MAKING SENSE -- August 10, 2012 at 10:04 AM EDT
What's the Best Way to Fund a College Fund?
The 2012 Vassar College Commencement in Poughkeepsie, New York. Photo by Paul Zimmerman/Getty Images.
Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Friday's query comes from a reader at Next Avenue. The NewsHour has partnered with Next Avenue, a new PBS website that offers articles, blogs and other critical information for adults over 50.
What is the smartest way to fund your kids' college careers? Last year we cashed in some stock and got killed with tax penalties, because it looked as though we had a windfall. In fact, we have stashed some stocks for retirement...which all of a sudden isn't that far away. Taking out a home equity loan scares us a little and the house will be paid off in eight years, so I'm not sure what to do.
--Valerie Smith Sheehy
Paul Solman: I don't understand, Valerie. You think you would have been better off not cashing in your stock until it dropped in value, so the tax bite wouldn't have been as great? Do you see that makes no sense? And makes even less sense if you think, as I do, that capital gains tax rates are more likely to go up than down.
As to loans to pay for college, there is one criterion and one criterion only: the interest rate. Get the lowest rate you can. Generally, that will be a home equity loan, which has the further virtue that they can't grab the collateral for the loan - your house - should you go bankrupt.
Now comes the hard part. I suspect you're really asking whether you should cash in assets OR take out a loan. Here, the calculation can be somewhere between tricky and impossible, but the essential principle is easy to grasp. Let me explain with numbers: a $10,000 loan versus withdrawing $10,000 from an account.
The basic issue is cost: which costs you more? Say the loan is at 5%. Is that more, after taxes, than you figure to make on $10,000 you've got invested? You can see the complications, I hope.
As for myself, my wife and I maintain a mortgage on our home because we'd otherwise have to liquidate all our non-retirement financial assets and we, like you, don't want to draw down our tax-deferred accounts if we don't have to.
As usual, look for a second post early this afternoon. And please don't blame us if events or technology overtake us. This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions.