30 Dec Which college savings to spend first?

Q. My son starts college in September and I have $125,000 in a 529 plan and $75,000 in mutual funds. He also has $26,000 in an UTMA. Which money should we pull first?
— Dad

A. Like so many financial questions, the answer to this question is “it depends.”

Some of the factors to consider are how much of the money is going to be needed for undergraduate studies, whether graduate studies are a consideration, how much the student earns and will you or your son have higher or lower income years during in college, said Peter McKenna, a certified financial planner with Highland Financial in Riverdale.

He said you’ll also need to quantify any unrealized gains in the UTMA and mutual fund positions, and see how these assets could impact need-based aid.

McKenna said you should start with the expected expenses.

“Once you know the first year’s expected costs break them down into costs that can be deducted on a tax return and those that are qualified education expenses that can be withdrawn from the 529 accounts,” McKenna said. “Looking forward to future years, consider whether an off-campus living arrangement may happen and look at those expenses through the same lens i.e. deductible or eligible for 529 withdrawals.”

McKenna said you shouldn’t stress about the accuracy of these projections. The exercise should be to get a rough idea of how much is likely to be in each bucket after four years.

The next step is to determine the tax ramifications of selling the UTMA and mutual fund positions, McKenna said.

“Depending on how the UTMA is invested, there may be a taxable gain recognized when that investment is sold to pay education bills,” McKenna said. “This gain should go on the student’s tax return as the UTMA is considered their asset.”

You will need to do the same exercise with the mutual funds, he said, and determine if there is a taxable gain to be recognized. You indicate that you have the mutual funds, so any gains recognized will go on your tax return, he said.

“A number of changes are anticipated in the tax landscape in the coming years, so it would make sense to review your plan with your tax preparer to determine if it’s best for you or your son to take some of the deductible expenses or education credits that may be available,” McKenna said.

In a broad sense, you have two sources of funding, tax-free (529 plan) and taxable (UTMA and mutual funds).

In order to deduct expenses, they have to be paid for out of the taxable bucket, so make sure you consume enough of the taxable money each year to take any deductions you are eligible to take, McKenna said.

If your son is eligible for need-based financial aid, you will need to be mindful that income recognition and the assets may impact that aid. Generally speaking, McKenna said, income and assets in your son’s name (UTMA) have a larger impact on the aid formula than income or assets in your name.

“If the education expenses are going to consume most of these assets, I would target to consume all of the UTMA money before the mutual funds on the taxable side, and take the 529 money throughout the four years,” McKenna said. “It may be `easier’ to use the 529 money while the student is on campus as a single payment to the school can be sent for tuition, room and board.”

If off-campus, McKenna said, one payment is sent to the school for tuition and fees and other payments are made for rent/food, etc.

McKenna had one other thought. You said you have mutual funds but you didn’t say what they were invested in.

“If those funds are `at risk’ in the market, i.e. stock or bond mutual funds, you may want to liquidate them even if there are negative tax impacts,” he said. “Your need for funding is immediate and four years isn’t enough time to ensure you can recover from any losses before the final dollars are consumed.”

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This post was first published in December 2016.