college savings

Saving Summer

photo shows a shiny red push lawnmower sitting in green grass in front of a brown picket fence

In the United States, as in most places in the world, we are governed by the Gregorian calendar. But as we flipped the page and entered the “-ber” months, many of us are facing once again the power of the all-important academic calendar. 

Children, grandchildren, and neighbors are back to school. Summer is over for most of the country, and it’s got us reflecting. Without school, summer for many families can include more sleepovers or late nights and long chats on the porch. It could mean hours at the city pool or the anticipation of a big vacation. 

For some of us, summers also meant more leisure and more work. 

It’s possible that you earned your very first dollar—and then some, hopefully—one summer long ago. Teens are more likely to be employed during June, July, and August than any other time of year. And it makes sense: teens are more likely to have the time and opportunity then, as jobs like lawnmowing, babysitting, and lifeguarding peak each summer. 

Clients, if anyone in your household under age 18 was out making money this summer, consider talking with them about the “Swiss Army Knife of finance”: the Roth IRA

As long as someone has earned income (and doesn’t make more than the cap), they can contribute to a Roth IRA (up to the maximum amount). This means they might contribute up to the smaller of $6,000 or their 2022 total earned income. 

Say your child or grandchild earns $3,000 in the summer: they could contribute up to $3,000 to a Roth. Of course, they may not want to forfeit all their earnings, but if they’re able to, this may be a prime opportunity to impart the value of saving. If you’re feeling nice, you could “gift” them the $3,000 to replace what they saved. Better yet, offer them a match: you pay them back some percentage of what they save.

Roth contributions are taxable now and enjoy tax-free future gains. Beyond the magic of compounding, starting a Roth account early has other benefits: 

  • At any time, you may withdraw contributions without facing a penalty or taxation. 
  • Beginning five years after the Roth was opened and funded, account holders can take out up to $10,000 (earnings and contributions) to fund the purchase of their first home, tax- and penalty-free.  
  • Beginning five years after the Roth was opened and funded, account holders can use it to pay for qualified college expenses, penalty-free (earnings will be taxed as regular income). 

As children near college age, investors may have questions: the government does not include retirement accounts as assets in the calculations for student aid, so this type of savings vehicle should not impact the availability of federal financial aid. 

Withdrawals would be counted in the calculation, but be aware: the FAFSA uses a “prior-prior year” income picture to avoid having to base their decisions on estimations. So, for example, even withdrawals made in a 4-year graduate’s junior year shouldn’t affect their aid eligibility. 

The process of getting something like this set up isn’t terribly complicated. It is not necessary that the working person have a W-2, though we do recommend keeping records (think: basic invoices or even simple receipts from the neighbors for those lawnmowing or babysitting services). 

Clients, could this be a way to help your children or grandchildren preserve a piece of summer? Call or write, anytime.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply. 

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. 

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College Savings Ideas When There’s More Than One Kiddo

photo shows graduation caps in the air against a blue sky

Some things that seem complicated can be made simple. Other things, like college funding accounts for descendants, may get more complicated over time when more than one child is involved.

Consider how disparities may develop across account balances:

  • Imagine that, upon their birth, the first child receives a one-time deposit of $1,000; the second-born receives $100 monthly from birth to age 18; the third on the way is set to receive the same deal as either of the first two. However, this third child will necessarily have less purchasing power from the same amount in contributions. Why? In the years that have passed, inflation will have done its work.
  • One-time deposits may go in at a more advantageous time to invest for one child than another.
  • Equity among children will remain a shifting target as asset values and college costs change over time.

… And all this is before we even consider the differences in children’s needs.

One approach to simplify this reality is to think of college funding as a consolidated endeavor for the group, not as individual accounts. With a 529 plan owned by grandparents or a Roth IRA earmarked for education, this can be done. (We should note: owners of 529 college savings plans may change the beneficiaries among siblings or cousins with no adverse tax consequences.)

Consider this example. If there are seven grandchildren, you can allocate 1/7 of the total college fund balance to the oldest, then 1/6 of what remains to the second-oldest, and so on as each grandchild reaches college age.

In the case 529 college savings accounts are used, transfers may be needed to set up the oldest with the proper balance. If a Roth IRA is used, a withdrawal in the proper amount can be made by the grandparent to meet education expenses, then the “paid” child is removed from the beneficiary (or contingent beneficiary) provision.

Proceeds of a gift via Roth may of course be used for purposes other than education, a house down-payment for example.

Some clients who have 529 accounts for grandchildren make adjustments from time to time among grandchildren’s accounts to reflect each child’s individual needs and to maintain a better sense of equity. Others deposit equal amounts for each grandchild and do not worry about differences that emerge later.

One general rule in college funding: the more removed the funding is from the child, the less impact it may have on college aid formulas. A 529 account owned by the child is 100% available for college expenses, but a Roth IRA balance of a grandparent or parent has little or no impact.

Clients, we talk about options and alternatives; you make decisions. If you would like to talk about strategies for your children or grandchildren, email us or call.

Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax-free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

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College Funding Ideas When There’s More Than One Kiddo Presents: The Best of Leibman Financial Services

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