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When Should I Use My 529 Funds?

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Wally Boudet College Finance Consultant

Written by Wally Boudeton June 30th, 2022

I joined College Coach as part of the college financing team after more than two decades of experience working with multiple student loan lenders and financial aid offices, including as Director of Scholarships and Financial Aid at Loyola University New Orleans. In my different roles, I have assisted traditional undergraduate, law school, and medical school students in navigating the complex world of higher ed financial aid and paying for college. I’ve also been active in several aid administrators associations including TASFAA (Texas), LASFAA (LA), SWASFAA (Southwest), SASFAA (Southeast) and FASFAA (FL). I have a master’s degree in public administration and a bachelor’s degree in business communications.
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by Wally Boudet, former financial aid officer Loyola University New Orleans If you have saved enough to cover your college costs, congratulations and well done! For families who have a shortfall, the question we hear often is, “Should I use the funds from my 529 plan to pay for college up front and then borrow loans, or divide the money over the four years and borrow loans each year? Here are some considerations:
  • If the parent owns the 529, it is counted as an asset on the FAFSA and Profile, and about 5.6% of the value is counted as an asset in determining eligibility for need-based financial aid.
  • Families eligible for the American Opportunity Tax Credit (AOTC) qualify for a tax credit of up to $2,500 based on up to $4,000 from a non-tax advantaged account. Paying cash or using a student or parent loan will qualify.
529 Plan Use 529 plans offer a flexible option to save money for educational expenses while offering federal income tax and in some cases, state income tax breaks. Although contributions are not deductible, withdrawals for qualified expenses are tax free. Qualified expenses for college include tuition and fees, books and materials, room and board (for students enrolled at least half-time), computers and related equipment, internet access, and special needs equipment for students attending a college, university, or other eligible post-secondary educational institutions. Evaluate College Savings Let’s face it. College is expensive. On average, the annual sticker price for in-state four-year public institutions is $27,000, and for private institutions, $55,000, with many costing as much as $25,000/year more. A great tool for families to use is a college savings calculator to help determine what you would need to cover costs in the future. We encourage families with younger students to revisit their saving strategies often. Families start 529 plans at different times. If you started investing early with hopes of covering the costs of in-state public institution and then your student decided on a private, or if you started late and don’t have enough saved, decisions need to be made about when to use your funds most effectively. Compare Rates Should you go straight to borrowing for college? If your 529 balance is insufficient to cover costs and alternative financing methods such as direct PLUS or private loans, or a home equity line of credit (HELOC) are required, the final consideration may be that it is best to use the source that either has the lowest rate of return, or the lowest interest rate. For example, if your 529 is invested in low-risk assets giving a 2% annual return, the private loan charges 6% and the federal loan charges 7.5%, then consider using the 529 funds first. But if the 529 is invested in higher risk assets, and is averaging 8% per year, then maybe it makes more sense to borrow the private or PLUS loan. Remember, there may be additional fees that are added to your borrowing cost and the repayment term you select will directly impact your offered rate. We encourage families to run the numbers before signing on the dotted line. Using savings/investments to pay for college might feel precarious with the downturn in the market and your college fund may be smaller than anticipated at this point in the process. For some families it might be better to let saving/investments sit tight to grow. Other families might want to borrow before they rely on their investments. Remember, you can pre-pay loans without penalty if you are worried about investment losses. If your investments are doing particularly well you may decide to borrow first (at a lower rate) knowing that you can use up to a $10,000 lifetime limit to repay loans in the student’s name. Assess Your Situation Before you pay that first college bill you will need to assess your situation: what interest rates do you qualify for, how much can your 529 funds actually cover, and what is the true cost of borrowing if you decide to borrow loans up front? Is there something changing in your financial situation down the road that may impact your loan repayment progress? Will your college costs stay relatively consistent over the four years? Consider changes to living arrangements or if your student wants to do a summer session or spend a semester abroad. In conclusion, while the question of how to use 529 funds is a common one, the answer varies greatly.

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