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It pays to go to college, according to the old adage. And there's more than a nugget of truth to it. A college education can pave the way to a broader range of interests, to increased career opportunities, to a more rewarding life overall. In dollar terms, it paves the way to higher income on average, nearly twice that of the person with just a high school diploma.
While college may pay, it also costs.
The youngster who entered college in 2003 will have spent an average of $70,9401 in tuition, room, and board by graduation in 2007 at a public institution. At a private institution, the cost is far higher.
The numbers can be overwhelming for families. The cost of college for one child can be a family's second greatest expense after buying a house.
Whether your child is still little or already in high school, there are ways to build an education fund that can make the picture brighter.
This writing introduces three of them. All tax-advantaged.
The 529 Plan
The 529 plan takes its name from the section of the tax code that governs the 529 plan. Initially, th 529 plan was available only as Prepaid Tuition Plans, offered by the states. This type of 529 plan allows people to open savings accounts that pre-pay future college tuition at the states own state-run colleges at today's tuition prices.
Now, a second type of 529 plan is available -- the 529 College Savings Plan. Instead of guaranteeing a rate of return that will cover future tuition increases, an investment-type 529 plan pursues the possibility of higher market-based returns through professionally managed investment portfolios. Most of the 529 plan presents a menu of such portfolios, some of which are automatically allocated among stocks and bonds based on the child's age.
In addition, the 529 plan offers a level of flexibility and control that makes them very attractive versus other methods of building a college fund.
The 529 plan offered by each state differs significantly in features and benefits. The optimal 529 plan for each investor depends on his or her individual objectives and circumstances. In comparing each 529 plan, an investor should consider each investment options, fees, and state implications of the 529 plan. An out-of-state 529 plan may not have the same tax benefits as offered to in-state residents of the 529 plan. The tax law exempting earnings on qualified 529 plan withdrawals from federal income tax expires on 12/31/2010, requiring Congress to take some further action prior to this date for them to remain in effect following 12/31/2010.
You maintain control
When you open a 529 plan for a child, you maintain control of the 529 plan account.
The money in the 529 plan does not become the property of the beneficiary when he or she reaches majority age (18 or 21, according to the state of residence). You, the donor, always control withdrawals from the 529 plan.
You may change the beneficiary of the 529 plan from one child to another family member which would not be allowable with a custodial account.
A high degree of flexibility
A 529 plan is flexible enough to meet a changing world.
Owner controlled, meaning you can change the beneficiary of the 529 plan at any time.
You may even change from one 529 plan to another, once in any 12-month period, without changing the beneficiary of the 529 plan.
The money in the 529 plan can be used at accredited colleges or universities in any state.
A number of financial advantages
No financial aid effect
Because the 529 plan assets are considered the property of the donor and not the beneficiary, the 529 plan account should have less effect on any financial aid that the beneficiary might possibly receive than would a custodial account.
No income limitations
No matter how high your income, you are eligible to contribute fully to a 529 plan.
Higher contribution ceilings
While there are differences from one 529 plan to another, most have set high ceilings on total contributions typically exceeding $125,000.
Tax advantages
While 529 plan contributions are not tax-deductible for federal income tax purposes, distributions from a 529 plan are federally tax-free when they are used for qualified higher-education expenses.
Anyone can contribute $12,000 per beneficiary in a single year to a 529 plan without federal gift tax consequences.
A parent or grandparent is allowed to put as much as $55,000 into the 529 plan at one time without triggering federal gift tax as long as that same person doesn't give any more to the beneficiary for another five years and files a gift-tax return.
Estate-planning possibilities
Although the donor controls the 529 plan, the value of the 529 plan account is not considered part of the donor's taxable estate for federal estate tax purposes.
Education Savings Account
When Congress passed the Taxpayer Relief Act of 2001, it changed the name of the Education IRA to the Education Savings Account. More importantly, it increased the contribution limits and greatly enhanced the advantages.
$2,000 Annual Contributions up to age 18
$2,000 may be contributed each calendar year, until the child reaches age 18. If more than one Education Savings Account is set up for the child, contributions to all of those accounts is still limited to a combined total of $2,000 annually.
Contributions may be made to the Education Savings Account even in years when money is added to a state-sponsored 529 plan that may have also been established for the child.
Who may contribute to an Education Savings Account
You don't need to be a relative to contribute to an Education Savings Account for a child. However, the amount you are eligible to contribute per child in a given year will be dictated by your AGI (Adjusted Gross Income).
| Adjusted Gross Income |
|
Annual Contribution Limit |
| Single Filer |
Joint Filer |
|
| Up to $95,000 |
Up to $190,000 |
$2,000 |
| $96,500 to $110,000 |
$193,000 to $220,000 |
Up to $1,800 |
| $110,000 and up |
$220,000 and up |
$0 |
Potential tax-free growth and withdrawals
While the money you contribute to an Education Savings Account is not tax-deductible, any growth of those dollars is tax-free as long as distributions are for qualified education expenses. Thus, unlike a taxable account, the Education Savings Account wont lose part of its growth each year to taxes.
That tax-free advantage continues when the 529 plan money is taken out to cover qualified higher-education expenses such as tuition, room, board, and books. Withdrawals are no longer limited to higher education expenses but may also be used to fund elementary and secondary education.
When it comes to calculating higher-education financial aid, the Education Savings Account is treated as the students asset. A HOPE Scholarship or Lifetime Learning Credit may be claimed in the same year that a distribution is taken from the Education Savings Account as long as the distribution amount is not used for the same educational purpose as the credit.
An attractive level of flexibility
What if the child for whom the 529 plan was established decides not to pursue higher education? Or, better yet, gets a scholarship that covers all expenses? The 529 plan account can be rolled over to another Education Savings Account for the benefit of a family member of the beneficiary.
While contributions to the 529 plan must end before the child turns 18 (later if the child is a special needs beneficiary), there is no set withdrawal schedule. The money may be taken out as needed for qualified expenses.
In fact, the money is allowed to stay in the 529 plan until the beneficiary reaches age 30 (later if the child is a special needs beneficiary). That means it might even be used for graduate school expenses.
If money remains in the 529 plan when the beneficiary reaches 30, a choice must be made. The beneficiary must withdraw the money and pay taxes and penalties or the 529 plan may be transferred to an Education Savings Account for a member of the beneficiarys family.
Custodial Account
Custodial accounts have long been a way of earmarking money for a child;s education. Custodial accounts can come in two varieties, depending on the state where you live: UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfer to Minors Act).
UGMA accounts can hold cash, securities, mutual funds, and insurance policies.
UTMA accounts can hold almost any type of asset, including non-financial assets.
How the 529 plan is taxed
Unlike a 529 plan or an Education Savings Account, a custodial account does not enjoy tax-deferred growth. The 529 plan account is subject to annual taxation.
However, the good news is that the first $750 of investment earnings is tax-free, each year.
Above the $750 mark, the tax rate depends on the beneficiarys age:
Under age 14:
Investment earnings between $750 and $1,500 are taxed at the childs rate
Beyond that, all investment earnings are taxed at the parents top rate
Age 14 and older:
All investment earnings above the first $750 are taxed at the childs rate
A number of advantages
No income limitations
No matter how high your income, you are eligible to contribute to a custodial account.
No contribution ceilings
Unlike Education Savings Accounts and 529 College Savings Plans, custodial accounts have no ceiling on the amount that you contribute.
Flexibility for withdrawals
Withdrawals from a custodial account are not restricted to higher-education uses. The money is available as needed for other purposes that benefit the child.
Estate-planning tool
Anyone can transfer $11,000 a year to a custodial account without federal gift tax consequences. Married couples who file jointly can transfer $22,000 without gift tax consequences.
A matter of control
A custodial account lets you give money to a child but to retain control over it as long as the child is a minor. You could see your gift grow to a sizable amount by the time college tuition bills start.
But a custodial account is truly a gift. The assets are legally the childs. And when that child reaches age 21 (or 18, in seven of the states and the District of Columbia), control of the money shifts to him or her. This can be a concern. However, by age 21, most college students are juniors or seniors and the money you hoped would help pay for college costs will have been doing its job for years.
Money Manager can help you find a financial advisor.
At Money Manager, we make it easy for you to establish contact with a financial advisor who will help you save money for college.
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