Americans are both blessed and cursed when planning for college. Never before have so many tax breaks, financial aid assistance, and tax-favored investment accounts been available. These options sound great until trying to piece together this ever-changing jigsaw puzzle into a workable plan.
The options are accompanied by restrictions, caveats, contribution minimum/maximums, income limits, potential negative impacts on financial aid, current tax consequences, and numerous ownership issues along with the uncertainty of tax law in the future. Further complicating the matter is the fact that financial aid formulas vary from school to school and every state has versions of their own state-sponsored (529) plans.
College is not cheap, and the purpose of this article is not to discuss figures, inflation or the value of education. This article is designed to highlight some basic options for funding a college education.
The options fall into three categories:
Borrowing – Debt is always an option (very popular and stressful). Financial aid is included in this category because the majority of financial aid is in the form of loans. There is no guarantee regarding interest rates or if an applicant will be approved for a loan.
Hope – No, not the popular Hope Scholarship Credit. This refers to the hope that an athletic/academic scholarship will be offered, Ed McMahan will show up on your doorstep, or tax breaks will be available to offset the costs of education. It could happen, but there are certainly no guarantees here either.
Savings – You have control over if and how investments are made.
The option that gives the most control is savings and should be the area of focus. It must be determined which type/s of investment account/s to use and then how to invest. Some factors to consider when choosing investment accounts are tax-benefits, control/ownership (affects financial aid calculations), investment options, account features, time frame, etc. The options include, but aren’t limited to:
529 plans – A recent development named after Section 529 of the Internal Revenue Code. Each state offers pre-paid or savings versions with contributions growing free of tax while in the plan. When distributions are made for qualified education expenses (can include books, fees, room and board, along with other expenses not limited to only college in many plans) they are also federally tax-free.
Anyone can contribute small or large amounts ($25 month in some plans; up to more than $300,000 total in some plans). A benefit is that the donor stays in control of the account and beneficiaries can easily be changed. Some states even offer income tax deductions for residents’ contributions. Do your research when choosing a 529 plan because your state’s plan is not necessarily a good option.
Roth/Traditional IRA – Contribution limits up to $3,500 for 2003 and 2004 if eligible. IRA’s can offer the flexibility to use funds for education or your own retirement. You must determine which IRA is appropriate.
Coverdell Education Savings Account (former Education IRA) – This is a new account similar to a Roth IRA that allows $2,000 to be placed in the child’s name that grows tax-free if used for qualified education expenses, but must be withdrawn before age 30.
UTMA/UGMA – Uniform Transfers/Gifts to Minors Account allows for tax benefits initially (first $750 of earnings can be tax free), but money is typically considered as the child’s for financial aid purposes because it’s in their control. These accounts are often used with gifting strategies.
Annuities/Cash Value of Life Insurance – Not typically considered a college savings option, but could be used. Consult your agent/financial planner/accountant.
Government Savings Bonds – Are conservative and can offer tax benefits for education expenses.
Taxable Accounts – Assets outside of a tax-favored account can be used, but can have current and future tax consequences. These accounts benefit from the tax rate cuts, but are still considered by many to be one of the least efficient means of saving.
A savings plan must be followed to be successful. It must also be reviewed and updated regularly. Do yourself and loved ones a favor, Invest the necessary time and/or consult a professional to help you determine the best course of action.
Hampton Scurlock III is CEO/Senior Financial Planner at Scurlock Financial Services Corporation. He can be reached at (859) 233-1083 or at email@example.com