Financial Frontlines®

Some of you may have decided to use your post 9/11 GI Bill for your children’s education.  Some of you may have also set up a 529 Plan to help pay for their college education.   If you have both in place, you have the possibility to pay for your children’s college at a reduced price and potentially with tax advantaged funds.  BUT…the tax ramifications are not straight forward and you’ll want to think this one through before you “pull the trigger”.

First of all,  Veterans Administration (VA) benefits are always tax-free.  You will not pay taxes on the amount the VA pays for tuition and fees, the monthly Basic Allowance for Housing (BAH) or the book allowance.  Ever.  So that part is pretty straight forward.

But using your 529 Plan assets is a little more complicated.  Distributions from a 529 Plan are tax-free IF they are used for qualified educations expenses.  But, qualified education expenses must first be reduced by any tax-free education assistance received.  So, if you use 529 Fund assets for expenses already covered by the GI Bill you may owe taxes and a potential penalty.  Here are some specific examples:

GI Bill covers full tuition and fees (in state) and student has no other qualified expenses.

In this case, since the GI Bill covers full tuition, any withdrawal from a 529 Plan would be subject to tax and penalty.  The tax would be on the amount of the distribution that is classified as “earnings” and the penalty is an additional 10% tax on the earnings.

GI Bill covers a portion of the tuition and fees (out-of-state or private school) and student has no other qualified expenses

In this case, since there is a difference between the tuition paid and the amount covered by the GI Bill, then an amount equal to that difference can be withdrawn tax-free.  Any amount over the excess would be subject to tax and penalty.

GI Bill covers all or a portion of tuition and fees and student has room and board expenses

This situation is a little less clear.  IRS Pub 570 states that you must reduce the total qualified education expenses by tax-free educational assistance received.  This amount is called the adjusted qualified education expenses.  To calculate it the amount of GI Bill received to pay for tuition and fees will be deducted from tuition and fees paid only.  Also, in this case, since room and board are included as qualified expenses then I believe the BAH received should be used to reduce the qualified education expenses which in this case include room and board.  But…the IRS Pub isn’t clear.  Like in situation one and two above, if the amount withdrawn exceeds the adjusted qualified expenses, the excess is subject to tax and penalty.  This is one where you will want to talk to your personal tax advisor and get a determination based upon your specific situation.

So based on these restrictions what happens when you can’t use all the money in the 529 Plan for qualified education expenses.  There are a couple of “outs”  First, you can roll the funds over to another child, grandchild, spouse and certain other qualified people.  Also, again in my interpretation, since you could not use all the funds due to VA benefits, you can withdraw the funds without penalty.  You’ll still owe taxes on the earnings but you won’t pay the 10% penalty.

So there you have it.  529 Plans and the GI Bill do work together, but the tax consequences are a little complicated.

This content is provided courtesy of USAA.
By Joseph Montanaro, USAA Certified Financial Planner™ Practitioner

U.S. investors had more than $300 billion invested in target retirement date funds as of the end of the third quarter last year, according to the Investment Company Institute. With that type of participation, you’d think the funds would be better understood, but unfortunately, that’s not the case.

All things considered, I think this type of investment can be an excellent choice for investors who are unwilling, unable or uninterested in spending a significant amount of time managing their investment portfolio. Note that I’m not saying these investments don’t require time and attention — just not an extreme amount.

Overview

A target retirement date fund is a professionally managed mutual fund that allocates your investment among a variety of different types of assets: stocks, bonds, cash, etc. The portfolio is rebalanced by the fund managers and becomes more conservative as the target date nears. This type of fund is designed to be a one-stop shop — invest in this type of fund and you should have a diversified portfolio. The Lifecycle or “L” funds available within the Thrift Savings Plan are a good example of this type of investment.

Low Maintenance

Being a glass-half-full guy, let’s first look at some of the potential benefits of target retirement funds. You invest in a single fund and get a variety of investments that are managed for you. Since the portfolio of investments is picked, automatically rebalanced and designed to become more conservative as you approach the target date, this type of fund offers the advantage of allowing you to build and maintain a diversified portfolio. Then, keep your investments going and bump them up with each pay raise or promotion.

Look Under the Hood

You should understand that not all target retirement funds are created equal, even if they have the same target date. An informal survey of data available at www.morningstar.com reveals some sharp discrepancies between different funds with the same date. For example, when I looked at a few funds with a target date of 2020, I found the stock component of the portfolios varied from a low of 38 percent all the way up to 72 percent. And, expense ratios ranged from a paltry 0.18 percent to a whopping 1.96 percent. These differences impact the bottom line for you, the investor, and the returns reflect just that.

In both years, the performance varied substantially. In fact, in each year there was more than an 11% difference between the best and worst performers. That’s huge! What do you take from all this? You do need to do your homework. Look for a fund with low expenses, an equity weighting that won’t keep you up at night and performance. While past performance does not guarantee future results it can be a good indicator, so look before you leap.

No Guarantees

Target retirement funds do not offer a guarantee and are certainly not without risk. Unfortunately, some folks didn’t understand that and may have been shocked when their funds took a beating in 2008.

Any fund is just an investment tool and not a cure-all. You still have to figure out how much you need to save to meet your goals, monitor your overall portfolio and progress towards those goals, as well as set aside money for your short-term needs. But, if you’re looking for a convenient way to invest for retirement, a target date retirement fund may be worth considering.

Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Download a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.
Diversification and rebalancing does not protect against losses or guarantee that an investor’s goal will be met.
This material is for informational purposes. Consider your own financial circumstances carefully before making a decision and consult with your tax, legal or estate planning professional.
Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the United States, which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
The risks of the Target Retirement Funds reflect the risks of the underlying funds in which the Funds invest. The target date is the approximate date when investors plan to start withdrawing their money for retirement purposes. In general, the Target Retirement Funds’ investment program assumes funds will start being withdrawn for retirement purposes at age 65. The principal value of the Target Retirement Funds is not guaranteed at any time, including at the target date. The Funds’ objectives do not change over time.
Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

I’m getting ready to send my two boys off to college soon and college expenses occupy my mind quite a bit.  So, while recently doing some preparation for the IRS’s Special Enrollment Examination I came across something I hadn’t thought about for my own family’s tax situation that may apply to you as well.  And the issue is the combination of GI Bill and Scholarships.  Here are the basic tax rules:

1. Education benefits received from the VA are tax free.  So if your child is using your GI Bill benefits then all benefits, including the “housing allowance”, are tax free.
2. Scholarships/Grants used for qualified tuition and fees are tax free
3. Scholarships/Grants used for room and board are not tax free

So…

If the GI Bill benefits cover 100% of tuition and fees (which is most likely the case at an in-state public university), then, in my interpretation, any scholarships used for room and board are taxable income to the student.  There may or may not be an actual tax due for your child depending on other income sources.

On a related note, GI Bill benefits are “second to pay”.  So, if your child has scholarships that must be used for tuition and fees only, then those amounts will reduce the VA tuition & fees benefits received (again, assuming in-state public university).  In this scenario, it may make more sense to transfer the benefits to one child versus another based on “tuition only” scholarships or in-state versus out-of-state/private tuition.

Finally, if VA benefits (or VA benefits plus scholarships) cover 100% of qualified education expenses you cannot claim education expense tax deductions or credits.

Not end of the world stuff, but like most financial/tax related issues it is never as simple as it seems on the first look.

*Note:  Only post 9/11 GI Bill benefits are transferable to children and you must have been on active duty after 1 Aug 2009 to qualify.  Each Service defines its exact rules for transfer.

Are you being offered a starter loan late in your commissioning program or upon graduation? Will you take it…should you take it? What will you do with it? I know what they say about opinions but here are some points I think you should consider.

1. Take it. HOWEVER…

2. Don’t buy crap! Think…what will you think about your use of the money 5 years from now? Did you buy meaningless material goods that wore out, went out of style, or got upgraded 3-times over? How exciting is that car now after the new car smell has worn off and you’ve maintained it over the years? What’s that car worth now? Make sure that 5 years from now you can look back and say, “I’m proud of how I made good use of that loan money.” You don’t want to look back and think what a dummy you were. Experience can be a cruel teacher—get your brain ahead of your emotions.

3. Pay-off other higher interest loans hanging over your head. You’re already in debt so you might as well pay less for it. The bottom line is debt cost you and you want to pay as little as possible for it.  Plus by consolidating your loans, you simplify your life a bit.  The bottom-bottom line is you don’t want to be in debt period. Debt is a Chinese water torture that drips on your forehead every month. Every month you seethe at how much less money you have for yourself. If you can’t pay for an item outright, debt should only be used for an item you need right now for an important reason.

4. Start your permanent emergency saving account. Put $5k, $10k, $15k away in a savings account; you decide the amount. How boring! Exactly! Until you need it. This money is to ensure you stay debt free. This money has to be liquid and it won’t earn you a high return. A huge bill hits you in the head—car breaks down, refrigerator goes out, water pipes burst—and there’s your emergency account to the rescue. Voila!, no debt created. Now you’re feeling good about yourself for having a smart game plan in effect. Strive to keep the emergency account balance maintained at your set value.

5. Furnish your living space with must-have items. Every living space needs some items to make the space livable. Sofa, chairs, dining room table, pot/pans, utensils…okay maybe even a decent flat screen. Shop for the best prices and don’t go overboard. Think “must have” items.

Best wishes as you start your new life. Keep your head screwed on straight and study a few solid money management concepts (look in this blog). You are at a point in your life where a lot of more senior people wish they could go back and not make the mistakes they did. Use their experience to your benefit and don’t repeat bad history.

Some of you retired or separated from the Service soon after implementation of the Post 9-11 GI Bill in August 2009.  You probably didn’t realize at the time (who did?) that you had to transfer the educational benefit to dependents BEFORE you actually separated from the Service.

Maybe others of you didn’t find out about the “…before you separate policy…” until after separation.  Of course, the longer the time period after the P911GIB implementation, the less likely it is that you couldn’t have known about the policy.

If you didn’t transfer benefits but intended to, you have an option to try and fight for your transfer benefit.  The Services control the transfer benefit, not the VA.  If you were still in the Service after the Aug 2009 Post 9-11 GI Bill start date, you were eligible to transfer the benefit up until your retirement or separation date.

Your option is the Board for Correction of Military Records (BCMR) program.  Each Service has a BCMR program.  This is not an automatic approval process.  You can be turned down under this program.  If, and this is a big IF, the Board decides in your favor, your transfer benefit can be reinstated.

You have to apply to the BCMR for consideration.  The burden is on you to prove the Service neglected to provide proper management or counsel that denied you benefits you intended to exercise or tried to exercise.  Saying something was “unfair” won’t cut it.  You have to show evidence that you were wronged by the Service per laws, regs, policies, directives, deficient base-level program, etc.  Why didn’t you apply prior to you leaving the Service?  How is this the Service’s problem and not a personal problem?

Think you have a case?  Put together your BCMR package and see what happens.  See the appropriate web site for information on the process:

Army:  http://arba.army.pentagon.mil/

Navy/Marines:  http://www.donhq.navy.mil/bcnr/bcnr.htm

Air Force:  http://www.afpc.af.mil/afveteraninformation/afbcmr.asp

Post 9-11 GI Bill law: http://www.law.cornell.edu/uscode/html/uscode38/usc_sup_01_38_10_III_20_33.html