Savings Plan Trusts:
Certain states such as Connecticut, Iowa, Kentucky,
Louisiana, Massachusetts, New Hampshire, and New
York offer college savings plans. These plans, also
known as 529 Plans for part of the United
States Code that governs qualified state tuition
programs, allow the contributor to save as little or
as much as they like on behalf of a designated
beneficiary's qualified education expenses.
Contributions, considered gifts by law, may be as
little as $25 or as much as $50,000 ($100,000 for
joint filers) in one year, of a five-year period,
without incurring gift taxes, assuming no gifts are
given to the same beneficiary within five years.
These accounts vary
from state to state. Some may guarantee a minimum
rate of return, others offer tax incentives, and
most generally provide favorable tax-deferral and
favorable tax treatment upon withdrawal. Currently,
money withdrawn for qualified education expenses is
taxed at the child's rate. Beginning in 2002 the law
will allow tax-free distributions from state plans
for qualified education expenses. Unlike
pre-paid tuition plans, the monies from the
account may be used at any qualified institution of
higher learning within the United States. If your
child does not go to college, the money can be used
for another family member's qualified education
expenses or you may keep the money and be taxed at
your rate plus a 10% penalty. Check with your
state's commission on higher education to see if a
college savings plan (529 Plan) is available where
you live. If your state does not have a savings
plan, many states have opened their plans to
non-residents. Several private plans have also been
developed.
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The Education IRA:
Though they're not at all designed for retirement,
these accounts share many of the most compelling tax
advantages of regular IRAs.
Starting in 2002,
you may contribute $2000 per year for each of your
dependent children under the age of 18, although
these contributions are not tax-deductible.
Because assets in
these accounts are free from current taxation, they
may grow faster than assets in regular, taxable
accounts. But perhaps the biggest advantage of the
Education IRA is that withdrawals to pay college
expenses are tax-free.
You may contribute
up to $2000 per year per child, but if your income
is more than $110,000 ($220,000 for joint filers),
this amount may be reduced or even eliminated.
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Variable Universal Life
Insurance: The cash value accumulated in a
variable universal life insurance policy may be
withdrawn for a variety of purposes tax-free. This
investment option also allows peace of mind in that
if something should happen to you, your child will
have the funds needed for higher education.
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UGMAs: Another popular
college funding option is the Uniform Gift/Transfer
to Minors Act Account (UGMAs/UTMAs), which allows
adults to transfer assets to minors. These accounts
may be helpful college funding vehicles because of
favorable taxation: once the funds are in the UGMA,
all or a portion of the investment income may be
taxed at the child's (usually lower) rate. For
children under 14, tax rates vary based on income
earned. Income on a UGMA account of a child over 14
is taxed at the child's rate.
However, investing
through custodial accounts is a strategy that might
backfire if you're eligible to receive financial
aid, because of the ways many colleges compute a
student's need.
Currently,
financial aid guidelines assume that adults will put
5.6% of their assets towards a child's college
expenses. But it's assumed that 35% of the child's
assets (which include the balance of any UGMA
accounts in the student's name) will be used.
In other words, a
college may assume that a student's parents will use
$2,800 of a $50,000 account each year to pay college
bills; if the same account is a UGMA in the
student's name, the college may assume that $17,500
will be used. Years of contributing through UGMAs
could push your child out of financial aid range.
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Prepaid Tuition Plans:
Certain states, such as Alabama, Alaska, Colorado,
Florida, Massachusetts, Michigan, Ohio,
Pennsylvania, Tennessee and West Virginia offer
various types of prepaid tuition plans, generally
for students attending state schools. Residents of
these states can buy a contract or bonds at a fixed
price, based on the rates of college tuition today.
Payments can be made in lump sums or monthly
installments. The state, in turn, invests the money
to earn the difference between the amount you are
paying and the projected cost of tuition at the time
your child reaches college age. Those who sign up
are fully protected, as the state assumes all the
risk of the investments. Check with your state's
commission on higher education to see if a prepaid
tuition plan is available where you live.
Prepaid tuition
plans are not for everyone. They mostly attract
middle-income families who tend to be more
conservative in their investments. Lower-income
families using this option may jeopardize their
chances for state aid and forfeit money needed for
immediate essentials. If you're interested and a
plan is offered in your state, you'll want to know
if it covers only the cost of tuition, or room and
board, too. Also, check to see if it applies to
other than state schools. Finally, confirm that your
original deposit will be returned if your child
attends a private or out-of-state college, is not
accepted at a state school or chooses not to attend
college at all.
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Education Tax Credits:
These two college-oriented tax credits may make
paying for college just a little easier:
The HOPE Credit
offers a tax credit up to $1,500 to cover expenses
for tuition and fees for yourself, your spouse, or a
dependent during the first two years of higher
education.
The Lifetime
Learning Credit is similar. It offers a credit
of up to $1,000 for tuition or fees. This credit may
also be used for courses to acquire or improve job
skills.
There is an
important restriction that goes along with these
credits: you may choose only one of these credits;
and if you take tax-free withdrawals from an
Education IRA, you may use the credit in that year
as long as it's for different educational expenses.
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CDs and Bank Accounts:
Bank Certificates of Deposit (CDs) and bank savings
accounts are two other places to put college
savings. Although CDs and bank savings accounts are
generally FDIC insured, they generally offer a lower
return potential than other investment vehicles and
are most appropriate for those with short-term
goals.
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Which Option Is Best for You?
That depends on your own financial situation and
financial goals. We suggest you meet with a
financial professional at QFA, who can go over your
personal situation and goals carefully, then
recommend an appropriate plan.
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