Headed for Divorce? Financial considerations to make sure your children receive a college education

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When parents divorce, a big concern is the children and how to pay for future college expenses and retirement at the same time. Parents with younger children can plan ahead and make contributions to a college savings fund before the child graduates high school. However, parents with children about to attend college have a more immediate concern when drawing up a college support agreement. This is where a financial advisor who is a Certified College Funding Specialist (CCFS®) can become invaluable to that family, and their lawyers.

When it comes to college, many states do not end child support once a child reaches legal age. If this is the case, then a child planning to attend college will be awarded “college support” (also called post-secondary or post-minority support) by the court. However, if a state has no statutes regarding college support, then parents must include provisions for a college education in the children’s support agreement.

Regardless, with college costs continuing to rise every year, it’s imperative for the divorcing parents and their lawyers to contact a Certified College Funding Specialist (CCFS®) to help design a detailed financial plan for college in the divorce settlement. And of course, if the family and college-bound student plans to apply for financial aid, then there are some specific issues that need to be addressed before completing the FAFSA® and CSS PROFILE® financial aid applications. 

Divorced or Separated Parents

If the parents are divorced or separated, the income and asset information of the parent with whom the student lived the most in the previous twelve months must be listed. A "separation" need not be a legal separation. The student’s parents may consider themselves separated when one of the parents has left the household for an indefinite period of time and no longer makes a substantial contribution to the finances of the household.

If the student did not live with one parent more than with the other (as in the cases of joint custody or a married couple who divorced or separated immediately before the financial aid application was signed), the income and asset information of the parent who provided the majority of financial support during the previous twelve months should be used. However, this may not be the parent who claimed the student on a tax return, or the parent who was awarded custody by a court order. And in this case, "financial support" includes money, gifts, loans, housing, food, clothes, car, medical and dental care, payment of college costs, etc.

Example:

On September 15, 2017, a married couple was divorced. On October 1, 2017, their college-bound child completed a financial aid application. For financial aid purposes, the household status is determined as of the date the financial aid application is submitted. Since it was determined that the mother was the custodial parent, in this case, only her income and assets were reported on the financial aid application. Based on their accountant’s advice, the couple had filed a joint tax return for 2015. Since only the mother’s income was reported on the financial aid application, she had to separate her income and corresponding income tax liability from the joint income and report it on the financial aid application.

Do you think divorce lawyers consider these issues when structuring a divorce agreement?

Speaking of structuring a divorce agreement, it may be beneficial for the parent who will have custody of the children to receive more assets and less income in the settlement. Especially if any of the children are approaching college age. Since only the custodial parent’s income and assets will be reported on the financial aid application, it may benefit the children’s financial aid eligibility because assets are assessed at 5.6% and income is assessed at a rate of 47%. Also, if the custodial parent has less income, it may be easier for that parent to qualify for the American Opportunity Credit, Lifetime Learning Credit, and/or the Student Loan Interest Deduction; as these tax incentives have income phase-out rules that will disqualify taxpayers who have too much income. 

Example:

A couple is in the process of structuring a divorce. The wife is expected to have $40,000 in income and the husband is expected to have $190,000 in income after the divorce. To make up for the disparity in income, the wife is to receive a greater share the couple’s assets. Because of the structuring of income and assets in this manner, they decided to have the children live with the wife. This will increase their children’s eligibility for financial aid. The wife’s income will also make her eligible for the education tax credits (provided she met the other criteria for claiming these credits).

Education Clause of Divorce Settlements

An “education clause” is often included in a divorce settlement. These clauses require the non-custodial parent to contribute a certain amount of money to the children’s cost of college. Some colleges will treat this contribution as a “resource” of the student. Thus, this non-custodial contribution reduces the child’s financial aid eligibility on a dollar-for-dollar basis.

Furthermore, many divorce settlements include a provision to create and fund a trust for the benefit of the children. Since assets are being shifted from the parents to the children, the parental asset assessment rate of 5.6% will change to the children's asset assessment rate of 20% and will cause a loss in financial eligibility.

Divorce Planning to Cut the Cost of College

Proper financial aid and tax planning in a divorce can preserve more of the income and assets for both the parents and the children. Here are some areas in divorce planning that financial advisors should consider when planning for college at the same time.

Property Settlements

Property settlements should be developed to ensure they are equitable. Even though the fair market value of the properties to be distributed appear to be equal, the financial risks and tax consequences related to these properties may be unequal.

For instance, a limited partnership interest in a business could lose some of its value, while a money market fund would retain its worth. Therefore the spouse who is responsible for the children's future college costs would probably not want to receive an asset whose value could potentially decrease, especially if that particular asset was going to be used to fund college costs. 

In addition, there are some assets that create a large tax liability, if liquidated for college costs. It may not be wise for the spouse who is responsible for future college costs to receive assets that have a potentially large gain or loss, such as stocks. The spouse does not need a large tax liability at the same time as college costs ensue.

Furthermore, the timing of tax consequences in divorce situations can also be significant. In the event that one spouse is expected to be in a lower tax bracket, a property settlement can be structured to take advantage of the tax savings created by having more gain taxed at a lower rate. This tax savings could be used to fund part of future college costs.

Alimony

Since alimony is deductible from the gross income of the spouse making the payment and included in the income of the spouse receiving the payment, the deduction for alimony creates an opportunity to shift income from a higher to a lower tax bracket spouse. Payments made to a former spouse that can be considered alimony are medical insurance, mortgage payments, real estate taxes, insurance, utilities, life insurance premiums, and college costs.

A divorced client can also use alimony to save for a child’s college education by investing in Roth IRAs. If the client had no earned income, no contribution to a Roth IRA could be made. Since alimony is considered earned income, the alimony payment could be used to fund a Roth IRA. Then during college years, these Roth IRA contributions could be withdrawn income tax-free to pay for college expenses.

Qualified Domestic Relations Order

Future assets, such as pensions and retirement benefits, are often not considered in constructing a divorce settlement. A “Qualified Domestic Relations Order” (QDRO) is required for an ex-spouse to receive an interest in a former spouse’s retirement benefits. A QDRO is a judgment, decree, or court order that provides an ex-spouse with the right to receive benefits from a qualified retirement plan. A QDRO specifies the amount of retirement benefits to be paid or rolled over from the retirement account owner to the former spouse, and the children. These retirement account benefits are taxed to the former spouse when they are paid and can be used to pay future college costs.

Prenuptial Agreements

If a client intends to remarry after a divorce or the death of a spouse, the use of a prenuptial agreement should be considered. Such an agreement can be used to preserve the funds established for future college costs for children from a prior marriage. Absent a prenuptial agreement, the ownership and disposition of property in future divorce proceedings will be determined by state courts. The court decision may be contrary to the original intention of using the assets to fund the future college costs of the children or stepchildren.

Consult a Certified College Funding Specialist

When divorce planning is involved in a client’s financial plan, the children’s eligibility for financial aid should definitely be considered. Married families with high income and assets will not qualify for need-based financial aid. However, once the parents become divorced or separated, the student could become eligible for considerable financial aid and a Certified College Funding Specialist (CCFS®) would become invaluable to that family, and their lawyers.

 

Posted by Ron Them

For over 20 years, the nation's leading financial advisors, broker/dealers, and major media outlets have been using his research, funding strategies, training, and insight. Ron is highly regarded as an expert in the college funding field.

He is a former Chief Financial Officer of a Fortune 500 company and currently owns his own financial advisory company specializing in cash flow planning for business owners and executives. He developed the Cash Flow Recovery™ process that uses cash flow management principals to increase asset value and build wealth for business owners.

He is also the originator of several software calculators to help advisors and families make college affordable, including:

* College QuikPlan EFC Calculator
* "Find the Money" College Cash Flow Calculator
* College Debt Reduction Calculator

Ron has been quoted in U.S. News and World Report, Kiplinger's Personal Finance, Smart Money, Financial Advisor Magazine, Small Firm Profit Report, Practical Accountant, LIMRA's Market Facts, Senior Advisors Magazine, HR Magazine, BenefitNews.com, Employee Benefit News Magazine, ProducersWeb.com, Entrepreneur Magazine, Insurance Selling Magazine, CollegeNews.com, The Christian Voice, and Columbus CEO Magazine.