We have received our first bill from the college I will attend in the fall. My parents and I are trying to budget our college payments for the coming academic year. How should we prioritize spending our college savings? Is it better to spend my assets or theirs first?
Families should spend down student assets before parent assets, because student assets are assessed more heavily than parent assets in the financial aid formulas. Use money from custodial bank and brokerage accounts first, spending it down to zero before touching the parent’s money.
There is one exception to this rule: the custodial versions of 529 college savings plans. If the student is a dependent student, these are treated as though they were parent assets on the FAFSA (Free Application for Federal Student Aid).
Parents may be tempted to spread out the college savings over all four years of the student’s college career, spending a quarter of the money each year. However, this strategy is less than optimal, because the college savings will not only reduce eligibility for need-based aid during the freshman year, but also each subsequent year. Spending more of the money sooner will increase the student’s financial aid eligibility. This strategy will also reduce the amount of debt during the first year or two, thereby reducing the amount of interest that will accrue on unsubsidized loans while the student is enrolled in school.
Note, however, that one cannot use a tax-free distribution from a college savings plan to pay for tuition and textbook expenses that enable the student to qualify for the American Opportunity Tax Credit. IRS rules prevent double-dipping, so families cannot qualify for two tax benefits from the same qualified education expenses. Accordingly, the family should carve out up to $4,000 in tuition and textbook expenses to be paid for in cash or through loans, not 529 college savings plan distributions, so that they can qualify for the maximum $2,500 tax credit.
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