More for Your Money
By
With
college costs steadily on the rise, the importance of a comprehensive college
funding plan has never been greater. According to the New York-based College
Board, the average annual costs at public and private colleges are more than
50 percent higher than what students paid just 10 years ago. Thankfully, there
are a number of steps you can take to offset these rising costs.
Investments
May Help. If your
youngster won’t be entering college for five or more years, consider using a
taxable investment account to generate college funds. As long as you don’t
sell investments in the account, you’ll only owe annual taxes on the dividends
or interest you earn, if any. Who’s
name to put on the investment is key. For children 14 and older the
income is taxed at their rate, which is probably less than the parent’s rate.
For children under 14 it is taxed at the parent’s rate.
When it’s time to withdraw from the account, any investments sold that
have been held for more than one year will be taxed at the long-term gains of
the child or parent, depending on who owns it.
There is also a new five-year gain rate that applies to taxpayers in the 15 percent tax bracket (which is the bracket that children are usually in) for assets held more than five years. As a result, an existing 10 percent long-term capital-gains rate will fall to eight percent on stocks and other investments held more than five years. This rate applies to the part of net capital gains that would be taxed at 15 percent if there were no capital-gains rates. This may provide an incentive for some parents to begin investing at least five years before money for education is needed. There is another thing to keep in mind for stocks that have been held for more than five years and have risen dramatically. If a parent sells the stock, he would pay a 20 percent capital gains tax. But, if the investment is given to a child who will be age 14 or older before the end of 2001, the child can sell the stock and the gain will only be taxed at an eight- percent rate if they are in the 15 percent tax bracket. In this case, the father’s cost basis and holding period would carry over to the child.
Before
deciding to transfer assets, you should consult with a financial or tax advisor
who can counsel you on the advantages and disadvantages in regards to your
situation.
Different
IRAs Provide Different Benefits. Two
types of individual retirement accounts (IRAs) are commonly used to fund college
costs: the Roth IRA and the Education IRA. If you qualify, you can individually
invest up to $2,000 a year in a Roth IRA and any earnings grow tax-free if
certain conditions are met. Withdrawals of contributions can be withdrawn income
and penalty tax-free. If any earnings are withdrawn, those earnings are income
taxable, but are not subject to early withdrawal penalty tax. While the
Education IRA also allows for tax-deferred contributions and tax-free
withdrawals if used for education, however because it has the same income limits
as the Roth IRA not everyone can contribute. Also, it has several restrictions
that may limit its usefulness. For example, the maximum amount you can
contribute annually to an Education IRA is $500, as opposed to $2,000 for a Roth
IRA. In addition, you cannot claim the Hope or Lifetime Learning Credit in any
year you withdraw from an Education IRA and elect tax-free treatment of that
withdrawal. Also, you cannot contribute to an Education IRA in the same year
that you contribute to a 529 plan. That means that any contribution to an
Education IRA would be an excess contribution subject to a six- percent penalty,
unless removed appropriately. Excise tax applies each year the money stays in
the Education IRA.
Consider
Tax and Tuition Credits. The federal government introduced the Hope Scholarship
and the Lifetime Learning credit in 1997 to assist students and parents with the
costs of higher education. The Hope Scholarship can be used in your child’s
first two years of college and is worth a maximum of $1,500 in tax savings per
student. The Lifetime Learning credit
can be used for 20 percent of expenses incurred in the third year of school and
beyond. The maximum annual credit is $1,000 until 2003, when the maximum credit
will go up to $2,000.
Financial
Aid Can Have a Positive Impact. Need-based financial aid, such as government grants, can
be useful when it's time for your child to begin college. And, financial aid can
help cut down on the amount you'll need to save for college over the long run.
To get a general idea of the potential benefits to your family, call for a free
financial aid guidebook from the U.S. Department of Education, 1-800-4FED-AID.
Or visit the department’s Web site at www.ed.gov/finaid.html.
Complex
Formula Determines Net Worth. Financial
aid eligibility for a student's freshman year in college is based in part on the
parents' and student's taxed and untaxed income received during the calendar
year beginning January 1 of a high school student's junior year, and continuing
through December 31 of his or her senior year. Consider these tips if your
youngster will apply for financial aid in the near future:
·
The
lower your family's assets and income, the greater the calculated need. Consumer debt from sources such as credit cards
and personal and car loans isn’t considered when figuring your family’s net
assets. So, if you can afford it, you may want to use your savings to pay off
such debts.
·
Notify
the school’s financial aid office about anything unusual in your family's
financial situation.
If you encounter unexpected financial circumstances, such as high medical
expenses or an inheritance that artificially inflates your income, write a
letter to your school’s financial aid office explaining the situation. Such
conditions may be taken into account when reviewing your overall net worth.
State
Plans May Be Worthwhile. Another college funding tool to consider may come from
your own state government. Many states sponsor college savings plans that allow
families to prepay tuition costs (and, in some plans, room and board expenses as
well). Although the options vary from state to state, the advantage of many of
these plans is that they may limit your risk while also giving you greater
potential returns than a money market account. Often, extended family, such as grandparents and
other relatives, can add funds to the state plan.
These plans allow you to save for college funding tax-deferred until the
money is withdrawn for college expenses. When funds are withdrawn, the earnings
portion of any withdrawal will be included in the student’s gross income and
taxed at the student’s rate.
Put
Your Funding Plan on the Fast Track. If
the number of available college funding options has you wondering where to
begin, consider turning to a professional investment advisor. You’ll learn how
it may be possible to simultaneously invest for multiple goals and advise you on
the best investment strategy. You’ll also be able to discuss the merits of
various college investment options in greater detail.