Time for some more
musings from madamwittyTM on this topic:
I've been evaluating all sorts of scenarios and before I get into the details I thought I should make a few comments about the framework I'm using to evaluate the various options:
- I am committing to fund the entire EFC for all three of my kids. I expect the vast majority of the EFC to be based on my financial situation and I don't think it's fair to penalize them (i.e. make them pay) for my financial decisions. (Especially the decision to retire early where that has a negative effect on EFC.)
- In addition, I will not limit their choice of colleges to public colleges only. I benefitted greatly from attending a private college as compared to my public options and want them to have the same opportunities. This means I cannot count on the "simplified EFC" or "zero EFC" option working for us (although if it does, some years, that would be great!) Many private colleges include home equity in their asset evaluations; some limit this as a multiplier based on annual income, but some do not. I can't afford to cover unlimited home equity, but I think 2-3 times annual income (which is common) is doable.
- On the flip side, I can't guarantee that a particular college will provide full financial aid for everything other than EFC. I will encourage my kids not to pick a school with a gap or substantial loans in the aid package, but ultimately that will be their decision and their financial commitment.
- I have 10 years of college to fund over 3 kids, which means my funding plan has to be sustainable over a long timeframe and flexible to market conditions.
- I plan to save enough money in 529 Plan accounts to cover EFC (to prevent college funds being assessed as income). If I run out of 529 money, I can dip into an IRA in the last 1.5 years, after the last FAFSA is submitted. I might also have a 529 in grandparents' names for the last 1.5 years of DD1 and DS2. But actually I wouldn't be surprised if I end up with too much 529 money.
- Annual living expenses need to come out of Roth pipeline, SEPP 72(t) withdrawals, capital gains from taxable investments, or even earned income. (For planning purposes, earned income will be purely incidental for something I do out of enjoyment, and not counted on in my plans. In fact, unplanned/variable earned income kind of throws a wrench in my plans! But some amount is desirable in order to get certain tax credits.)
- I assume I can manipulate the starting amount in my taxable investment accounts to whatever I want (at a coarse level.) I am pretty sure this is true. I can either boost taxable savings in the years prior to retirement by foregoing 403(b) contributions, or I can spend down savings in my first couple years after retirement. I have yet to evaluate the impact to my Roth pipeline.
My conclusion:The lowest EFC solutions I could come up with all involved SEPP 72(t) withdrawals. I suppose this makes sense upon reflection. Pulling directly from a retirement account reduces the amount taxable investments needed to cover living expenses, and avoids the "double counting" of income that applies to a Roth pipeline. SEPP withdrawals also lend themselves well to fitting within the constraints of the "simplified EFC" assessment - no 1040A required (I think?).
Now for an aside on the topic of SEPP withdrawals:Even though SEPP withdrawal calculation is specified by the IRS, I can manipulate a SEPP withdrawal amount by splitting off a separate IRA with the proper account balance to get the annual withdrawal amount I want.
I mentioned before that I don't like the lack of flexibility, because distributions have to continue exactly as specified until age 59 and 1/2. For me that will be about 15 years from the time my kids start college! Ultimately, the problem comes if I start to have significant earned income and am being taxed at a higher marginal rate on my (now unneeded) SEPP withdrawals. Really, at that point additional earned income is something I do for the fun, not really for the profit. While unfortunate, taxes on the extra income are not going to change the fact that I will already be FI.
If too big of a SEPP annual withdrawal is a problem, there is a one-time opportunity to switch calculation methods to the "minimum withdrawal method". The minimum withdrawal method has the potential to reduce the annual withdrawal (depending on circumstances), e.g. after the kids are out of college. The minimum withdrawal method may not be a valid option for reducing the distribution if my IRA value has grown too much (not a bad problem to have!)
On the other side, you can have more than one SEPP withdrawal as long as they come from separate IRAs. So, I can start with a smaller SEPP withdrawal and add on a stream or two if necessary. I don't have to be committed initially to a large SEPP withdrawal. And for unexpected single-time event I could take a Roth withdrawal (despite its unfavorable effect on EFC.)
Does SEPP really help me address my goals?The ultimate purpose of "maximizing financial aid" probably varies by person, so the appropriateness of a given method probably depends on context. Such goals might include, for example: sooner FI, decreasing risk of running out of funds in retirement, increasing money for fun in FI, or increasing money for bequests/inheritances after death.
I think my main goals are:
(1) don't run out of money in retirement (while maintaining a certain [Mustachian] standard of living), and
(2) pay for the kids' college.
I think using SEPP helps reduce risk of running out of taxable investments before age 59.5 by shrinking my dependence on a taxable account (even if I decrease the size of the account accordingly). DH and I will probably have a withdrawal rate of 3% in retirement so I am not concerned about after 59.5 when we get full access to our accounts. Long term use (15 years) of SEPP probably increases the risk of "non optimal" use of the money *if* I have earned income - but I guess I don't really see that as an issue.
I would love to hear from others on this board to see if this line of logic makes sense, or if I am overlooking something.