Transcript

Steven Jarvis:

Hello everyone, and welcome to the next episode of the Retirement Tax Services Podcast: Financial Professionals Edition. I am your host, Steven Jarvis, CPA. And in this show, I teach financial advisors how to deliver massive value through tax planning. Really excited to have on the show with me today, Andrew Windham, who is America’s college and cash flow coach, and Andrew and I are going to talk about college planning and particularly about tax implications of the planning process. So Andrew, welcome to the show!

Andrew Windham:

I really appreciate you having me. I’m excited to share a little college knowledge today.

SJ:

Yeah really excited to have you, this isn’t a topic we’ve covered yet, and we’ll get into some of the things that I’m sure immediately come to mind for advisors when they hear college planning – 529 plans and setting up Roth, things like that. But we want to start with, okay why even have the conversation in general? A lot of advisors work with pre-retirees, retirees, people late in their careers. So for a lot of advisors, this isn’t even on the agenda. So just kind of share your perspective of why this is such a huge focus for you.

AW:

You know, I’m kind of known for managing cash flow relative to college. And so that ties in really perfectly because college is the single largest cash flow event in the life of a student, in a family that they’ll ever have. And regardless of how well and how efficient a financial advisor for their clients, Steve, and manage all the other aspects, not paying attention and understanding the size and the, the, the potential impact of the cost of college can really, really be, you know, seven figures or better impact on what kind of money mom and dad have in those golden years to do more of what they want to do.

SJ:

Yeah and, you know, there’s a lot of debates about, uh, about the rising cost of college and is college really for everyone? All these different headlines. And those are all interesting conversations, but really for our purposes today, I mean, there are still so many people who are committed to this idea of ‘my kids are gonna go to college and I want to pay for it’. And so this is more about helping our clients fulfill their dreams, as opposed to trying to wade into the middle of any sort of political debate about what the outcomes should be. So that’s our focus today is, okay. When you have clients, whether this is planning for their kids or quite possibly for their grandkids, I know that grandparents would make up a huge percentage of contributions towards college education. How do we have that conversation and help the planning process to make sure this is effective?

AW:

Absolutely. And so Steven outside of dollars that have been set aside in accounts for education, regardless of what those might be, and then scholarships one from the colleges, grandparents, or one degree, extended family, grandparents, uncles, brothers, sisters, those types of things, or the single largest source for paying for college. And so it’s really important. Usually when they do that, they’re wanting to, they’ve got great intentions. They want to do it efficiently and effectively. They want to maximize the value delivered. And so how people receive those dollars can make a big difference in how far the dollar stretch and the impact, right?

Beginning Steps For Setting Up A College Finance Plan [03:33]

SJ:

Yes, so for advisors listening, even if your clients don’t have college aged kids or kids who are still going to be going to college someday, this can still be a really impactful question to understand what their intentions are. We talk about tax planning over the lifetime of a client’s wealth and helping to pay for college might be one of those things. That’s, that’s in their plan. Something that we can help them with, if we’re aware that that’s their intention, and then we’re aware of how to help them along the way. So Andrew, talk about some of the things that you work with clients on as far as from their education standpoint on this topics. Set the university aside for a second, and what are some of the starting places of just getting people to kind of understand the different moving pieces involved.

AW:

Well, I think first and foremost, it’s really important to help your clients understand the gravity of the college process. So most families find out far too late in the game, meaning is late as fall or spring of senior year. Wow. This can be a very, very daunting, overwhelming process. Purely and simply from the time perspective. And so I think if, as advisers think about how busy their personal lives are, they can also appreciate how busy their client’s lives are. And so how do you fit 200 hours on average for the well-run or well-executed college strategy and process in with everything else going on that they’ve got to do? And what are those types of things? Well, college visits getting prepared for interviews. If you get invited for honors or scholarship weekends, filling out financial aid forms, filling out the applications themselves and essays that go along with that and getting good recommendations that help highlight the student in question, um, to the best of their ability, which indirectly impacts a college’s perception of the value of the student, and then rolls downhill to what kind of free money they get, which is always a topic everybody wants.

AW:

Right?

SJ:

Yeah, definitely. When, when you’re looking at that college process, the cost is such a big question there. So Andrew, I think for a lot of people and probably for a lot of advisors, when we think college planning – 529 plan comes to mind, and then that might be about the extent of what comes to mind of great. Our options are to fund a 529 or don’t, then let’s move on to something else. But as we were getting ready for the show, and you were showing me some of the content that you present on this, I mean, one of the things that stood out to me was, uh, a list of myths. One of which is that ‘529s are the best way to save for college’. So talk a little bit about your perspective on the advantages and disadvantages of a 529 plan.

Important Factors to Consider About A 529 Plan [06:00]

AW:

Well, I think a very big thing that is near and dear to my heart is that all solutions are not one size fits all for every client. What comes to mind in particular, I saw a post just the other day. Dave Ramsey says the only things you should invest in Steven or mutual funds and spread them out over these four areas and real estate that you pay in full, and you should never invest in ETFs or crypto or, you know, all of these things. And so I think the biggest mistake that I see advisors make unintentionally is that because they don’t play a lot in this space, the 529 is the easy, low hanging fruit place to use. And it’s certainly a good option. The greatest benefit, obviously if you’re funding that and it’s managed successfully, is that a 529 allows the benefit of paying for education with tax advantage dollars.

The big mistake that I see that advisors make though, and even clients don’t think about Steven is the fact that dollars that go into a 529, if 529 accounts were losing tons of money, they would not be a place that a lot of folks would like to part money. And so sometimes clients and advisors can mistake that they should expect a similar growth rate in a 529 type of account that they might see in any other type of an investment. And the return on a 529 is just like any other investment account. It varies significantly with how those dollars are allocated. And so the average 529 is not managed by an advisor in this country. I don’t know what the percentage is, but until recent years, the average rate of return that most folks see in a 529 is 3 or 4%.

Now that’s certainly better than nothing. That’s even more true given we’re currently in an inflationary environment. More so depending on where you live, of course, but you know, families that in their mind are applying a 7 or 8% rate of return. That’s not very typical. Number one in a 529, because nobody would put dollars in if they were just going to evaporate, right? So they tend to be more conservatively invested. Number two, they tend to be invested similar to target types of funds or target date types of funds like in 401(k)s. And so that’s not good or bad. It’s just an awareness of that. And then another aspect that I think is often not considered is what I would call a horizon mismatch. And so if you look statistically by Kitces or, you know, the, the gurus that are far smarter than me about investing assets in accounts, if a client came to an advisor and said, Hey, I’m 62, I’m planning to retire in three years, where do I put money in the market?

You’d be kind of like, what, wait a second. That’s probably not in the client’s best interest, depending on how much they can afford to risk, the timeline to be able to access it. And so, as a general rule, I think the rule of thumb, don’t quote me on this as somewhere around 8 to 10 years, is where you can traditionally flip to a significantly higher probability that you’ll come out on top, meaning have a positive versus a loss. And so the typical 529, Steven doesn’t get started until somewhere around the oldest student being in sixth, seventh, eighth grade. And so if you’re starting that with the student, that’s in the middle school age, you’ve got to be really careful with expectations and potential horizon mismatch, because you’re going to put those dollars in places that will dictate how they’re counted in financial aid formulas. And there might be an as good or better place just from a flexibility, liquidity use control type of scenario. Also, I would say that income’s important in that too, right?

SJ:

Definitely. I liked that you brought up expectations cause that’s so important in so many things we do. And I, I think that also highlights another just thing to consider with 529 plans and making sure we’re clear with clients on what their expectations are, because, um, like you said that the 529 plan can be an easy option. That’s what the mind goes to when we think, okay, let’s help a kid with college, especially we’re talking maybe about a grandparents, but what might be more important is to understand what is your client’s real goal with helping that kid helping that student? Is it that you’re just set that they’ve got to pay for college or nothing? That’s all they can use this for because there are limitations on what the 529 plan distributions are used for, or is really the intention. Hey, I just want to have an impact. I want to be able to give my grandson, my granddaughter, some kind of leg up, whether that’s helping them make a down payment on a house, whether it’s helping them start a business or potentially go to college. And so understanding, having real clear expectations as to what, what would be a successful use of those dollars can also help inform whether limiting our use to a 529 plan might make sense.

AW:

And I would add there that also the amount of dollars we put there, you know, over-funding a 529, the general school of thought is, oh, well, don’t worry about it. You’ll just roll it forward to a future child or future generation. But let’s say you have a family with a student who gets a significant amount of dollars and they don’t extract those dollars successfully from the 529. And let’s just say they took 30 or $40,000 times a couple of kids rolled that forward. Well, at a good rate of return, 5-6-7%, that could be a quarter to half a million dollars, 20 years, 30 years down the road that family might want to use in a more effective manner. And you might say, well, yeah, but that’ll just pay for education. But at some point that, you know, compounding uninterrupted compounding interest can grow to an amount that is really not feasible. Now, keep in mind, the new tax law allows us to use those five 20 nines now for private school and some of those things. So there’s some ways to be able to use that more proactively for future generations or other kids, but you certainly wouldn’t want to, in my opinion, to get a huge chunk of dollars stuck in a 529.

SJ:

And we move on to other tax advantaged ways to potentially save for college. You had mentioned the distribution opportunity for 529 plans, that a lot of clients you run into just aren’t aware of. So can you talk a little bit about what happens if you save in a 529 plan and then your student ends up with scholarships?

AW:

Absolutely. Well, so, you know, the general school of thought is when you put money in a 529, it’s there and it’s stuck there, but remember the 10% penalty for withdrawal out of a 529 is only the difference between the basis in the growth. So if you’ve had somebody drop money in a 529, for example, and it hasn’t had a significant growth, one positioning or planning strategy that should be considered very specifically to the client’s unique position. I’m not advocating for withdrawing money from 529. It’s just to be crystal clear, but there are some instances where dollars in a 529 can be a disadvantage in the financial aid process by and large. A very generic example, and I reiterate generic; let’s say Susie or Johnny goes to college XYZ. And the colleges looking at Susie or Johnny and student B. One student has money in a 529, the other doesn’t. It is a very typical, not necessarily all the time or even the majority of the time, but it’s not atypical at all that the student, without the 529 dollars or monies in some type of education savings vehicle would get less scholarship money that they would not have to repay is a result of that because the college is trying to figure out how they can get as many kids in the door at the highest net revenue. Colleges are businesses too. Right. But let’s say your son or daughter in the state of Georgia, which I’m in Atlanta, your son or daughter gets the Zelle scholarship. So all of tuition is paid for by the University of Georgia and you put money away in a 529. You’re allowed to withdraw dollars from the 529 in the year that they’re realized dollar for dollar without the tax penalty and without taxable income, a tax advantaged withdrawal from that account. That is a great way if somebody has put money aside because they want to be able to help with college, but the student earns it by their merit or given the scenario, you can retract those dollars and then repurpose them for the student, whether it be for a down payment for a house. So you don’t have to pay for dorm expenses or lots of different things like that.

SJ:

Yeah. So that’s a great reminder for clients who have 529 plans that you need to stay involved and keep asking questions throughout the process. Not just when it was originally funded or how much they’re putting into it as the kids are leading up to college, but that there’s these life events that we’re on the lookout for to say all these opportunities come up because you made the point there. But I think it’s worth reinforcing that for that, scholarship distribution to happen and be tax advantage. It has to be in the same year  as the scholarship we can, we can’t, we can’t wait around and a couple of years later say, oh, let me go back and do that. It’s gotta be in that same year. Absolutely. Okay. So if 529 plans, aren’t, aren’t the, the magic answer for every situation to save for college. What are some other things you work with clients on as far as trying to get tax advantage dollars set aside for college?

Other Strategies For A College Finance Plan [15:35]

AW:

Well, uh, so I tend to work with a lot of entrepreneurs and business owners, and so I always love the old hire your kids strategy, as long as you’re doing it legally, ethically and morally. Right? And so I really loved the previous episode you did with your brother where he said, ‘Hey, now wait.’ Or somebody said, ‘Hey, well, we could pay them as a model, right? We’ve got to document and do all that correctly.’ But let’s assume that you are trying to mitigate the tax impact and the net cost. So there’s multiple ways to pay for college. One is certainly through scholarships, but in other ones, do what we call tax scholarships. Meaning the way that you pay for college can significantly impact the net opportunity, cost or wealth transfer, if you will. So if you’re a business owner, if you could hire your kids, that’s certainly one way that you could transfer dollars from your side of the tax ledger to theirs.

And so you’ve mitigated some tax liability there. And then where do you put those dollars? Well, there are a lot of places you could have your student fundamental Roth, certainly as one option, but you know, if there’s a timeline mismatch or getting later dropping those in 529, usually doesn’t provide near that advantage that most folks think like in Georgia, the tax deduction is 90 bucks, right? So if you’re making decent money, certainly 90 bucks is 90 bucks, but there can be a lot of time hassle getting it set up, getting it in, getting it withdrawn, all those things. You know, I know this will be a, I’ll get lots of jeers from this, but correctly formed in designed life insurance is a good pass through vehicle that can be used for that. Certainly again, not suggesting that it’s the end all or even should be the majority, but it’s an option.

So there are lots of ways and places to do that. Another great way to pay for college is some people will buy a piece of real estate, close to a college like Athens, if your kid’s gonna eat like a dog bark, like a dog and play dead like a dog, you’ll go ahead and buy a piece of real estate and you get some equity there and then maybe you rent that and that helps pay for college. And so there are some great ways to be able to do that. That allows some tax advantages as well. So, you know, I think just like a lot of things, there’s tons of options that really that’s where the advisor is so crucial to understanding what’s going on in the client’s life and then having a good resource or somebody who can say, ‘Hey, I’m thinking about this. Do you know how this is going to impact?’ Just like I suggest folks get with their CPA. You take advantage, I like to call it the wealth team. Steven, you need more than one expert. You get great professional oversight by and large. I don’t think advisors in any area of finance intentionally make bad decisions. They just make un-holistically informed or considered decisions. Yeah.

SJ:

Yeah. And as we talked through all this for advisors who don’t spend a lot of time on college planning, this, this can sound like a lot and it is there’s, there’s a lot of moving pieces and we haven’t even gotten into how these different savings options and the distributions from them might impact the FAFSA, which is the application for a student aid. Uh, so there’s, there’s a lot of moving pieces, but similar to taxes in general, as an advisor, if you can spend enough time on this, to be able to identify the opportunities, to be able to ask your client good questions about whether this is, this is going to be impactful, whether this is meaningful, whether there’s opportunities here. And then to your point, Andrew, of, of having a wealth team of the advisor, who’s got that primary relationship. If they can identify the opportunities and then point their client the right direction, just like with taxes in general, you’re looking for the opportunities you’re looking to kind of be the guide, to be the one who kind of quarterbacks the relationship. But that doesn’t mean you have to be the end expert on all of these things.

AW:

Yeah. And I want to throw one in that we didn’t talk about, you know, with the education loans, a lot of advisors have clients that show up with significant loans, especially if they’re attorneys, physicians, dentists, those types of things. And the only thing that is probably more complicated than the education loan pay off is security. So prior to a recent addition of a new income driven repayment plan, there were 168 ways to pay off loans. And so sometimes the loan option that you choose and a quick tax insight is so the Biden administration, just in the most recent legislation buried in there was they wiave or there’s no income event generated by forgiven loan amounts. And there’s also a public student loan forgiveness, reconsideration that was in that. So what does that mean? Well, take somebody who might work for the public sector, government, be an educator. Those folks might qualify for the ten-year public student loan forgiveness program, in which case, how you pay those off could be a significant impact in wealth transfer. And now that there’s no tax event that’s going to come out of a forgiven amount, that’s all the more reason why somebody who has a significant amount in particular that can be certainly worth looking at.

SJ:

Yeah, that’s a great reminder. Appreciate that. There’s so many potential opportunities here. If these are things that we’re looking at. So Andrew, before we wrap up, uh, one of the questions I get from advisors at times is related to the FAFSA and related to proposed changes to it. Can you give us just a couple minute overview of kind of where that’s at, where, where it’s headed from your experience digging into all this?

FAFSA And Its Proposed Changes [21:03]

AW:

Absolutely. So where we sit right now over about the last 14 years I’ve been doing this, the asset protection allowance or the amount of dollars that a family is allowed to have pigeonholed, I think emergency funds, Steven, that number has significantly dropped. It’s less than about $10,000 for the average family now. And that’s in the current formula, which is the expected family contribution calculation. Okay, and so the FASFA or the Free Application for Federal Student Aid is administered by the department of education. And if you want to qualify for any type of Stafford loans, which by the way, all loans are not created equal Steven. I’m a big fan of using Stafford loans, subsidized and unsubsidized as a way to have a student put skin in the game and to maximize the efficiency of the cash flow. But back to the formula, there are seven factors.

Parents’ income, parents’ assets, student’s income, student’s assets, the age of the oldest spouse, the number in college at the same time, which by the way, can’t count mom and dad. Okay. All of those things dictate what we call the income and the asset protection allowance. Now, during the Trump administration, they passed a simplification of that. And we’re moving away from the EFC to what we call a Student Aid Index or SAI, a couple of the very specific and important changes in that, or the current formula is, as you recall, just said, takes into account the number of students that are simultaneously in college. So it’s just a quick and dirty example. Let’s say a family had an expected family contribution of $20,000 and their first child went to college and then their second child was two years behind. So child number one or student number one is, is junior or third starting third year of college. Child number two is going to be a freshmen. That same expected family contribution would be not exactly a BOGO, a buy one, get one free, but it would be basically 110% of the ESC or $22,000 divided by the number in college, which would be two. Now that’s an approximation on exact math, but that would take a student’s EFC from 20,000 to 11,000 for both students, if you’re looking at a school that meets a high percentage of need-based aid, think of school like Emory or Stanford or some of those schools, that means the student just qualified for potentially 8 to $10,000 more in free gift aid, that you would never have to pay back by understanding that, and that might really impact what type of college that somebody chose to attend. When we move to the Student Aid Index, we’re going to take out of the calculation, the number of kids simultaneously in college.

AW:

So, boo! For the families with twins, triplets, quintuplets, or, families that have gotten married. But the good news is, like most things the governments do, it’s taking a little longer to implement and execute than expected. So right now that it was originally supposed to go into effect in 2022, it’s already been moved out to 2023, and we’re actually expecting that we’ll receive an update again, and it’ll probably be 2024 before they can get it all implemented because they have to change the FASFA, the formulas, the technology, all of those things have to get aligned or otherwise you can imagine, with millions of folks across the country, filling those out, because remember you have to fill out the FASFA every year, the student is going to college. So not only the year before they go, but every year thereafter until they’re  in that last year of graduating.

AW:

So the number in college will be taken out, but the income protection allowance is going to significantly increase and that will help families with middle income significantly because it’s going back up to around 40, 50, $60,000. Advisors that’s great news because that means when our, when our clients are being fiscally responsible, in setting up emergency funds and those types of things, they’re not going to be tapped on the hand for that or penalized for that. And I think that’s really a huge thing for advisors and really for our country. And it’s a vote for being more fiscally responsible Steven.

SJ:

Always a good vote! And just to tie this back in real quick, because, uh, obviously we talk a lot about taxes on this podcast, the reason that thing is important that you went through all of that is that I get a lot of questions from advisors about how other tax planning decisions are going to affect financial aid is going to affect the fast application. And while in a 30 minute podcast, we’re not gonna be able to get through all of the intricate details. It just highlights that there are moving pieces here. And as you work with clients who have college age kids, or they’re approaching college, as we make other tax planning decisions, we’ve got to keep in mind that those numbers that’s certain of those numbers are getting reported on this FAFSA that there’s other implications beyond just, ’Hey, how much tax did I save on my tax return?’ So a great, great reminder to keep that in the planning.

AW:

Yeah, I’d be remissed if I didn’t also say, remember, there’s also a CSS profile and a consensus methodology that apply to certain schools. And so an easy way for an advisor to understand or appreciate that is think fast as the 1040. The 1040 easy, right? But the CSS profile and the consensus have a 170 plus questions. So that’s kind of like having to fill out a 1040 and a couple of schedules to go with that. And so that can certainly make the planning more complex as well, because remember when we talk about parents’ income, how many countless factors in lines are on a tax return that feed into that one number, you know, alone Steven. So yeah, that’s what makes it complex and makes it fun. I guess if that’s what you like, like I do.

SJ:

Yeah, well, definitely, definitely appreciate those people out there spending their time on this, making sure that, uh, there’s, there’s great resources and, and people are getting information they need. Uh, as we wrap up, we want to talk about action items. So Andrew, can you start with, what is, what does an action item, an adviser who wants to learn more about the college planning process to help their clients with w what’s what’s, what are some great resources they can go to?

Action Items [27:33]

AW:

So, I’m always a fan of the FPA. There are several, uh, great resources that the FPA puts out there. It depends on what area you want to learn. If you want to learn about how you pay off education loans and things like that, certainly seek out some of those. I have an education loan analyst designation, which just means I know a heck of a lot more than I want to, or anybody else wants to know about education loans. But, anybody with that is always a great resource. I also think, um, that most advisors have education consultants. So we didn’t really talk about the 200 plus hours in extensive nature that it takes to manage that process. So I think those are important. And then the other tool that I would say is starting an effective college process really needs to be a conversation, not just talking about how we save for it, but we really should be priding clients to begin thinking about the planning process or management of the process is early as sixth, seventh, eighth grade, because that extra time and bandwidth gives them time to not be as overwhelmed and to really be intentional with the planning outside of the finances, because the national average to graduate is 5.93 years, Steven, and I’ve never met a family that said I’m average, and they’re always thinking four years.

AW:

So starting in eighth grade, ninth grade, 10th grade managing a process significantly impacts the probability they’ll graduate in four years or less. And when you’re talking about a 30 to $60,000 expense, everybody would like to have an extra 60 to $120,000 in their retirement account or, you know, their, their favorite place to sock away money.

SJ:

Yeah, I like that. So, so making sure that you you’re taking the time to go out to those great resources and then building your, your wealth team, building your resources that you can refer people to, I think are both great action items from that. I would also add that you need to make sure that this is on the list of questions that you’re asking clients that we’re not just generically asking, ‘Hey, were there any life events we should be aware of?’ But making sure you know, how old their kids are, what their intentions are, is as far as, as funding college or making the opportunity available asking great questions is always going to be an important step in the, in the planning process, whether that’s tax planning or any other planning.

AW:

Yeah. One other question it’s really important for an advisor to ask that they probably can, or don’t have time to solve. But when the student is looking at college, we typically ask, what do they want to be when they grow up? And that’s a really bad question. They don’t have the mental capacity to make that decision. And so they usually make it just like we would based off of experiences and exposure, a better way to go at it is to figure out what they’re not good at and to reverse engineer that. And just like we wouldn’t go to Home Depot to buy groceries for dinner. Picking a good college really needs to come from narrowing down what our focus is from a career direction. And that also can be a great indicator of this is a four year college, even the right direction.

AW:

I mean, locally, we’ve got a trade school that is turning out and booked 15 months out on welding Steven, and they’re making six figures right out of the gate. And so if college is not your thing, really helping the student understand what the purpose is and what turns them on can really help the student become the driver of the process, which makes it easier for mom and dad and the advisor and drives the cost down and all those things. If you don’t mind, I’ll put in a shameless plug for my podcast, Educated Freedom. We talk about a lot of those, those different topics around college that’s a pretty good resource every now and then too.

SJ:

I love shameless plugs! Yeah, Andrew, I really appreciate you taking the time to come on and talk about all this, really appreciate the experience and knowledge that you have. So thank you. Thanks a lot for being here!

AW:

Pleasure. Thanks for having me, man. Yeah.

SJ:

And to everyone listening really appreciate you being here today. And until next time, remember to tip your server and not the IRS!