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withdrawn for qualified education expenses is taxed at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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