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How to Fix 6 College Funding Mishaps

Bo Hanson, Brian Preston

When it comes to college planning, all parents need to take a deep breath and exhale. It's difficult to budget for a major expense and help your child transition into adulthood at the same time. And the best laid plans rarely play out in the real world. Here's how to handle college funding when the unexpected happens.

Traditional four-year college is not for your child. A traditional four-year college is not the best choice for everyone. There are several great careers that do not require a four-year college degree, and some students are not ready to transition to a full-time college. Parents are often surprised to find that their 529 plans can be used to pay for local community colleges and trade or vocational schools.

[See: 10 Ways to Repair Your Retirement Finances.]

Your son or daughter has a full scholarship. Congratulations on hitting the jackpot. But what happens to your 529 account? Even if your child is talented enough to get a college scholarship, you can't necessarily count on it. You may still want to fund a 529 account because these accounts can be transferred to another qualifying family member without penalty or taxes. There is also an exception to the 10 percent penalty for withdrawals if your child earns a scholarship or attends a military academy. However, income taxes will still need to be paid on any earnings.

You don't earn enough to save for college and retirement. We all want the very best for our children, and there is tremendous pressure to support your child's educational aspiration. But most financial advisors will tell you that retirement planning should be prioritized over saving for higher education. There is an entire industry devoted to education funding, including student loans, scholarships, grants and work-study programs. However, there is no loan, scholarship or grant for retirement and financial independence. Your only back-up plan if you prioritize education over your own retirement is the hope that your children will allow you to live off of them or with them. For most parents (and children), this is a less than ideal situation.

[Read: How to Prioritize Retirement Versus College Savings.]

You want to use another state's 529 plan. You do not have to set up a 529 plan in the state where you reside. However, there might be some state tax incentives and deductions you could take advantage of if you open an account in your state of residence.

Your child attends college outside the state of your 529 plan. There is no limitation on the state where you can use your 529 savings plan. The entire account can be used at a qualifying institution no matter which state the institution is in. However, some states also offer prepaid tuition programs. Some of these prepaid plans allow you to transfer the value of your contract to a private or out-of-state college, but you may not get 100 percent of the value on the transfer.

You want to help your child with other big purchases. The simple truth of having children is that they are expensive and their needs are diverse. Education planning and funding is only one facet of their many needs. Many parents also have the desire to help pay for a future wedding or even provide a leg up on life with a down payment on a first house. Education funding accounts are not the ideal choice to fund these other goals since any earnings that are not used for education are subject to a 10 percent penalty. Fortunately, there are other accounts that you can use to fund these goals.

Custodial accounts could help you to save for weddings and a future house down payment. However, if the accounts grow to the point that they generate over $1,050 of unearned income, you will have to file a separate return for them and in certain circumstances those earnings could be taxed at your marginal tax rate.

Roth IRAs can be set up for children who generate earned income. To jump-start a desire to save for the future, parents could provide a matching contribution that will incentivize saving for the future. However, the total account funding cannot exceed the lesser of 100 percent of the child's earned income or $5,500.

[See: 10 Costs You Can Eliminate in Retirement.]

With all the stresses connected to being a parent, it is comforting to know there are multiple options and resources to help you and your family reach your education and other financial goals. However, the best resource you can provide your family is a healthy and supportive environment. A big part of that is to ensure your financial household is on stable ground before trying to provide financial assistance to your children. Making smart money choices sets an example for what sound financial decision making looks like.

Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".

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