About eight months ago, a recently divorced friend called me in a panic. John and his ex-wife, Mary, as I'll call them for the sake of privacy, were sorting out their financial affairs and realized that there was little money available to pay for college for their only child, who will be heading off to school in 2013.
John, who had never used a financial adviser, called to ask my advice about tapping his retirement fund to pay for his daughter's education.
Mustering all my tact and being mindful of how John's life had just been turned upside down by a divorce, a job change and finding a new place to live, I decided to go easy on him.
“That's the dumbest, most idiotic idea I have ever heard in my life,” I said gently.
After a few more supportive words between old friends, I suggested that he consult a financial professional to get a more informed opinion. He was hesitant, but I assured him that seeking professional help was the best way to go.
An adviser I know introduced John to another adviser, who agreed to meet and discuss college funding. The adviser, who asked for anonymity, decided to work pro bono with John and Mary.
The first meeting, six months ago, evidently was a success.
Betty, as we'll call the adviser, put John and Mary at ease because she provided them with sound advice and alternatives, showing them that there is light at the end of the tunnel.
“She listened to us and made us feel important, even though we don't have a lot of money,” John said. “That didn't seem to be a big deal to her.”
John told me that Betty stressed that most assets — especially retirement savings — should be left alone and not be used to pay college expenses. She also explained that the situation was more complicated because of the couple's divorce. Without proper planning, a divorce can disrupt retirement planning.
Betty explained the drawbacks of using a 401(k) for college funding.
If John withdraws funds from his 401(k) before he reaches 591/2, he most likely will owe a 10% premature-distribution penalty on the withdrawal. This penalty is in addition to income taxes he will owe on the sum withdrawn.
John admitted to me that he didn't like the sound of that.
Betty also said that 401(k) withdrawals may count as income and affect his daughter's eligibility for college financial aid.
She explained that if John and Mary cannot find a way to pay for college out of their normal income, and if financial aid from a college is insufficient, they should start researching Stafford Loans, parent PLUS Loans or private student loans.
The bottom line was that they shouldn't tap into important assets, most especially retirement savings, in order to pay for college. There are always alternatives, she assured them.
John called last week to thank me for pointing him in the right direction. His first experience with a financial adviser was a good one.
I suggested that he consider expanding the relationship with Betty to handle more than college planning. Perhaps that will make him more confident about his future financial plans overall — and lead to fewer panicky calls to me.
