“Navigating College Costs: Alternatives to Selling Investments”

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What to Consider Before Selling Investments to Pay for School

Dipping into an investment account to cover educational expenses can help minimize the need for student loans. If the account was created specifically for this purpose, the decision might be straightforward. However, selling investments not originally intended for college costs requires careful consideration of potential downsides, such as tax implications and opportunity costs.

Potential Tax Implications

The tax treatment of investment gains varies based on the type of account and the duration of the investment:

• 529 plan or Coverdell ESA: Withdrawals are tax-free if used for qualified educational expenses.
• Brokerage account: Gains are taxed at your ordinary income tax rate if held for less than a year, and at a lower long-term capital gains rate if held longer.
• Custodial account: The first $1,250 in gains are tax-exempt; the next $1,250 are taxed at the child’s rate; additional gains are taxed at the parents’ rate.
• Traditional 401(k) or IRA: Gains and original contributions are taxed at your ordinary income rate, with a possible 10% early withdrawal penalty.
• Roth 401(k) or IRA: Contributions can be withdrawn tax-free, but gains are taxed at your ordinary income rate and may incur a 10% penalty.

Consult a tax professional to understand the potential tax bill based on your specific situation.

Lost Investment Gains

If the investment account was not initially set up for educational expenses, consider the opportunity cost of withdrawing funds. The average annual return in the stock market is about 6% to 7% after inflation. In contrast, federal student loans for undergraduates have a 5.5% interest rate for the 2023-24 academic year. The long-term cost of student loans might be lower than the potential gains from leaving investments in the market. Additionally, student loan forgiveness or repayment assistance could further reduce the cost of student debt.

Limited Future Financial Options

Withdrawing from an investment account intended for future needs, such as retirement, can limit your financial options later. Even if you believe you have time to replenish the funds, it remains a significant risk.

Alternative Ways to Fund Your Education

Before tapping into your investments, explore other options for covering educational expenses:

• Scholarships: Colleges and universities offer scholarships based on financial need or merit. Check with the school’s financial aid office and use scholarship databases like Scholarships.com and Fastweb.
• Grants: Federal and state grants are available through the Free Application for Federal Student Aid (FAFSA). Private grants can also be found in scholarship databases.
• Employment: The federal work-study program offers part-time jobs on and off campus. Alternatively, you can find jobs independently for more control over your work hours.
• Student loans: Federal student loans have fixed interest rates and flexible repayment options. Private loans vary in interest rates and repayment terms based on creditworthiness. Apply for federal loans through the FAFSA and compare private loan rates individually.

How to Choose College Funding Options

With numerous ways to finance college, research all options to find the best approach. Often, a combination of methods is necessary:

• Use scholarships and grants for tuition and fees.
• Work part-time to cover living expenses.
• Sell some investments for books and supplies.
• Use student loans for remaining costs.

Follow these steps to determine the right mix:

1. Assess your situation and available options.
2. Apply for financial aid to understand your resources.
3. Evaluate your expenses, both upfront and ongoing.
4. Determine the amount needed from each source to cover educational costs.
5. Reevaluate your situation annually, as scholarships, grants, and employment opportunities may change.

The Bottom Line

If you’ve been investing for educational expenses, using those funds when needed is logical. However, if considering selling investments meant for other financial goals, weigh the pros and cons and explore other options to make an informed decision.

For any mortgage service needs, contact O1ne Mortgage at 213-732-3074. We are here to assist you with the best solutions tailored to your needs.

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