education-department-announces-changes-fafsa-form-more-accurately-and-fairly-ass.

Until this change, the DoE had defined a student’s family as the parent with whom the student lived the most in the prior twelve months, and that person’s different-gender spouse, if there was one. This meant that the parents who disclosed information on the FAFSA were:

Just because I appreciate a good turn of phrase does not mean I’m poised to write the next great American novel.   Nor do my frequent visits to WebMD make me qualified to dispense health advice.  As I opened my Outlook calendar this morning, I realized it is late March.  Tax time.  I better call my accountant, not my best friend who majored in economics in college.

It’s unlikely you would consider using an attorney who did not pass the bar or a contractor without a license.  So as you think about how to identify the most qualified person to help your family navigate the college admission process, allow me to give you one piece of advice:

Hire a college admissions expert. 

Spokespeople for the Common Application recently announced that the 2013 – 2014 version of the application would include five brand new essay prompts, which are:

• Some students have a background or story that is so central to their identity that they believe their application would be incomplete without it. If this sounds like you, then please share your story.
• Recount an incident or time when you experienced failure. How did it affect you, and what lessons did you learn?
• Reflect on a time when you challenged a belief or idea.  What prompted you to act? Would you make the same decision again?
• Describe a place or environment where you are perfectly content. What do you do or experience there, and why is it meaningful to you?
• Discuss an accomplishment or event, formal or informal, that marked your transition from childhood to adulthood within your culture, community, or family.

At a recent family gathering, a good friend pulled me aside to ask a question about the University of California system.  Having read that UC Berkeley admitted a record number of non-California residents, she wanted to know whether or not the UCs remained a viable option for her own children who would be applying to college in California as in-state students.  Resisting the urge to playfully remind her that her oldest was only five, I started addressing one of the biggest questions college admissions consultants are often asked:

Are state schools increasingly admitting more out of state and international students at the expense of qualified state resident applicants?