Annuity for college savings

Please excuse me, I don't know a whole lot about this.

My husband and I are 29y and married with about 70k in income. We have a 1y old daughter and would like to start a college fund for her. We have about 12k to start the account and would like to make monthly contributions of around $100-150.

My accountant has advised us to buy her an after tax annuity that matures in 17y, not a 529. His reasoning is that with a 529 her potential $ of merit based scholarship is reduced by the amount of $ in her 529. Our only other savings vehicle is a 401k, through my husbands employer, which we have not maxed our contributions to yet.

My question is, where should I purchase this annuity and does anyone have any thoughts on this strategy?

Any other advise on this topic would be greatly appreciated as I'm not sure that I even know what questions I should be asking.

As a side note, I am also going back to med school this year, so I am looking at optimizing for my own profile for financial aid. (ie I don't want a big chunk of money sitting around in an IRA or other savings account)

Thanks!!

Monies in an IRA have ZERO impact on financial aid calculations and as such they are one the BEST places to have your lump sums tucked away.

A 529 has minimal impact on financial aid (5.64%) of balance. However they growth tax exempt and withdrawals are tax exempt when used for qualified education expenses. So, what does this mean? You essentially are being taxed at a measely 5.64% on your balance.

Well, your accountant wants to SELL you an annuity and make a commission. Normally, I try to understand the reasoning of such recommendations. Yet, this is one instance where the motive driving this recommendation is blindingly obvious to me.

The annuity grows tax deferred and saves you the 5.64% against financial aid. BUT, BUT, BUT...the growth (which comes out first for tax purposes) will be taxed at NORMAL INCOME with a 10% penalty if you are under 59.5 years old.

PLUS...withdrawals will be treated as income in the year that you take the money, causing a negative effect on financial aid to the tune of 18-30%. Now aren't you happy you avoided the 5.64%?

A deferred annuity is hands-down one of the WORST college planning vehicles on the planet. Stay away.

Fund your Roth IRAs to the maximum extent possible and then squirrel away some money in a mutual fund based 529 plan. Check your state 529, they may also offer a tax deduction for your contributions!

a side note, I am also going back to med school this year, so I am looking at optimizing for my own profile for financial aid. (ie I don't want a big chunk of money sitting around in an IRA or other savings account)
If you want to optimize your own profile, you WANT all of your money in IRAs or retirement plans (401k, etc.). They are 100% protected from FAFSA calculations. Just be sure to keep the money you may actually need within arms length for immediate expenses.

Consider replacing your accountant if he is the one that has taught you these things. He is deceiving you.

Unbelievable.

Since your trusted accountant can't be trusted, I recommend spending some time at this site to educate yourself about financial aid.

http://www.finaid.org/savings/accountownership.phtml

Do you notice that an annuity is not even listed as an option for college savings?

Here's the home page to the same site:

http://www.finaid.org/

You may be absolutely right regarding my accountant, however we have used him for a few years and I know several other people who have used him without any problems. Having said that I could easily be getting blindsided!!

As to motive for advising us to buy the annuity. He told us to buy it anywhere (state farm...), not through him. (ie no commission for him). Can you think of any other reason he would suggest we do this if there is no financial gain for him? And on the subject of penalties for withdrawing monies prior to 59.5yrs old, he said to buy an after tax annuity that matures in 17yrs (implying that this is not your typical retirement annuity). Does any of this make sense? Maybe I am not conveying it accurately.

I did just read the info in the link that you sent me re: what affects 401k and IRA's have on your fin aid. Thank you for the link. When I filled out FAFSA the other day they did ask me for our 401k contribution total. Why would they do that?

Also, with respect to the issue of affect on financial aid. We have to look at parental assets now (for my education) and then 17 years from now for my daughter.

thank you. thank you for any more info!!

Well...I have been scouring the internet and found this article. Any thoughts?

http://www.smartmoney.com/mag/index.cfm?story=tuition4

Maybe this is the strategy regarding using an after tax annuity, with a monthly payout, to cover college expenses. It gets the money out of the way for my immediate fin aid needs and then serves to pay for my daughter later without affecting her fin aid.

They also say that 401k contributions are factored into the FAFSA. This is conflicting info...Am I still missing something??

Why does this have to be so complicated....AHH! :)

Can you think of any other reason he would suggest we do this if there is no financial gain for him?No...seriously. I can't think of any reason why this would be a good move and on the surface, this advice seems to be bordering on negligence.

And on the subject of penalties for withdrawing monies prior to 59.5yrs old, he said to buy an after tax annuity that matures in 17yrs (implying that this is not your typical retirement annuity). Does any of this make sense? Maybe I am not conveying it accurately.All annuities are subject to the same rules regarding taxation. Whether it's after-tax or pre-tax, the 59.5 rule applies. The only exception is if you choose to convert your annuity into "substantially equal payments" based on IRS mortality tables and withdraw them as such until you do reach 59.5. This is the only way to avoid the 10% penalty. Proceeds will still be subject to normal income tax too.

Maybe this is the strategy regarding using an after tax annuity, with a monthly payout, to cover college expenses. It gets the money out of the way for my immediate fin aid needs and then serves to pay for my daughter later without affecting her fin aid.
What it doesn't say is that the income payments from the annuity MUST CONTINUE until you are age 59.5 or 5 years, whichever is later. This means that you will have to continue withdrawing the money at the same rate long after college is over. This depletes the tax deferred savings in the annuity and increases your taxable income! Also...the income payments DO affect financial aid. Any amounts withdrawn becomes income when completing the next years FAFSA. Income is counted against financial aid at a higher penalty rate than a lump sum saved in a highly liquid account elsewhere. There are so many better ways of doing this. This strategy is silly when compared to Roth IRAs, 529s, 401ks, etc. For example, a Roth IRA is not subject to a 10% penalty for college and you can use the growth and principal tax-free for qulaified education expenses, while sheltering the lump sum from FAFSA. Ther are NO advantages to using the annuity. A 401k can be boirrowed against for 50% of it's value at a comparably low interest rate, as can home equity.

They also say that 401k contributions are factored into the FAFSA. This is conflicting info...Am I still missing something??
They only use the amount to determine your GROSS income because this dictates the FAFSA testing method used for you application. Married couples earning less than ~$50000 are subject to the "Simple Test". This treatment protects 100% of ALL assets regardless of size or location of the assets from the FAFSA calculation. In this case, protecting your assets from FAFSA are moot because they don't matter anyway.

Still, there is no reason to use an annuity when your IRAs and 401k provide the same protections and offer you much, much better liquidity and tax treatment. It's still bad advice no matter how you look at it. The only instance that may make sense is if you have such a large lump sum that you can't fit it into other tax deferred accounts. Also, only money that you KNOW you will not need for college (but may want for retirement) should be considered for an annuity with the intention of shielding the asset from FAFSA.