Borrowing for college poses risks for parents

Your Money

May 20, 2007|By Janet Kidd Stewart | Janet Kidd Stewart,Chicago Tribune

We are 57 and 58 and have two children in college, one at a state school, one in a private school. They will be there for the next four years.

My husband has just started putting money in his 401(k)-type plan because of (previous) concerns over cash flow. I have put in the max and catch-up for many years. My thought is to get a "line of credit" loan to pay college bills so that the maximum can be put in retirement plans. I would rather pay interest on a home loan to decrease our taxable income now.

Is this a rational line of thinking?

- Mariana Johnson, Lincolnshire, Ill.

Ann Laferriere, a financial planner and president of Griffon Financial Planning Inc. in Bend, Ore., said she thinks your plan could work, but she's nervous about it.

You said your retirement savings are roughly five years' worth of income, and you and your husband are within seven years of traditional retirement age.

If you will be receiving a traditional pension at retirement or inheriting a pile of money, you may be fine. If not, you'll have to save aggressively and probably not retire until beyond normal retirement age, Laferriere said.

"I think they should reconsider how much they're willing to spend on college," she said. "It's too dangerous to fund the children's education and simply hope you'll be OK in retirement."

Another problem is ongoing cash flow. You indicated an inability to save much for retirement in the past because of concerns over paying current expenses. Laferriere wonders what will change in the future that will allow you to pay down the home-equity line.

And, if your effective tax rate is low, the incremental benefit of borrowing so you can continue funding your workplace savings plans also is low, she said. If your effective tax rate is high, the idea makes more sense.

Should you decide to go ahead with your idea, be sure to first take a look at the tax limitations. If you fall under the alternative minimum tax, for example, interest deductions on home-equity debt for non-home-related purchases can be limited. Even in non-AMT returns, there are limits to deductions.

Check out Publication 936 from the Internal Revenue Service for more information on the tax issues. And run a more detailed retirement analysis or hire someone to do that for you before committing to the next four years.

I retired last year and started receiving monthly pension checks in August. The only deductions from my pension payments were to cover federal and state income taxes. To supplement my pension, I recently exercised some stock options. Not only were there deductions from the proceeds for federal and state taxes, but an additional withholding amount of 6.2 percent was retained for Social Security and another 1.45 percent for Medicare. I was under the impression that I was exempt from paying Social Security and Medicare taxes since I am retired. Am I required to pay this? If not, how do I recover what has already been withheld?

Also, is there an IRS publication that addresses this subject?

- Paul Wroblewski, East Hartford, Conn.

Sue Hales, an IRS spokeswoman in Chicago, thinks there may have been a withholding error. Generally, stock options are not treated as income but are taxed like capital gains. She suggested notifying your employer to confirm that the exercised options were not ordinary income. If the employer must refund that money, you will likely receive the refund from the employer and then the company will have to apply to the IRS for a refund of the taxes.

Hales also pointed out two IRS sources on dealing with stock options and taxable versus non-taxable income. They are at: and (relevant data starts on page 10).

Have a retirement question? Write to, or via mail at Your Money, Chicago Tribune, Room 400, 435 N. Michigan Ave., Chicago, IL 60611.

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