E12: 4 Retirement Draining Taxes and How to Avoid Them

Nate: In this episode we will discuss the biggest myths about paying for your children’s college education and how you can survive the college years without destroying your retirement. She’s Holly, and she helps people find financial freedom.

Holly: He’s Nate, and he makes sense out of your money. This is Dollars and Nonsense. If you follow the herd, you will be slaughtered. Episode 12.

Nate: All right, Holly. This was really exciting stuff. This is something that’s on almost every parent’s mind is that with the college education cost is spiraling out of control, and it can cause a lot of stress on parents who think that’s it’s really up to them to be able to afford their kids to go to school.

Holly: Yeah, and really Nate, a lot of parents today have a bunch myths or things they’ve been told or taught that really affect them, and they believe the myths to be truth. That’s how they’re planning on paying for this college education or on trying to really provide the most for their children without realizing that some of those myths aren’t actually true, and that how colleges and universities determine financial aid, grants, and things like that is very different than from what most of us are taught to believe.

I know that I live in an area where we’re told right off from the bat, per kid you’ve got to put $600 a month away starting when they’re newborns just to be able to afford four years of university. How many of us really can afford that or is the belief that if we can afford that, they’ll be able to make it through college, graduate, and have these great jobs?

Nate: Yeah. It’s a huge investment for the family. One of the biggest fears as we mentioned at the very beginning was that there’s so many people who are really sacrificing their own ability to build wealth and to hopefully retire one day. They’re forsaking that with the good intention of investing in their children so their children can have a better life and go to school and not have to graduate with all this debt.

Yeah, with the cost just spiraling out of control, our goal here today is going to be to dispel some of the myths out there that are actually making college less affordable for people and maybe even present a new way to fund it that will allow you to actually get the money back and retire in a way that you can actually do it without having to push back retirement 10 extra years. That’s probably almost the average for a lot of people, especially if you’re wanting to actually pay the full force of your kid’s education. If you have a couple of kids, that’s hundreds of thousands of dollars you may be on the hook for.

Holly: Yeah, and I think most of them look at it they’re going to go to college for four years, maybe five. They still have that belief that, hey four years or five years, I can get them through that. When the reality is the average student now is going to school for six years.

Nate: Yeah.

Holly: Thinking long term even, I really can’t afford that. Instead of retiring in ten years, now it’s maybe 15 years because they went to school longer and I have even more bills.

Nate: I know for my kid I’m going to try to force them if they go to school to graduate in three. I’m going to be like no messing around guys. This is dad’s money.

Holly: Yeah. It’s called summer school and …

Nate: Exactly.

Holly: … midterm school and finish those courses.

Nate: Yeah, you’re going to just get through it as quickly as you can, but anyway. We’ve got really three myths today that we’re going to cover. We’ll cover those right after this break.

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Welcome Back. We just want to remind you we’re going to dispel some of the myths around how to fund college education today. The first myth is that I make too much money or as a family, as an individual, or couples you make too much money in order for your kids to receive any type of aid.

Nate: I think almost everyone of us believes that to a certain extent, and even people who don’t actually make a ton of money actually believe that I probably make too much money to receive any aid or for my kids to receive any aid when they go to school.

Holly: Yeah. I think with that it’s tied in [inaudible 00:05:35] what do I do with this money in order to make it look like I don’t make that much money in order to provide more for my kids to be able to go to school and receive more aid? When in all actuality, it really isn’t how much you make. It’s actually dependent on the student going to university.

Nate: Yeah. One of the things that we wanted to mention is that there’s really four tiers of what most schools and what FAFSA, that’s the Federal Aid Program really, what most schools and FAFSA, they have a tiered approach for what they weigh most heavily when they come up with a number. The number is called your expected family contribution. Based on a few factors, they say, okay, you guys should be able to as a family afford to contribute this much.

What actually is weighed the heaviest, if you think about like a pyramid, the very bottom of the pyramid, the thing that’s weighed the heaviest is the student’s assets. They will actually take into account 20 to 25 percent of the student’s assets. They will actually include in the expected family contribution right from the beginning.

One of the things, Holly, is that really should your kids actually have very much in their name when they’re going to school?

Holly: Yeah. Nate, this is their checking account or maybe they were left money by a loved one or a grandparent that wanted to help them out with their future or education. Then that money has been transferred to the student’s name in some form of asset. As soon as that transfer happens to the student’s name, it directly impacts what they are able to receive. I had a couple that their daughter actually received money from a grandparent, but she didn’t receive it until she was 21.

As soon as they transferred that asset from the parent’s name to her name, she immediately got half of her financial aid cut due to the amount of money that now was considered an asset for her and that she could afford the cost of going to university.

Nate: Yeah. The biggest thing that will prohibit you from getting any financial aid is if your kids have assets, checking accounts, savings accounts, especially like 529 plans that are in their name. Those things they prohibit you from receiving really free money. That’s the best. The government does provide loans, and they even can provide interest free loans if you get subsidized, but the main thing we want to get is scholarships, grants, and the free money. If the kid has a whole bunch of assets, if your child does, that’s not good.

The second tier that is weighed the next heaviest right after the assets is actually the student’s income. That’s actually weighed the next amount. I think there’s up to $6,000 they give the student an allowance or something in that area that you can earn before it starts coming into effect. One of the things as your kid is going to school or beforehand if they have a high income, that’s also going to count against them pretty drastically.

Holly: If they’ve been working since they were 16, 17, 18, they’ve been making pretty good money, and they’ve earned more than $6,000 or they continue to earn more than $6,000, automatically then that’s a big no, no for funding. They once again get a strike. I’m going to call it a strike like three strikes then you’re out to receive that free funding in the form of scholarships and stuff because they look at it as, well, they have a job. They can afford going to college. They’ve been working, so this is just another tier that is added on for the student. Basically you might have wanted to work real hard so you could afford to go to college, but what has happened is that has worked actually against you.

Nate: Then after the student income is taken into effect, then the next tier is actually the family’s assets. The family’s assets, they’ll take into account. The student was like 20 to 25 percent of their assets will be included in the expected family contribution. Around five to six percent of the family’s assets are included in that regard. Certain assets are more included than others. What FAFSA counts as far as family assets are 529 plans.

Holly: Absolutely.

Nate: They definitely count money, checking, and savings accounts weigh heavily against you. Many times FAFSA doesn’t include your home equity in FAFSA, but there’s actually some schools even go deeper themselves. There’s about three hundred schools that go even deeper than FAFSA who actually will include your home equity as a part of it. I was actually surprised to hear that retirement accounts those actually don’t count as a part of the family assets for the most part in FAFSA. I think they do in the more deep ones, but what was interesting was the money that you’re putting into retirement accounts that year.

In other words, if you normally max out a 401K contribution or an IRA contribution, they’ll see how much money did you actually put into that retirement account. They’ll count that towards your assets as saying you could have not made that contribution this year. You could have given that to your kids to help pay for school. The next tier was the family assets. Go ahead Holly.

Holly: Well, I think a key with that is just to say that that myth of I’m going to have to work for 10 more years or 15 more years does actually come into play because family or a mom and dad is making the choice to either not contribute towards their retirement program because it’ll be looked against them because of FAFSA or what they’ll do is say, okay, we’re still going to contribute because that’s our retirement program, and then it affects what the child is actually able to qualify for in regards to funding.

It really is sad that they look at it as what did you put in this year, and you could have put that towards your kids college. Having to actually pick between my kid’s college education or retirement in the future.

Nate: Right. That leaves us with one more tier. That’s the tier that what most people think of when they say I’m not going to get any aid is they think of their income. They say I make too much money. The very last tier, the thing that’s weighed the least heavy as far as all the tiers that you can think of is actually the family income. I believe that’s subject to an allowance. I think it’s only 25,000, somewhere like there that they give you an allowance. Anything above that they take into account. What we really want to stress is that the family income, the thing that most of us think I make too much money to get any aid, is actually the thing that they weigh the least of all possibilities. That’s the first thing, make too much money.

I wanted to bring one more thing in Holly before we moved to the next point. That’s really that probably one of the most, I guess I can’t really say the most, but it could be the most important thing is to make sure that you file for aid, file for FAFSA, file for anything else that you find for aid as soon as the door is open.

It was 2016 is the year that I’m thinking of. I think it was October 1st was the opening day that you could file for aid for the coming school year, so that would fall 2017 if you filed October 1st, 2016. A lot of people just wait, but if you think of it like a picture, it’s like there’s a big room full of money. It’s pretty much first come, first serve. If you’re in line way in the back because you filled yours out in December, January, February, you had all of these people going before you who were receiving grants and things. You’re just getting the crap that’s left, which is mostly the loans because all the grants have been distributed by that point.

The most important thing you can do is make sure you have all the paperwork filled out and ready to submit the day that the application is available. That will give you the highest chance of receiving aid. Any free money you can get is money that you and your kids don’t have to spend, which will of course drastically reduce the burden that you guys have.

Holly: It is normally around October for the following year. Really you might not be thinking about what college your kid’s going to school or they’re just going to start applying in January or February, but what you’re actually doing is really hindering them from receiving those funds first because you’re at the back of the pack. The parents that have been prepared are on top of it. October 1st, they were filing for that funding for 2017. They weren’t going to wait.

Nate: Yeah, that’s a huge thing that most people don’t realize. The first myth was you make too much income. That is the least important. The most important is filing on time and moving the assets of course out of the students name, also understanding what are you going to do with your assets because they’re actually are ways to shield your assets from being seen. That’s actually what we’re going to get into in myth number two.

Myth number two that most of us believe is that 529 plans are the best place to save money for college. Now Holly why is that a myth?

Holly: The reason that’s a myth is because often we either put it in our kids’ names or it’s in our names, so it goes against them for funding, but the other biggest reason is that the belief that this money can be used for anything for college education as well. Actually 529 plans are very specific in regards to what the money can be used for and can’t be used for. It actually is a strike against your student when you have a 529 program versus somebody who never did the 529 program.

Nate: Yeah, definitely. The first thing you mentioned was first off many times that’s either in your name or that’s even worse in your children’s name, which is a huge strike against you. It’s going to increase your expected family contribution that people are going to assume you can just come up with.

We want our expected family contribution to be way down. If you’ve got most of the money set aside that you wanted to spend for your children in a 529 plan, they’re not going to give you any free money. They’re going to say, you guys are going to have to use that first before we give you the free money. That’s terrible.

Then secondly as you said Holly is that what happens if your kid doesn’t want to go to school?

Holly: Well, if your kids doesn’t want to go to school, then you have all this money in a 529 program, and then there’s penalties to take it out. There’s penalties to remove it. Then you’ve put all this money in a 529 program that basically you have no access to really without penalty even though it was your money to begin with that was for your kid’s education.

Nate: I know. [inaudible 00:16:57] especially because Holly and I was talking about this before the podcast is that on top of that, college education itself is turning out to be a pretty bad investment because there’s so many people who go, spend all this money going, getting into debt, and then they go work as a bank teller when they graduate. Not only do these 529 plans require you to use the money for education or else they will charge you a fine to pull it out, the chances are getting more and more likely that college is not even a good idea if the cost of it continue to inflate the way that they have.

Holly: Yeah. It’s really sad that we are told one thing, and yet really the truth about that the myth that we’re debunking is that this 529 plan is the only way to go. It’s the best place, yet never in any planning are you told that goes against your child. It’s considered an asset. It affects funding. If your kid doesn’t go to college, guess what, now you’re going to be paying penalties, surrender fees, and all this other stuff just because your child chose not to go or you find out you can’t use that for this in college, you can only use that for this.

Then you might have put enough money aside, but you can’t use it for books maybe, they needed a computer, or something like that. You can only use it specifically for a designated outline that they tell you what you can and can’t use that money for.

Nate: Yeah, and 529 plans what most people are using them for is simply because you can put money in the 529 plans, and the 529 plan is actually after tax money. You put money in the 529 plan. You don’t actually get a deduction for it, but the selling point is that, hey, whenever you pull the money back out if there’s gains in whatever the money was invested in, you won’t have to pay taxes on the gains when you use it for college, which is nice, but many times that money is invested in the stock market directly or in mutual funds. What happens if you have a 50% drop like we had in 2008, and that happens to be the year that your kid goes to school? That’s going to be a pretty rough time to go pull money out of the 529 plan to pay for the kids. You thought you had enough money to send them to school, but then half of it is gone.

First off the volatility that is normally associated with those is terrible. The tax benefits are there, but honestly, Holly, what essentially I’m getting at is that you can do the same thing with a banking policy, what we use for infinite banking that’s designed for a cash [inaudible 00:19:32]. You can do the same thing with a policy that you can do with the 529 plan and not pay taxes when you pull the money out just by the nature of it being life insurance. You never have to worry if there’s a stock market collapse by the time that you get there.

I don’t mean to hog all the airtime here, but secondly the policy is not counted against you or your children when it comes time to fill out the FAFSA. It’s a hidden asset according to FAFSA. We don’t even have to report it. Not only can you guarantee that you’ll have the money, and you’ll also guarantee that it’ll be tax free when it comes out, but on top of that, the chances are actually higher by you changing where the assets were at instead of having a 529. Moving that into a policy, you’ll actually potentially reduce what your family’s going to have to pay in the first place.

Holly: Well, and Nate, also there’s a guaranteed growth rate that’s tax free for them, so you have the same, in my viewpoint, you have better tax considerations that the money is growing tax free for you. The thing is that this 529 program ties up your money for a period of time. You’re giving them those strong dollars today.

Maybe 18 years you’ve been putting money into this program, and it’s not necessarily there because you’re not in control of it. Yet with the life insurance policy, you are in complete control of that money. If you need to use it, you can use it. If your kid didn’t want to go to college, you’re not out the expense of having put it into a 529 program. In fact, there’s way more flexibility with a life insurance policy and to send your kid to college and university than there ever was with a 529 program.

Nate: Yeah. You can use it for whatever you want. There’s no fees even if the kid never goes to school. It’s just such a better place.

Holly: There’s more flexibility. If you want to pay for your kid to have a computer when they’re at school to do their schoolwork or stuff, you can take that money out of that life insurance program. 529 plan you can’t use money from that for that. It prohibits you, so your hands are tied. Like you said, the fact that this life insurance policy does not affect the funding your student will be receiving. It has no bearing on that. Even if they go deeper into your financials, most of the time nothing is asked in regard to a life insurance policy.

Nate: Yeah. Very few schools even ask about it. FAFSA definitely doesn’t, but they’re some schools who may, but very few actually count it as a true asset. That just adds to the power of using it.

Are 529s really the best place to save money for college? The answer is really no for the most part. They’re actually one of the worst because they’re market based. They penalize you for using it for anything else. They count against you when it’s time to receive aid. Let’s not worry too much about using those. Let’s focus on building wealth elsewhere.

The third point and the third myth, Holly, is that most people think that they’ll have to delay retirement or they’ll pretty much just never retire because of how much money they’ve had to spend sending their children to college. Why is that a myth or how can we bypass that at least?

Holly: I think the biggest way to bypass that myth is to understand that if you didn’t put the money in the 529 program and you used it in a whole life insurance policy, banking policy, by being able to borrow that money and pay it back, actually gives you additional income later on to retire. But really that big myth of I’m never going to be able to retire, if you’re depending on funding your kids education and you’re only going to use those resources, the 529 programs or borrowing the money and paying it back, or hoping they get grants or scholarship, you do have no hope that you’re going to be able to retire because basically you’ve used the traditional method. You haven’t thought outside the box. You believe what everybody told you. Do that 529 program. Put it in there, and instead it didn’t give you any flexibility.

By using those whole life insurance baking policies, you are actually able to not only borrow, but continue to have the money grow for you and still have money at retirement.

Nate: Yeah, I think that’s a huge point is that whenever you build money the traditional way to spend for college, which is normally in a savings account or in a 529 plan, that’s how most people pay for it, every single time you take money out of that and go send it to the school to pay for tuition or whatever, the money’s gone, and it has no chance of earning for you. The only way for you to replace it is to just work harder and start earing more money or start scrimping and start saving more just to replace what you had to just spend.

Whereas inside of a policy, you can actually borrow against the policy to send the money to the school. All the money in the policy’s going to grow as if it’s all there because you didn’t actually make a withdrawal. You took a loan out. You can decide, okay, I can repay this policy if I want to and get all the money back in there plus all the growth that occurred during that time frame or other ideas that we’ve had, Holly, like at one point you can lend money from the policy to do it, but also have the child pay you back just like they would have normally paid back a student loan company.

You can actually show them how they will receive such a great inheritance by doing so more, so not only can you get your money back, but upon your death, they can get all the money back that they paid you back for the loan. All of the money that normally people just spend can actually be kept in the family and reused for generations to pay for things like college education.

Holly: I think one of the real important points there Nate that you said is that you can either pay it back or you can give that responsibility over to your child and really show them the power and the benefit of what it does for your future and their future by having them actually pay you back the money that was used for the college education.

It’s not something that they have to start while they’re in college. You can actually delay that and wait until they’re actually out of college and they have a job. You can determine what those rates are, how long it’s going to take to pay it back, so that it’s not actually a financial burden to your child. It actually increases their future wealth when you graduate from this earth, but it also increases your ability to be able to retire and to have more retirement income.

Nate: Yeah, and honestly the whole point, if they also know they’re going to have to pay you back for it, it might actually make them more serious while they’re going to school, knowing that it’s not just free money to a certain extent. But even on top of that, we’ve actually built plans, have done thing, and we’ve actually seen it happen where we’ve built it to where the parent goes out and funds a policy during the building years as their kids are growing up and uses that policy to fund college education, but actually will after college education is funded down the line maybe five or 10 years after the kid graduates because the policy never stopped growing the entire time, they may actually have enough money in the policy to recoup all the premiums that they paid in to build the cash values plus all of the interest that they would have paid on the policy loans that they took out.

They can actually get all of their money back that they put into it, and then they can actually give the policy over to their child at that point. The parent is made whole and normally the policy actually still has enough money to benefit the child. The child can choose to repay the policy loan back, get back all the money, make all the profits. In other words, everybody can be whole. The parents can help fund it. The kid can actually receive it and receive benefits from the rest of his life from that same policy. It didn’t just go away like a 529 plan does when college is over.

Holly: Well, and Nate, the key there too is that basically what clients have discovered and individuals that work with us is they actually have been able to pay for their kids entire college education, so gotten all that money back, and still been able to give their child something with the life insurance policy for the child to be able to use.

To have the freedom to know all the money that you put in to pay for the education you have been given back, and yet your child still has this life insurance policy that they can use later on down the road, whether it be for a down payment on a house, a wedding, or a car, whatever it is that they’re going to use this for. It’s a win-win for both the parent and the child.

Nate: Yeah, exactly. The final thing is you actually can retire after spending the money on college. The issue is you just need to probably think differently about how you’re going to spend the money, where it’s going to come from because for the most part, the way normal people are doing it is they’re losing a whole bunch of money, not only the money that you’re spending, but the earning potential that that money had. That’s what really keeping you from being able to retire, a policy you never actually kill the earning potential, so that makes it extremely powerful over the lifetime.

Anyway Holly just to recap, the three myths when it comes to funding college education. The first myth is that you make too much money to receive any aid. That’s just not accurate. Many times that’s the least important thing. The most important thing is where you and your children’s assets are held. You want to try to find places where they’re not going to see them when it comes time to receive aid. Because any free money that you can get is money that you guys won’t have to spend, which is money really that’s in your pocket.

Second myth is that 529 plans are the best place to save money for college. As we’ve talked about, they’re really not. They go against you. They’re mostly market based, which means they may not be there, and they’re so restrictive on what they can be used for.

Final myth is believing that you’ll never be able to retire or that you’ll have to work longer to make up for the money you spent on college, which if you just simply change where the money was coming from to spend on it, didn’t lose the earning potential, you actually can get the money back and recoup it over the rest of your lifetime to be able to retire at the same time you thought you could.

Holly: I couldn’t agree with you more Nate. I hope that everybody basically has learned something new today, and that you really are able to start thinking outside of the box. This has been an episode of Dollars and Nonsense. If you follow the herd, you will be slaughtered. Get free resources and transcripts from this episode by visiting livingwealth.com/e12.