Educational planning Paying for College College tuition costs The cost to attend college continues to rise faster than inflation. For the 2007-2008 school year, average tuition and fees at public four-year colleges or universities rose 6.6% to $6,185, according to the College Board report, "Trends in College Pricing 2007".
For private four-year colleges and universities, average tuition costs rose 6.3% over the year earlier, to $23,712. If you add the cost of room and board, the average bill at public institutions rose 5.9% to $13,589. For private institutions, the combined bill rose 5.9% to $32,307. (Note: all data are weighted for enrollment statistics.)
The trend of college costs growing faster than overall prices is also a long-term one. Adjusted for inflation, tuition costs at public colleges have grown 31% over the past five years, according to the College Board. (Tuition increases at private schools have outgrown inflation by 14% over the last five years.)
With increasing costs like these, saving for a child's college education is a daunting challenge. However, choosing not to attend college has even graver consequences. The College Board estimates that a person with a college degree earns in excess of $1 million over his or her lifetime more than a high school graduate. Several alternatives exist to pay for a college education, whether it is an education for your child, grandchild, or yourself. In addition, the Economic Growth and Tax Relief Reconciliation Act of 2001 expanded college-savings incentives.
Planning for college expenses involves considerable research into how one qualifies for financial aid, what type of aid is available, what money sources are available, tax advantages that may be available to encourage attendance, and repayment of loans. This section will be divided into 6 subsections. Click on the section below to go directly to the section you are interested in. Qualifying for student aid To determine whether your child is eligible to receive federal financial aid for college, the U.S. Department of Education (DOE) uses a formula called the expected family contribution (EFC). The formula considers the financial resources of the student's parents, as well as those of the student. Federal aid programs for college include: - Grants. A grant is a gift. It does not require repayment. In general, the government gives grants to only those students it deems most in need of financial assistance. The two main types of grants include Pell Grants and Federal Supplemental Education Opportunity Grants (FSEOGs).
- Subsidized loans. Subsidized loans are those student loans whose interest is paid by the federal government until the loan-repayment period begins. A subsidy is also like free money, since qualified recipients have to repay the loan principal but can avoid hundreds to thousands of dollars in interest expense. Stafford Loans may or may not be subsidized. All Perkins Loans, however, are subsidized student loans.
- Work-Study. Work-Study is administered by the university or college, which reserves some on-campus paid jobs for recipients. Work-Study lets students earn money to offset some of their school-related expenses. To the extent that the student is able to pay some of his or her cost with an on-campus job, he or she may have to borrow less.
For purposes of counting assets in the EFC formula, the DOE considers money in UGMA/UTMA accounts and education savings accounts to be the student's assets. Assets in Section 529 plans are considered assets of the parents. To apply to the subsidized programs described above, the DOE requires a student to complete a Free Application for Federal Student Aid (FAFSA). To be eligible to receive aid from one of these programs, a student must meet the following requirements: - Demonstrate financial need (see below).
- Have graduated from high school or have earned a G.E.D.
- Be enrolled in an eligible program of study.
- Maintain a level of satisfactory academic progress.
- Certify that you are borrowing to pay for educational purposes.
- Not be in default on any other student loans.
- Have a Social Security number.
- Be either a U.S. citizen or eligible non-citizen.
- Have registered with the Selective Service, if required.
Financial aid applicants fall into one of three categories. - Dependent students. For students who are claimed as a dependent on someone else's income tax return, the EFC formula is based on assets and income of parents and student.
For the 2008-2009 financial aid year, 12% of the parents' adjusted assets and 100% of adjusted income are included in the EFC calculation to determine their potential contribution. For the child, 20% of his or her adjusted assets and 50% of adjusted income are used in the calculation.
- Independent student with no dependent(s) other than a spouse. The expected contribution is based on the married couple's combined assets and income. For the 2008-2009 financial aid year, 20% of adjusted assets and 50% of adjusted income are used to determine the potential contribution.
- Independent student with dependent(s) other than a spouse. The expected contribution is based on the married couple's combined assets and income. For the 2008-2009 financial aid year, 7% of adjusted assets and 100% of adjusted income are used to determine the potential contribution.
You may wish to refer to the worksheet used by financial-aid officials at the DOE's Office of Student Financial Assistance to calculate your EFC for the 2008-2009 financial aid year. Grants Attending college is a major life event. Tuition, fees, and room and board at a public four-year college or university in the 2007-2008 academic year averages about $13,589 a year for an in-state student, according to the College Board.
Several investment vehicles with tax advantages also exist to help save for college. However, most college-bound students and their parents rely, in part, on financial aid to help pay for college. Federally funded financial aid comes in several forms, including grants, loans and work-study programs. It can also include part-time military service during and after college. This educator aims to familiarize you with the major types of federal financial aid and scholarships to help pay for college.
Let's first take a look at grants. A grant is a gift. It does not require repayment. The two main types of federally funded grants are Pell Grants and Federal Supplemental Educational Opportunity Grants (FSEOGs): - Pell Grants. Pell Grants are available to students, mostly undergraduates, who demonstrate financial need. Financial need is based on a formula that subtracts the expected family contribution (EFC) from the cost of attending college. The maximum annual Pell Grant award for 2008-2009 is $4,731.
If enrolled on less than a half-time basis, a student may still be eligible to receive a Pell Grant, albeit a lesser amount. The U.S. Department of Education (DOE) disburses Pell Grants either directly to the recipient's school, to the recipient, or combination of the two. The school must notify the student when a Pell Grant has been received on the student's behalf.
You must reapply for a Pell Grant each year. You can use an abbreviated form to reapply if you applied in the previous year. You also cannot receive more than one Pell Grant in a year. If a Pell Grant is paid directly to the school, the school must pay the student at least once each school term and notify the student how it will disburse funds.
- Federal Supplemental Educational Opportunity Grants. FSEOGs are campus-based aid. As such, the college or university is responsible for disbursing the award and has final say over how much in funds are actually awarded. Amounts disbursed to a recipient of an FSEOG may not be the same amount awarded by the program.
Like Pell grants, FSEOGs are intended as financial aid for the neediest college students, usually undergraduates. Priority for FSEOGs goes to recipients of Pell Grants. To be eligible for an FSEOG, an applicant must demonstrate financial need by completing a financial-aid application. The current annual maximum amount for an FSEOG is $4,000. To apply for federal financial aid, complete a Free Application for Federal Student Aid (FAFSA). You can submit a FAFSA as early as January 1 of the upcoming academic year, which usually begins in August or September. (The DOE urges you to complete a FAFSA if you are also seeking financial aid from non-federal sources since these sources use the FAFSA.)
The DOE deadline for receiving a FAFSA for the upcoming academic year is June 30. Keep in mind that the deadlines for FSEOGs and other forms of campus-based aid may be different.
In addition to these federal grant-based financial aid programs, you may wish to look for grants from state government sources. Visit the Web site of the DOE to find a list of higher-education state agencies. You may also wish to contact charitable organizations, associations, foundations and corporations for case-by-case availability of financial-aid programs. Many of these organizations sponsor scholarship funds, which we take a look at next. Scholarships When it comes to searching for scholarships, the federal government is not the premier source of information. A scholarship is an academic award to a student for outstanding academic, athletic or artistic talent. Like a grant, a scholarship does not have to be repaid.
A scholarship often requires the recipient to maintain a high standard of academic success or artistic accomplishment. If the recipient falls short of the minimum standards, he or she may lose a scholarship. Losing a scholarship doesn't mean you have to repay anything. Instead, it means you will have to turn to other sources of financing to pay for college, including grants or loans.
While the Internet is a great place to search for scholarships, it's also important that you avoid scams. You can usually tell if an offer is a scam if it seeks a payment from you upfront. A few free Web search engines for scholarships are shown below.
A scholarship fund is the entity that pays and replenishes the scholarship. Colleges and universities, foundations, charities and corporations may sponsor a scholarship fund -- there is really no restriction on the type of organization that offers a scholarship. Scholarship funds are often endowed and supported by contributions from individuals and organizations committed to such ideals as improving public education and the arts, developing future community and business leaders, and developing new technologies.
A few of the major Web site databases that let you search for scholarships for free include: - College Board. The College Board offers a scholarship search engine that lets users search through 2,300 undergraduate scholarships, internships and loan programs. The non-profit membership association of colleges and universities also publishes yearly a handbook of similar programs.
- Peterson's. Peterson's offers a database of scholarships that can be easily searched by specific criteria that match your interests. A cursory search shows scholarship funds sponsored by such diverse organizations as the North Carolina Police Corps and Russian Federation of Presidential Scholarships.
- The Princeton Review. Test-preparation services company Princeton Review claims to have over 650,000 scholarship awards in its free database. The registration process takes about 30 seconds.
- FinAid. In addition to offering free access to scholarship search engine FastWeb, FinAid offers links to other specialized scholarship search services, including VollegeNet Mach25 and SRN Express. For more information, see the scholarships section of FinAid's Web site.
A major scholarship program available to all high school students is the National Merit Scholarship (NMS) program. If a student scores high enough on the PSAT/NMSQT test (usually administered in the student's junior year), they may qualify for an NMS scholarship.
For more information, see the Web site of the National Merit Scholarship Corporation (NMSC), a non-profit organization.
Next, we take a look at Stafford Loans, one of three major federal loan programs available to help pay for college. Stafford Loans Unlike a grant or scholarship, you have to repay a student loan. Student loans can be issued to either you or your parents. A Stafford Loan is a federal loan program that is made directly to the student. Stafford Loans come in two types: subsidized and unsubsidized.
Stafford Loans are loans guaranteed by the federal government that are disbursed by a bank or other private lender that participates in the Federal Family Education Loan Program (FFELP). The government may disburse the loan directly through the Federal Direct Student Loan Program (FDSLP).
A subsidized loan is a loan whose interest is paid by the federal government. An unsubsidized loan is one where you pay the interest on the loan. Since a subsidized loan is clearly the better deal, eligibility rules for these loans are much stricter than for unsubsidized loans. In order to be eligible for either type of Stafford Loan, you must complete a Free Application for Federal Student Aid (FAFSA).
For the 2008-2009 academic year, first-year students who are dependent on their parents' support can borrow up to $3,500 in Stafford Loans. If they are independent of their parents, they can borrow up to $7,500 in their first year. Second-year borrowing limits increase to $4,500 and $8,500, respectively. Third- through fourth-year borrowing limits increase to $5,500 and $10,500, respectively.
For students enrolled in an undergraduate program and dependent on parents for financial support, the current total borrowing limit for Stafford Loans is $23,000. If they are independent of their parents, the current total borrowing limit is $46,000.
However, the ceiling on borrowing limits should not be a license to borrow all that you can. Other sources of income, including part-time work and sticking to a personal budget, can reduce the amount you need to borrow for college.
At 8% interest and $25,000 in student loans, a monthly payment for a five-year loan repayment plan is $507. If you extend the repayment plan to 10 years, you owe monthly payments of $303.
After you graduate, your lender gives you a grace period before you have to start repaying the loan. A grace period is typically six to nine months long. You may also be eligible for a loan deferment. A loan deferment is a temporary suspension of loan payments -- it is not debt forgiveness. Federal government service may be one potential reason for seeking a loan deferment.
If you experience a financial hardship during the repayment period, you can also request forbearance from your lender. Forbearance is temporary relief from making loan payments, often due to the loss of a job or similar financial duress. During the time that you receive forbearance, your interest expense is capitalized, or added to the amount you owe.
When you begin to repay a student loan, you owe accrued interest together with any capitalized interest. As a result, some of your early payments are applied entirely to interest with no reduction in loan principal. You should check with your lender on how your payments are applied to principal and interest. Monthly payments are often calculated for a specific repayment period such as 10 years. If you make extra or larger loan payments, or either skip or make smaller payments, your loan period is likely to be different from 10 years.
The interest rate that you pay on a Stafford Loan used to be reset every July 1. However, for loans disbursed after July 1, 2006, the interest rate is fixed at 6.8%.
Additional loan amounts for graduate students. Graduate students can borrow up to a total of $65,500 and $138,500 for subsidized and unsubsidized loans, respectively. Graduate students can borrow up to $20,500 in a year, $8,500 of which may be in subsidized loans.
Interest-rate margins are higher for older Stafford Loans. Margins on student loans made prior to July 1, 1998 are generally higher than those made in the past few years. For example, in the three years prior to July 1, 1998, the margin is 2.5% for students still in school and 3.1% if repaying a loan. Current interest rates on these older loans for 2007-2008 work out to 7.42% and 8.02%, respectively. Interest rates on student loans made between July 1, 1998 and June 30, 2006 are indexed to the 3-month Treasury bill. Rates on those loans for 2007-2008 are currently 6.62% if the student is still in school and 7.22% if the loan is in repayment.
It's important to keep in mind that you or your child may have more than one student loan. As a result, the types of loans and interest rates are likely to be different. When it comes time to repay those student loans, you may wish to consolidate them using a federal consolidation loan or other consolidation loan.
As a result of the 2001 tax law, you can take a deduction for interest expense paid on student loans over the entire loan term. Previously, you were limited to taking a deduction during the first 60 months of the loan term.
The tax law also increases the income limits for taking this deduction. For taxpayers filing a single return in 2008, your allowable deduction begins to phase out when your modified adjusted gross income (MAGI) reaches $55,000. The allowable student-interest deduction phases out completely when your MAGI reaches $70,000. For married taxpayers filing a joint return, the increased income limits are $115,000 and $145,000, respectively in 2008.
To take a student loan interest deduction, enter the amount of the deduction on line 33 of IRS 2007 Form 1040. If your income falls within the income limits shown above, see IRS Pub. 970 to calculate a partial deduction.
Next, we take a look at another federal student-loan program, the Perkins loan. Perkins Loans Perkins Loans are disbursed directly to the student by the college or university where the student is attending.
Because of the school having control over the purse strings, Perkins Loans are also considered a form of campus-based aid. Often, the school disburses the loan in two payments during an academic year.
Borrowing limits for the 2008-2009 academic year for undergraduates is $4,000 a year and $20,000 in aggregate. For graduates, borrowing limits are $6,000 and $40,000, respectively. The $40,000 borrowing limit includes any Perkins loans received for undergraduate study.
Like Pell Grants, FSEOGs and Stafford Loans, Perkins Loans require the student to complete a Free Application for Federal Student Aid (FAFSA). However, Perkins Loans are more competitive than Stafford Loans because: - Relative scarcity of subsidies. The federal government subsidizes the interest on Perkins Loans (and subsidized Stafford Loans) while students are in school. Since the federal government's budget is limited for these programs, the loan dollars are relatively scarce. Unsubsidized Stafford Loans are also made by private lenders, making these loans relatively plentiful.
- Interest-free loans until loan repayment begins. From the student's or parent's perspective, a subsidized Perkins loan is more attractive simply because it is a free loan. Students aren't charged interest on a Perkins Loan until the loan repayment period begins. Borrowers of unsubsidized Stafford Loans owe interest from the beginning of the loan period (when the loan is disbursed).
A Perkins (or other federal) student loan may be cancelled under certain circumstances. For example, if the student dies or is completely and permanently disabled, the government cancels the full amount of debt.
Other cases for receiving partial or full debt cancellation include military and corrections service, teaching in teacher-shortage areas or in schools for low-income children, and certain cases of personal bankruptcy. You should check with the U.S. Department of Education (DOE) to learn more about canceling student debt.
As a result of the 2001 tax law, you can take a deduction of up to $2,500 for interest expense paid on student loans over the entire loan term. Previously, you were limited to taking a deduction during the first 60 months of the loan term.
The tax law also increases the income limits for taking this deduction. For taxpayers filing a single return in 2008, your allowable deduction begins to phase out when your modified adjusted gross income (MAGI) reaches $55,000. The allowable student-interest deduction phases out completely when your MAGI reaches $70,000. For married taxpayers filing a joint return, the increased income limits are $115,000 and $145,000, respectively in 2008.
To take a student loan interest deduction, enter the amount of the deduction on line 33 of IRS 2007 Form 1040.
If your income falls within the income limits shown above, see IRS Pub. 970 to calculate a partial deduction.
Next, we take a look at a third federal student-loan program, the PLUS Loan. PLUS Loans A third federal college-loan program is the Parent Loan for Undergraduate Students (PLUS) Loan program. Unlike Stafford and Perkins loans, PLUS Loans are made to the parents of the college student.
The borrowing limit for a PLUS Loan is not a fixed dollar amount. Rather, it is equal to the student's total cost of college, less any other sources of financial aid. For example, if it costs your child $12,000 a year to attend a state college for all expenses, and he or she receives a grant of $2,000, you can borrow up to $10,000 a year.
In order for parents to be eligible for a PLUS Loan, their child must be an undergraduate student and attending college on at least a half-time basis. If you are uncertain about the half-time status, you should check with the records office of your child's college. In order for parents to be eligible for a PLUS Loan, their child must be dependent on their financial assistance.
Since parents are the borrowers of a PLUS Loan, the lender will check their credit report as part of the loan-approval process. In the event of bad credit, the parents may still be able to obtain a PLUS Loan if they receive a personal guaranty to repay the loan. Also, parents must not be in default on any federal student financial-aid program.
The interest rate on PLUS Loans used to be set every July 1 for the subsequent year. However, for loans disbursed after July 1, 2006, the interest rate is fixed at 8.5%. The loan repayment period for a PLUS Loan begins two months after the loan is disbursed.
PLUS Loans can be administered through either the Federal Family Education Loan Program (FFELP) or Federal Direct Student Loan Program (FDSLP). A private lender disburses FFELP loan funds to your school, while the government disburses FDSLP funds to the school directly. Fees on a PLUS Loan are as high as 4 percent of the loan amount.
In addition to Stafford, Perkins and PLUS Loans, there are a variety of federally guaranteed loan programs for specialized education. These loan programs include Sallie Mae Loans for graduate business, law, medicine and vocational programs. Sallie Mae, a government sponsored enterprise, also offers loans to parents to help pay for costs of primary and secondary education.
Sometimes, borrowing from the loan programs described above doesn't cover all the costs of college. Some parents turn to home equity loans to raise money for their child's college expenses. Or, they may have set aside funds in a college savings plan or education IRA. If you don't have such resources, you may wish to consult a private lender.
Next, we take a look at federal Work-Study programs. Work-study financial aid programs In addition to grants and loans, Work-Study is a federal financial aid program for college students. Work-Study awards a part-time job to eligible students to work on or off-campus in exchange for an hourly wage. The hourly wage is at least as much as the current federal minimum wage. In some cases, graduate students may receive a salary instead of an hourly wage.
Off-campus work opportunities may include jobs with a non-profit organization or position related to your academic interest. You should contact your school's financial aid office for specific information.
Together with Perkins Loans and Federal Supplemental Educational Opportunity Grants (FSEOGs), Work-Study is a form of campus-based aid. As such, the college or university receives funds from the federal government and is in charge of matching the recipient to a job and in controlling the purse strings.
Depending on the school's financial aid resources and funding requirements, the size of your award may be different from the award you received from the federal government. You can generally work up to the amount of hours for which you are awarded by Work-Study.
It's important to remember that Work-Study is a form of federal financial aid. In order to retain a Work-Study position, you have to reapply. You can reapply using an abbreviated FAFSA form.
Next, we take a look at the eligibility requirements for federal aid. Determining eligibility for financial aid To apply for federal financial aid to pay for college, you must complete a Free Application for Federal Student Aid (FAFSA). The application is free and only needs to be completed once a year. You can use an abbreviated form to reapply for financial aid the following year.
Since the FAFSA is also used by non-federal financial aid sources, the U.S. Department of Education encourages you to complete one even if you do not seek federal financial aid.
The following general requirements exist to determine eligibility to receive federal financial aid. The applicant must: - Have graduated from high school or have earned a G.E.D. Consult your school's financial aid office for exceptions to these requirements.
- Be enrolled in an eligible program of study.
- Maintain a level of satisfactory academic progress.
- Certify that the aid is to pay for educational purposes.
- Not be in default on any other student loans.
- Have a Social Security number.
- Be either a U.S. citizen or eligible non-citizen.
- Have registered with the Selective Service, if required.
Your FAFSA must demonstrate financial need in order to receive a Pell grant, Federal Supplemental Educational Opportunity Grant, Perkins Loan, subsidized Stafford Loan or Work-Study.
You do not have to demonstrate financial need to receive an unsubsidized Stafford loan, PLUS Loan or federal consolidation loan.
Financial need is the difference between the student's total expected cost of college and amount the applicant is expected to contribute. The contribution amount is calculated using a worksheet and is called the expected family contribution (EFC).
For example, if the total expected cost of college is $60,000 and your expected family contribution is $35,000, you are eligible to receive up to $25,000 in financial aid other than unsubsidized loans. Your school's office of financial aid may have some latitude in adjusting the expected cost of college or the data used to calculate your EFC.
Financial aid applicants fall into one of three categories. - Dependent students. Generally unless a student is over age 23, married, or in the military, the student is considered a dependent for purposes of federal financial aid. For other exceptions to the dependency rule, see the instructions to the FAFSA. For dependent students, the EFC formula is based on assets and income of parents and student.
For the the 2008-2009 financial aid year, 12% of the parents' adjusted assets and 100% of adjusted income are included in the EFC calculation to determine their potential contribution. For the child, 20% of his or her adjusted assets and 50% of adjusted income are used in the calculation.
- Independent student with no dependent(s) other than a spouse. The expected contribution is based on the married couple's combined assets and income. For the 2008-2009 financial aid year, 20% of adjusted assets and 50% of adjusted income are used to determine the potential contribution.
- Independent student with dependent(s) other than a spouse. The expected contribution is based on the married couple's combined assets and income. For the 2008-2009 financial aid year, 7% of adjusted assets and 100% of adjusted income are used to determine the potential contribution.
You may wish to refer to the worksheet used by financial-aid officials at the DOE's Federal Student Aid office to calculate your EFC for the 2008-2009 financial aid year.
Next, we take a closer look at the application process for federal financial aid.
Aid application process
Applying for financial aid starts with you completing a Free Application for Federal Student Aid (FAFSA).
You can complete a FAFSA online or call the Federal Student Aid Information Center at (800) 433-3243. You can also obtain a FAFSA from your school's financial aid office or most high school counseling offices.
Within two to three weeks of submitting a FAFSA, you should receive a Student Aid Report (SAR). The SAR report tells you the amount of your expected family contribution (EFC) and confirms the information you submitted on the FAFSA.
When you submit a FAFSA, a financial aid specialist will process the application and calculate your expected family contribution. The U.S. Department of Education uses a worksheet to calculate your expected family contribution.
Your financial need is calculated as the difference of your expected college costs and EFC. You may find that your school's financial aid office is able to adjust either the expected or the data used to calculate your EFC in order to increase your financial need.
Timing to apply for federal financial aid is important. Generally, you should apply after January 1 for the upcoming academic year. The DOE requires you to apply by June 30. The academic year of colleges and universities in the U.S. is generally from August to May or September to June. (The DOE uses a calendar year of July 1 to June 30 for purposes of calculating financial aid.) Your school's financial aid office may impose earlier deadlines for campus-based aid programs.
Your Student Aid Record tells you the type and amount of financial aid for which you are eligible. In most cases, federal financial aid -- grants, loans or Work-Study -- is disbursed to your school's financial aid office. The financial aid office, in turn, disburses it to you on its own terms. To ensure that your aid is awarded on a timely basis, you should visit your school's financial aid office after receiving your SAR.
Your school's financial aid office is required to notify you when it receives financial aid on your behalf and notify you of how it intends to disburse funds to you. The financial aid office may intend on retaining some of the aid award to pay for expenses in a subsequent term (semester or quarter) of the same academic year.
Next, we take a look at another source of financial aid to pay for college: military service. Savings and payment strategies for funding college education Why is saving for College the right way so important? Consider these four main factors: • Rising cost of education • Education pays in terms of future earning power • Saving even a little can go a long way • Reduce reliance on debt College is an investment for a lifetime - the gift of a college education can open the door to a world of opportunity for your child or grandchild. Saving, even a little at a time, can make a big difference down the road. With the cost of a college education continuing to increase at an estimated 6% annually, the key is to start saving early and regularly. Rising cost of education According to the College Board, the average cost for tuition and fees at four-year public institutions has increased nearly 51% over the last 10 years (after adjusting for inflation), and these costs will almost certainly continue to rise. Saving for college can help with the increasing cost of a college education and help you be financially prepared when your children are ready for college. No matter how much you save, even a little can make a difference. Education pays Saving for your child's college education is an investment in their future. The savings you make today pay off in an increased earnings potential in the future. According to the U.S. Census Bureau, college graduates earn an average of $1 million more than high school graduates during their careers. The value of your investment in a college education will continue to grow for a lifetime. It will pay for itself both personally and professionally. Among men, median earnings of four-year college graduates were 63 percent higher than median earnings of high school graduates in 2005. It was also 70 percent higher among women. Saving a little can go a long way Like any other major investment, the key to saving for college is to start early and save regularly. By saving a set amount at set times, your money can grow as your child does. And before you know it, you'll be just as ready for college as they are. Set your college savings goals realistically. You may not be able to save enough for all four years of tuition, room and board, and other expenses - but you could save enough to give your child the right start. Remember, no matter how much you save, even a little can make a difference.
A family that begins setting aside $50 a month when their child is born can accrue over $21,000, in an account that earns 7% interest per year, by the time the child turns 18.
 « Reduce reliance on debt
More and more families rely on student loans to pay for college. Though low-interest loans are often available for college financing, paying even small amounts of interest can add up considerably over long periods of time. By saving for college, families can reduce their reliance on loans, earn interest versus paying interest and help their student leave college debt-free.
Tough choices: Retirement versus College Paying for college is not your only financial concern. Providing for your own retirement can be even more important since no one offers grants, scholarships, or federally guaranteed loans to support you when you leave the workforce. Ideally, college and retirement should be part of the same financial plan, but you should still expect some trade-offs as you try to balance these goals. You may have to work longer than you would like or your children may have to borrow more money than they would like. The important thing is that it is possible to meet these two major financial responsibilities. - Keep these key facts in mind when thinking about retirement and college savings:
- Most advisors agree that you should take full advantage of special retirement accounts such as 401(k), IRA, and 403(b) tax-sheltered annuities before funding your college savings accounts. These retirement plans offer special tax advantages, and, in some cases, matching contributions from your employer.
- Assets in retirement accounts will not affect your child’s prospects for federal financial aid (unless you actually take distributions from them during the college years). Neither will life insurance or annuities. If your child is earning a small amount from working, a Roth IRA can be a great way to invest unspent income.
- IRAs can even be a secondary source of college funding. Tax law permits you to tap your traditional or Roth IRA for qualified college costs without incurring the 10 percent penalty for distributions before age 59 1/2. Income tax may apply.
- Except in unusual circumstances, your 401(k) is less accessible for college. You might be able to borrow from your 401(k), but any money borrowed will have to be paid back in short order.
Just remember that using any of your retirement money to pay for education costs means it won’t be there for your own retirement expenses. You probably don’t want to support your children through college only to risk becoming a burden to them in your later years. HOWEVER- the need for education funding will arrive before you are ready to retire and you cannot ignore that! Hence, an excellent solution may be… 529 Prepaid Tuition Plans 529 Plans: A Great Way to Save for College 529 plans have become one of the more popular options for families saving for a child's college education, and for good reason. Though the plans differ from state to state, they are all exempt from federal income tax, and that can give a real bottom-line boost to your college fund. What is a 529? A 529 plan is a tax-advantaged investment plan designed to encourage saving for the future higher education expenses of a designated beneficiary (typically one's child or grandchild). The plans are named after Section 529 of the Internal Revenue Code and are administered by state agencies and organizations. All withdrawals from 529 plans for qualified education expenses will remain free from federal income tax! Many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses. There are two essential 529 plans. One is a prepaid tuition program, where you pay for college tomorrow at today’s prices. The other is an investment program that will have an initial deposit, ongoing payments, and will have gains and/or losses depending upon market performance. For most people, the Guaranteed Savings Program is the best option. This will ensure that you are paying for college tomorrow at today’s prices, which is the best inflation protection available. Consider that the cost of college education is said to grow by 6% annually. Therefore, in order to keep pace with this college inflation cost, you would need to net an extremely high rate of return in order to break even with the inflation rates. This is virtually impossible. More specifically, in an overall tax bracket of 33%, you would need a 9% average rate of return to make 6%, allowing you to meet the level of inflation. The GSP is the anecdote to this unbelievable inflation problem for college tuition. Why do state plans differ? Each state that offers a 529 plan determines how its plan is structured and which investment options are offered. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as a state tax deduction, a matching grant, and scholarship opportunities, protection from creditors and exemption from state financial aid calculations, for investors who invest in 529 plans offered by their state of residence. Types of 529 Plans There are two types of 529 plans: prepaid tuition and savings. Prepaid tuition plans (sometimes called guaranteed savings plans) are offered in 15 states and allow for the pre-purchase of tuition based on today's rates and then paid out at the future cost when the beneficiary is in college. Performance is often based upon tuition inflation. Prepaid plans may be administered by states or higher education institutions. Participating states include:
- Alabama
- Florida
- Illinois
- Kentucky
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Nevada
- Pennsylvania
- South Carolina
- Tennessee
- Virginia
- Washington
Savings plans are different in that your account earnings are based upon the market performance of the underlying investments, which typically consist of mutual funds. Savings plans may only be administered by states. 48 states and Washington, D.C. offer a savings plan. Most 529 savings plans offer a variety of age-based investment options where the underlying investments become more conservative as the beneficiary gets closer to college-age. They also offer risk-based investment options where the underlying investments remain in the same fund or combination of funds regardless of the age of the beneficiary. In addition, many savings plans offer a stable value or guaranteed option designed to protect an investor's principal while providing for some investment growth, while others offer investments in certificates of deposit. 529 plans are designed to encourage early and consistent savings by offering an easy, affordable and convenient way for families to save for college. While the tax advantages are one of the primary benefits, states also offer a variety of features and benefits to help families reach their college savings goals.
This chart shows the difference between saving with a tax-free account like a 529 plan versus saving with a taxable account. Benefits of the 529 include: - All money grows federal and state income-tax free
- All withdrawals used for qualified higher education expenses are exempt from federal income tax
- Many states also exempt withdrawals from state income-tax for qualified higher education expenses
- The account holder retains control of the assets within the program regardless of beneficiary's age
- Most plans have very low minimum monthly contribution limits making them attractive to families regardless of income level. Some states have minimum limits as low as $15.
- The beneficiary can be changed at any time to another member of the beneficiary's family
- Money can be used at virtually any accredited college in the country
- Money can be used to pay for tuition, fees, room, board, books, supplies and required equipment
- Contributions can be made conveniently through payroll deduction or automatic transfers from a bank account
- Many states offer maximum contribution limits of $300,000 or more
- Assets within 529 plans are protected from bankruptcy
- Most states offers a low cost option that can be opened by contacting the plan directly
- 529 plans are also offered through professional financial advisors who can help you choose a 529 plan and an investment strategy to meet your needs.
- Account owners can make a lump sum contribution of up to $60,000 per beneficiary or $120,000 if married filing jointly and avoid incurring a taxable gift on this amount by electing to use five years of the annual gift tax exclusion all in one year. After utilizing this provision, the annual exclusion cannot be used again for the same beneficiary until the five year period has passed. Should a donor die within those five years, a pro-rata amount of the gift will revert back to their estate and be treated as a taxable gift
Frequently Asked Questions Q. What is a 529 Plan?
A. A Section 529 college savings plan is a tax-advantaged state-administered investment program that is authorized under Internal Revenue Code Section 529. These plans allow investors to save money in an account in which the earnings will grow free from federal income tax and, when used to pay for "qualified higher education expenses", may be withdrawn federal income tax-free. In many states, a participant can receive special state incentives, including state tax treatment that mirrors the federal tax treatment, tax deductions/credits and/or other state tax benefits, based on participation in their state’s program(s). Q. What’s the difference between a 529 prepaid tuition program and a 529 savings program?
A. Prepaid Tuition: Essentially, parents, grandparents, and other interested parties may purchase future tuition at today’s rate. The program will then pay the future college tuition of the beneficiary at any of the state’s eligible colleges or universities (or comparable payment to private or out-of-state institutions). Amounts of tuition (years or units) may be purchased through a one-time lump sum purchase or monthly installment payments. The program pools the money and makes investments to enable the earnings to meet or exceed college tuition increases in that state.
Savings: Savings plans (also known as investment plans) enable participants to save money in a college savings account on behalf of a designated beneficiary. Amounts contributed and any earnings on the account may then be used to pay the beneficiary’s qualified higher education expenses. Contributions can vary, depending on the individual savings goals. The plans offer various investment options that provide a variable rate of return usually based on stock or bond funds, although some plans offer investment options that guarantee a minimum rate of return. Q. Which type of plan is better?
A. It depends upon the college plans and the investment needs and goals of the family. Most states have created innovative college savings programs individually designed to reflect the unique needs of its citizens. The plans offer affordable, flexible, and tax-advantaged options that can ensure the education of our most precious resources - the children of America. While prepaid tuition plans offer the opportunity to assure future tuition payments, savings plan assets can be used for tuition and other qualified expenses such as room and board. Some states offer their citizens both types of programs, giving families the option to choose the 529 plan that is right for them. Q. Who can be a beneficiary?
A. Generally, anyone can be named the beneficiary of a 529 account regardless of their relationship to the person who establishes the account. You can even establish an account with yourself as the named beneficiary. The only requirement is that the beneficiary must be a US citizen or a resident alien, and must have a social security number or federal tax identification number. Q. Can a beneficiary have more than one account?
A. Yes. Since only one account owner can be named per account, family members may choose to open their own account for the same beneficiary. Q. Can anyone open a 529 account? What about grandparents?
A. A 529 account can be opened by anyone. Grandparents, other relatives or family friends can all be account owners, or simply choose to contribute to an existing account. In most states, a trust, corporation, non-profit or government entity can also open an account. Q. Does my child have to go to an in-state school?
A. No. Funds can be used at any eligible educational institution in the country to pay for qualified higher education expenses. “Eligible educational institutions” are accredited post-secondary educational institutions offering credit toward a bachelor’s degree, an associate’s degree, a graduate level or professional degree, or another recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions and certain institutions located in foreign countries are also eligible educational institutions. To be an eligible educational institution, the institution must be eligible to participate in U.S. Department of Education student aid programs. Q. What if my child doesn’t go to college?
A. You have several options available if the beneficiary decides not to go to college: • Change the beneficiary to a member of the beneficiary's family. • Defer use of your savings and leave contributions invested in the account. • Withdraw the assets in your account for a “non-qualified” distribution (a distribution that is not for qualified higher education expenses). Earnings (but not contribution amounts) would be subject to state and federal tax plus a 10% federal tax penalty on the earnings. Q. What if my child is in high school? Is it too late to open an account?
A. It is never too late to save for higher education. You may open an account for an individual of any age, and the account may be used immediately. Q. What if my beneficiary receives a scholarship?
A. Earnings (but not contributions) on the amount you withdraw would be taxed at the scholarship recipient's tax rate, but will not be subject to the 10% additional federal tax penalty. You can also, of course, use your funds to pay for expenses not covered by the scholarship, such as room and board, books and other required supplies. Q. Who qualifies as a family member of the beneficiary?
A. A qualifying family member includes: • Natural or legally adopted children • Parents or ancestors of parents • Siblings or stepsiblings • Stepchildren • Stepparents • First cousins • Nieces or nephews • Aunts or uncles In addition, the spouse of the beneficiary or the spouse of any of those listed above also qualifies as a family member of the beneficiary. Q. Are there age or income limitations for participating in a 529 plan?
A. Anyone can participate in a 529 plan regardless of income of the account owner and in most states, regardless of the age of the beneficiary. Q. How do I open a 529 plan?
A. 529 plans are available by contacting the state which administers the program. This CSPN Web site offers links to plan web sites and toll-free numbers to contact the state plans. Most states offer residents the opportunity to invest in the plan directly though the state. These plans are often called “Direct Sold” and are typically offered at lower fees and without sales commissions. For those looking for professional advice on how to invest in a 529, “Advisor Sold” programs are offered by many of the state plans. Advisor Sold programs offer professional investment advice and service with standard sales commissions applying. Q. How can I change the beneficiary on an account?
A. Each 529 plan can provide the forms necessary for changing the beneficiary on an account. Contact your 529 plan to determine the specific requirements and forms necessary to complete this procedure. Depending on the relationship of the new and old beneficiaries, changing the beneficiary of an account may trigger a taxable event, which could also include a penalty, gift tax or both. Q. Is investment in qualified tuition programs recommended by financial advisors?
A. Many financial planners, tax accountants, and other financial advisors recommend 529 plans to their clients as a program that may fit their college planning needs. You may want to consult an advisor to see if 529 plans would be best for you. Q. Are there restrictions regarding a 529 Plan and Education IRAs?
A. Beginning in January 2002, individuals can contribute to both 529 plans and Education IRAs (now called Coverdell Education Savings Accounts). The Economic Growth and Tax Relief Reconciliation Act of 2001 permits contributions to the Coverdell Education Savings Account to cover K-12 education expenses on a tax favored basis. Individuals may benefit by funding a 529 plan for the child's college expenses and utilizing the Coverdell Education Savings Account for elementary and secondary education expenses. Q. Once an account is established, who controls the investments?
A. Many states have chosen to contract with an investment manager to work with the state to develop investment portfolios and options that will help investors meet their college savings needs. Federal law prohibits the investor from having direct control over the selection of specific investments. Therefore, the state and the investment manager typically offer multiple savings options for the investor to choose from when they open an account. The account owner may change investment options subject to certain federal tax law limitations. Q. Who can contribute to an account?
A. Generally, anyone can make a contribution to an account for any beneficiary. However, you should contact the 529 plan of your choice to determine any restrictions that may apply. You may find that you will only be eligible for specific state tax incentives by being recognized as the account owner. Q. What are the most common investment options offered by Section 529 savings / investment plans?
A. The most common investment option is the age-based allocation strategy in which the age of the beneficiary determines the specific mix of investments. As the child ages, your investment mix is automatically reallocated and becomes more conservative as the beneficiary approaches college. There are many other options available, including 100% equity funds, fixed income funds, stable value funds, as well as a variety of equity and fixed income options within many plans. Some states offer guaranteed or principal protected options, as well as FDIC insured bank options. Q. Can you change investment options once you have opened an account?
A. The investment option chosen for an account can be changed one time each calendar year or whenever you change beneficiaries. However, each time a new contribution is made to an account, the investor can select a different investment option for the new contribution into the plan. Q. Can a savings / investment account be rolled over to another 529 program?
A. Yes. The account owner can choose to move funds from one state’s 529 plan to another states’ plan one time Q. Who controls a prepaid tuition account?
A. The account purchaser maintains control over all of the money in the account and is the only one who can request account changes or refunds. Typically, a prepaid account has only one owner, check with the plan in your state for details. The student beneficiary does not have any control over the account, unless he or she is also the designated purchaser. Q. Does the account owner have to be related to the beneficiary?
A. No. In most states, you can open an account for your child, grandchild, nephew, friend – even yourself. Review the program materials for naming and changing the designated student beneficiary. Q. What are the eligibility requirements to participate in a prepaid tuition plan?
A. Typically, the beneficiary of a prepaid tuition account must be U.S. citizen or a legal resident. Additionally, either the account owner or the beneficiary must be a resident of the state that administers the plan at the time the application is signed.
Most prepaid plans also require that the beneficiary be a participant in the plan for at least three years prior to using the account to pay for higher education. Additionally, the beneficiary is typically required to be 15 years old or younger when the account is opened, thereby providing the plan with a minimal amount of time to begin investing the assets of the account in anticipation of the beneficiary using the plan to pay for college. Prepaid tuition plans can vary, you should always check with the plan in your state to determine the specific requirements necessary to participate in the plan. Q. Can more than one person make contributions to a prepaid tuition account?
A. Yes. Generally, anyone can contribute to an account. Prepaying tuition is an excellent gift idea for grandparents, other family members and friends. You should contact the program in your state to determine the specific process to follow to make additional contributions to the account. Q. Can prepaid tuition plans only be used at in-state schools?
A. Prepaid tuition plan benefits are generally designed to be used at in-state public universities and community colleges. However, in some cases, they can also be used at private institutions and at out-of-state public and private colleges and universities. Be sure to check the plan details for the prepaid plan in your state. Q. What happens to my prepaid tuition plan if my child receives a full or partial scholarship?
A. If the scholarship covers some or all of the student's tuition and fees, the unused prepaid tuition benefits can be transferred to another member of the family, held for possible future use, or a refund can be paid to the purchaser on a semester-by-semester basis. Q. What if my child decides not to attend college?
A. Refund and transfer options are available. You should check with the program to determine who the benefits can be transferred to or how to receive a refund from the account. Q. Does a prepaid tuition account guarantee college admission or in-state tuition?
A. No. Having a prepaid tuition account does not affect your child’s chances of getting into a particular college, or your eligibility for in-state tuition rates. Q. Can a prepaid tuition account be rolled over to another 529 program?
A. Generally rollovers are allowed. For instance, if the beneficiary of the account decides not to attend a post-secondary institution, the account owner can typically transfer funds in the account to another eligible beneficiary. To avoid penalty and income tax, the new beneficiary must be a member of the family of the preceding beneficiary. Additionally, you should check with the program you participate in to determine if there are other requirements that may apply. How do I enroll? It’s easy!Simply click on your state below and you’ll be directed to their website. - Alabama
- Florida
- Illinois
- Kentucky
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Nevada
- Pennsylvania
- South Carolina
- Tennessee
- Virginia
- Washington
Sources:
The College Board The College Board is a not-for-profit membership association whose mission is to connect students to college success and opportunity. Founded in 1900, the association is composed of more than 5,400 schools, colleges, universities, and other educational organizations. Each year, the College Board serves seven million students and their parents, 23,000 high schools, and 3,500 colleges through major programs and services in college admissions, guidance, assessment, financial aid, enrollment, and teaching and learning. Among its best-known programs are the SAT®, the PSAT/NMSQT®, and the Advanced Placement Program® (AP®). The College Board is committed to the principles of excellence and equity, and that commitment is embodied in all of its programs, services, activities, and concerns.
The College Savings Plan Network The College Savings Plans Network is a national non-profit association dedicated to making college more accessible and affordable for families. Our web site provides detailed information about 529 college savings plans and allows you to compare plans from around the country.
Bankrate Incorporated Saving for college.com was established as a private company in 1999 with a mission to help individuals and professional advisers better understand how to meet the challenge of paying higher education costs.
Financing Education via Home Equity
The value of ownership built up in a home or property that represents the current market value of the house less any remaining mortgage payments, is one’s home equity. Equity in one’s home is built up over time as the property owner pays off the mortgage and the market value of the property appreciates. Home equity represents one of the largest sources of net worth for most people, and since home equity can be borrowed against through a home equity loan or home equity line of credit (HELOC), it may provide a tax efficient opportunity for college financing . A popular strategy for financing college education, is to take out a home equity loan and purchase prepaid tuition credits, thereby paying today’s prices for future college education, tax efficiently. Using UGMA/UTMA accounts UGMA (Uniformed Gift to Minors Act): An act that allows minors to own property such as securities. The IRS allows persons to give so many thousands of dollars to another person without any tax consequences. If this recipient person is a minor, the UGMA allows the minor to own the assets without an attorney setting up a special trust fund. Under the UGMA, the ownership of the funds works like it does with any other trust except that the donor must appoint a custodian (the trustee) to look after the account. The donor can appoint him/herself or another person to be custodian. The custodian, who has a fiduciary duty to manage the minor's assets wisely, can use the funds to buy securities on behalf of the minor. Access to the gift must be given to the minor when he or she reaches the age of majority, either 18 or 21 (sometimes even 25), depending on UGMA state law. Should a donor acting as the custodian die before the custodial property is transferred to the minor, the entire custodial property is included in the donor's taxable estate. UGMA/UTMA accounts are custodial accounts you may use to save for your child's college education. Contributions to the account to pay for future higher education expenses are exempt from gift taxes as long as no more than $12,000 (in 2008) is contributed by a single donor to a single child.
(Note: The Economic Growth and Tax Relief Reconciliation Act of 2001 added a new tax rate of 10%. This new rate applies to the first $8,025 (in 2008) of income for single taxpayers.)
If the child is under 18 or a full-time student age 19-23, the first $900 (in 2008) in earnings on an UGMA/UTMA account is tax-free. The next $900 is taxed at the child's tax rate. At higher levels, earnings on the account are taxed at the parents' highest marginal income tax rate. The following table shows the future value of monthly contributions to a tax-exempt account. (Keep in mind that the earnings -- not the contributions -- to an UGMA/UTMA account are taxable. After the child turns 18 or 24 if a full-time student, the earnings are taxed at the child's tax rate.)
For example, if you contribute $250 monthly, invested at 6%, the future value in 18 years is $97,322: | Monthly Amounts | 6.0% | 8.0% | 10.0% | | $100 | $38,928 | $48,328 | $60,556 | | $250 | $97,322 | $120,821 | $151,391 | | Financial professionals may recommend that you buy growth stocks or mutual funds that invest in growth stocks for UGMA/UTMA accounts. Since growth stocks usually don't pay dividends, the account grows instead by earning capital gains. Capital gains earned over a period of more than one year are taxed at a lower rate than ordinary income. The tax rate on long-term capital gains is 0% for investors in the lowest tax brackets. For all other brackets, the tax rate is 15%.
There are two major drawbacks to using UGMA/UTMA accounts: - Impact on applying for student financial aid. The expected-family contribution formula used to calculate a child's eligibility for financial aid assigns a greater weight to assets held in UGMA/UTMA accounts. This is because these accounts are considered the child's assets.
- Loss of control of assets. Since UGMA/UTMA accounts are considered the child's assets, the child gains control of them when they reach age 18 or 21, depending on the state.
For more information, see IRS Pub. 929: "Tax Rules for Children and Dependents."
Next, we'll take a look at the major types of student loans and rules for deducting interest on those loans. Education savings bonds The federal government's Education Savings Bond Program allows you to take a deduction for some, or all, of the interest you earn on savings bonds provided you use the proceeds to pay for college expenses.
Savings bonds must be either Series EE/E or Series I bonds issued since 1990. In order to take the deduction, the bonds' principal and interest must be used to pay for qualified educational expenses in the year you cash in the bonds. The expenses can be for you, your spouse, or a dependent.
You can take an interest deduction for an amount that is equal to the amount of qualified educational expenses in the same year. For example, if your expenses are $4,000 and you have $5,000 in maturing bond principal and interest, you can deduct 80% of the interest earned.
You may wish to keep in mind the following requirements of the Education Savings Bond Program: - Age, ownership, and tax filing requirements. You must be at least age 24 when you begin to buy eligible savings bonds. The bonds must be registered in your, or your spouse's, name. A dependent can be designated as beneficiary. If married, you must file a joint tax return.
- Coordination with other sources of financial assistance. You must reduce your eligible educational expenses by the amount of scholarships, employer-paid assistance, or other financial aid you receive.
- Yearly purchase limits of bonds. You can buy up to $30,000 a year in face value of either Series EE/E or Series I bonds. (An exception is if Series EE/E bonds are co-registered in you and your spouse's name. In that case, you can buy up to $60,000.)
- Income limits. The tax-deductible benefit of the bond savings program has income limits that determine whether you can take a full or partial deduction. The following table shows the levels of modified adjusted gross income (MAGI) that you can earn in 2008 before your tax deduction is phased out.
You lose the entire tax deduction at higher incomes. For single persons, the tax deduction is completely phased out when income is more than $82,100 in 2008. For married persons filing a joint return, the tax deduction disappears when income is more than $130,650 in 2008.
| Tax Filing Status | Partial Phase-out | Full Phase-out | | Single | $67,100 | $82,100 | | Married filing jointly | $100,650 | $130,650 | | Even if you are ineligible to participate in the Education Bond Savings Program, you can still buy savings bonds to pay for your child's college. The tax treatment is a little different, however. For 2008, the first $1,800 in interest is taxed at your child's rate, if the child is under age 18 or is a student age 19-23. This amount is indexed yearly for inflation. Interest earned in excess of that amount is taxed at the parents' highest marginal tax. When your child turns age 18 and is no longer a student age 19-23, however, all the interest on these bonds is taxed at his or her rate.
For more information on buying U.S. savings bonds online, see the U.S. Treasury's Treasury Direct website.
Next, we'll take a look at using Coverdell education savings accounts, formerly called Education IRAs, to save for future college expenses. Education Savings Accounts Coverdell education savings accounts, formerly called education IRAs, are an attractive tax-advantaged vehicle to help pay for college.
Education savings accounts are actually tax-deferred accounts used to pay for education expenses. You can contribute up to $2,000 in a year to each child's education savings account until the child reaches age 18. A child may have more than one education savings account, but combined contributions to all accounts in one year may not exceed $2,000.
Amounts in excess of qualified expenses are taxed at the beneficiary's tax rate. Similarly, you generally owe a 10% penalty on withdrawals that exceed the amount of qualified expenses.
Contributions to an education savings account are subject to income limits. If your modified adjusted gross income (MAGI) is above the lesser amounts shown below, your allowable contribution is reduced, or phased out. You can still make an allowable contribution of less than $2,000. If your MAGI exceeds the larger amounts shown below, however, you are not allowed to make any contributions to an education savings account for the current year. | Tax Filing Status | Partial Phase-out | Complete Phase-out | | Single | $95,000 | $110,000 | | Married filing jointly | $190,000 | $220,000 | | You may wish to keep in mind the following about education savings accounts: - Control of account. An education savings account becomes the asset of the beneficiary when he or she reaches age 18.
- Withdrawing leftover funds. Assets left in an education savings account must be used within 30 days of either: a) the beneficiary reaching age 30, or b) the beneficiary's death (unless a special-needs situation applies).
- Rollovers. If you decide to transfer the assets of an education savings account to a new beneficiary, you have 60 days to complete a rollover to avoid triggering a tax bill. (A similar 60-day rule applies when rolling over regular and Roth IRAs.)
- Using an education savings account with other tax-advantaged accounts. As a result of the new tax law, beneficiaries may use education savings accounts together with the Hope Credit, lifetime learning credit, or a Section 529 plan.
For more information on education savings accounts, see IRS. Pub. 970: "Tax Benefits for Higher Education."
Paying for college with IRAs & 401(k) plans The IRS lets you take out money from a regular IRA or Roth IRA, penalty-free, to pay for qualified higher education expenses. These college expenses can be for you, your spouse, or a dependent for whom you claim an exemption on your tax return.
However, depleting your retirement account has an opportunity cost. You may be meeting a lofty financial goal of paying for a child's college. However, the opportunity cost is that you could be benefiting from compounded growth in a tax-deferred account. As a result, you'll be doing the equivalent of the proverbial "robbing Peter to pay Paul." In addition to depriving yourself of future growth in a tax-advantaged account, you will also owe income taxes on the withdrawal. Moreover, if you take out more than what you pay in qualified expenses, you'll owe a 10% penalty tax on the amount of excess withdrawals.
Clearly, there are costly trade-offs in taking an early withdrawal from an IRA, no matter what the reason. However, if you insist, you should be diligent to avoid taking excess withdrawals and paying additional taxes. Be sure to include income from the following sources when calculating how much you need to take out: - Any and all sources of extra income or savings. Be sure to add any income earned by the person on whose behalf the qualified expenses are being paid. Include any savings that the beneficiary may have.
- Tax-advantaged savings plans. Include as income any money that is in a Section 529 plan that is designated for the same beneficiary.
- Loans and gifts. Gifts, grants, scholarships, or any other nonrecurring awards should also be included as income. Include in income any amounts of inheritances from other IRAs.
For more information on taking money from an IRA to pay for educational expenses, see IRS Pub. 970.
Instead of taking money out of your IRA, you may find out that your employer will allow you to borrow against your 401(k) plan assets as collateral. (The IRS doesn't allow early withdrawals from a 401(k) plan to pay for college expenses.)
Similar to taking money out of an IRA, borrowing against your 401(k) plan, using the assets should be a plan of last resort. This is especially true in light of the variety of vehicles introduced in this educator that are available to pay for college.
A major risk of borrowing against your 401(k) plan is that your employer will demand repayment in full, and immediately, if you lose your job. You may find yourself scrambling to take out a consolidation or home equity loan to repay your ex-employer.
However, if you do pursue this source of raising money, be sure to ask your employer to explain the terms and conditions of a 401(k) loan. Terms and conditions may vary widely. The role of grandparents and other sponsors in funding college education: Saving for a child's college education is not limited to just his or her parents. Let's explore the role of grandparents and other sponsors that wish to help pay the college bills of a grandchild or other beneficiary.
Whether you're a wealthy aunt or uncle, or simply a charitable person wishing to help pay a deserving student's way through college, many of today's tax-advantaged savings vehicles for college are available to you.
Section 529 plans allow you to set aside well over $100,000, in aggregate, for a single beneficiary's college education. As long as your grandchild uses the money in these accounts for qualified higher education expenses, the withdrawals are tax-free.
Unlike UGMA/UTMA accounts, the money you save in a Section 529 plan for grandchildren is controlled by you. You can also change beneficiaries of a Section 529 plan easily.
In 2008 Section 529 plans can be front-loaded with an investment of up to $60,000 in a single year per child. However, since gift taxes are levied on gifts of more than $12,000 per child in a year, you will have to coordinate your funding of a Section 529 plan with your overall estate planning. If you give the maximum of $60,000, you will have to wait for another five years before you are able to give additional amounts free of gift taxes. (The $12,000 a year exclusion limit, multiplied by five years, in this example.)
While nothing comes quite as close to the tax benefits of Section 529 plans, grandparents or other sponsors can also open an education savings account to pay for a grandchild's or beneficiary's college education.
Education savings accounts were formerly called education IRAs. You can contribute $2,000 a year, after taxes, to each beneficiary's education savings account. In addition to being used tax free to pay for qualified higher education expenses, the funds in an education savings account can also be used tax free to pay for qualified educational expenses paid to attend secondary schools.
Finally, don't forget about making contributions to charitable organizations. You can always make a gift or endowment to a foundation or scholarship fund to give hope to some youngster's college aspirations. Part-time work: You may decide to pay for some of your college expenses by taking a part-time job. Retail shops and restaurants, which often abound next to campus and cater to the local college population, often hire students as part-time workers.
While a part-time job may only pay the federal minimum wage of $5.85 an hour (July 24, 2007 through July 23, 2008), the extra income makes a difference. For students who rely on student loans to help pay for college, the extra income means having to borrow less.
At the current minimum wage, working 10 hours a week for 30 weeks a year (the estimated length of a school year) adds up to about $1,750 before taxes. As a result, a student who relies on student loans may be able to borrow that much less if they stick to a personal budget. If the student works through the summer, they are easily able to earn another $1,000 with perhaps a slight increase in weekly work hours.
This $2,750 in annual loan savings adds up to $11,000 over a four-year period -- a significant reduction in college-funding expenses.
Of course, most student part-time jobs offer no health insurance or other benefits. However, if you can find the right job with a mutually beneficial work schedule, you may find that a part-time job offers sufficient financial rewards.
Work-Study, which is a form of federal financial aid, provides eligible students with campus, or community based, work. Students ineligible for Work-Study (or who do not submit a FAFSA) can turn to the retail stores and restaurants that are often located near campus.
When seeking a part-time job as a college student, you may wish to keep in mind: - Number of weekly work hours. You don't want to work so many hours that you jeopardize your studying or attendance. In particular, late work nights may result in oversleeping and missing too many classes. If delivering those pizzas an extra night each week crimps the hours you need to study for physics, you may wish to limit the number of hours you work weekly.
- Flexibility of work and school schedules. You may not wish to miss a course that is vital to graduating, or of academic interest, for the sake of a part-time job. At the same time, you have to offer some flexibility in the hours you can work to fit your employer's needs. Finding the right work schedule is a bit of a balancing act. It's no surprise that, once a part-time student's and employer's schedules work out, a student is likely to remain at a part-time job until they graduate.
- Applying for financial aid. If you receive federal financial aid as a college student, you may have to limit the number of hours you work per week. Similarly, if maintaining a scholarship or grant requires you to maintain a certain grade point average, you should check with the financial aid office or scholarship donor to ensure that there is no conflict with a part-time job.
- Additional opportunities to work. You may have an opportunity to work extra hours or weeks of the year, such as when school is not in session. Once employed and established as a reliable employee, you may be easily able to ramp up the number of available hours when school is out of session. On the other hand, some retailing businesses rely on students for business to such a degree that they cut back staff when school is not in session. In that case, you may be better off enjoying your own vacation!
In addition to earning extra income, working part-time as a college student teaches financial responsibility, self-discipline and other good habits. It's important, however, that a part-time job doesn't conflict with your primary objective of completing your college education. Military service If you are ineligible for a grant and don't relish the idea of borrowing to pay for college, other financial-assistance options exist to pay for college. These options include military and community service.
Here are four major types of military-service options: - Military academies. Attendance at one of the nation's military academies is an all-expenses-paid college education. (Provided you make it through the rigors of life as a cadet or plebe.) When you graduate as a commissioned officer or ensign, you serve a minimum number of years of active duty. (It should come as no surprise that a high percentage of academy graduates aspire to lifelong military careers.)
The four national military academies are the U.S. Military Academy in West Point, New York (U.S. Army); U.S. Naval Academy in Annapolis, Maryland; U.S. Air Force Academy in Colorado Springs, Colorado; and U.S. Coast Guard Academy in New London, Connecticut.
Admittance to all of the military academies is very competitive. The major academies enroll about 1,200 applicants each year. The Coast Guard academy enrolls about 260 applicants.
Applicants to military academies are often motivated more by a desire for public service than for financial assistance. However, attending a national military academy is probably the most comprehensive financial-assistance package available among the military service options.
- ROTC programs. Reserve Officer Training Corps (ROTC) programs are available at hundreds of state colleges and universities. ROTC programs often include a number of fully funded scholarships for four years. Sometimes, scholarships are for fewer than four years. An ROTC scholarship pays tuition, fees, books and a tax-free monthly stipend to offset living expenses.
In exchange for an ROTC scholarship, you must complete a minimum military obligation after graduation as a commissioned officer. For more information, see the Web sites of Army ROTC, Navy ROTC and Air Force ROTC.
Tuition assistance and some student-loan forgiveness. As an enlistment incentive, National Guard and U.S. Armed Forces Reserve units offer tuition assistance for state colleges and universities. A debt forgiveness program may also be available as an additional incentive to retain Guard and Reserve members who have certain military specialties. For more information, see the recruiting-center Web sites of the Army National Guard and Air Force National Guard.
- G.I. Bill benefits. The G.I. Bill helped to pay for college for hundreds of thousands of veterans returning from World War Two and to pave the way to acquiring civilian job skills. The Montgomery G.I. Bill, as it's currently called, provides fixed monthly payments to eligible veterans for up to three years to attend college after leaving the military. For more information on the G.I. Bill and other education benefits for veterans, see the education benefits programs at the Web site of the U.S. Department of Veterans Affairs.
Financial assistance may also be available for members of the Armed Forces currently serving on active duty. The Servicemembers Opportunity Colleges (SOC) is a consortium of colleges and universities that help active-duty sailors, soldiers and airmen earn a college degree.
In addition to military service, other federal programs offer financial assistance to help you pay for college in exchange for working in public service for one to two years. These programs include the Peace Corps and its sibling, AmeriCorps, which focuses on volunteer programs in the U.S. Loans & interest deductions You may not be able to avoid borrowing some money to help pay for college. Stafford Loans and Perkins Loans are the two major loan programs that loan directly to students. (A third category, PLUS Loans, are loans made directly to parents to help them pay for a child's cost of attending an undergraduate program.)
Stafford Loans are either subsidized or unsubsidized loans. Stafford Loans are disbursed by a bank, or other private lender, that participate in the Federal Family Education Loan Program (FFELP). The government may disburse the loan directly through the Federal Direct Student Loan Program (FDSLP).
The amount you can borrow with a Stafford Loan depends on whether you are an undergraduate or graduate student. You can also borrow different yearly amounts depending on your year in college or whether you are a graduate student.
Undergraduate students who are dependent on their parents can borrow up to a total amount of $23,000, or $46,000 if independent. Graduate students who are dependent on their parents can borrow up to a total of $65,500, or $138,500 if independent. The following calculators are useful in budgeting college expenses and loan repayments: What will it take to pay off my balance? The interest rate on Stafford Loans was formerly indexed to the yield on 3-month T-bills. However, for loans disbursed after July 1, 2006, the interest rate is fixed at 6.8%. With a Stafford Loan, you may defer interest payments until the loan's grace period expires. The deferred interest is added to your loan amount.
Perkins Loans are student loans that the school makes directly to the student with the use of government funds. The federal government pays the interest during school and during a grace period that lasts nine months. The interest rate cap on a Perkins Loan is 5%.
To apply for either a Stafford or Perkins Loan, as well as any other federal financial aid, you must complete a Free Application for Federal Student Aid (FAFSA).
As a result of the 2001 tax law, you can take a tax deduction of up to $2,500 for interest expense paid on student loans over the entire loan term. (Previously, you were limited to taking a deduction during the first 60 months of the loan term.)
The tax law also increases the income limits for taking this deduction. For taxpayers filing a single return in 2008, your allowable deduction begins to phase out when your modified adjusted gross income (MAGI) reaches $55,000. The allowable student-interest deduction phases out completely when your MAGI reaches $70,000. For married taxpayers filing a joint return, the increased income limits are $115,000 and $145,000, respectively.
To take a student loan interest deduction, enter the amount of the deduction on line 33 of the IRS Form 1040.
If your income falls within the income limits shown above, see IRS Pub. 970: "Tax Benefits for Higher Education" to calculate a partial deduction.
Next, we'll take a look at qualifying for student aid. Deducting college expenses The Economic Growth and Tax Relief Reconciliation Act of 2001 created a new tax deduction for college expenses. For 2002 and 2003, taxpayers could deduct up to $3,000 in qualified higher education expenses.
However, the tax deduction was initially only available for four years, beginning in 2002. The amount of the deduction was also subject to income limits. For 2002 and 2003, you could take the maximum allowable deduction of $3,000 if your adjusted gross income (AGI) was $65,000 or less. If you were married and filing a joint return, the AGI limit was twice that amount, or $130,000.
Married persons filing a separate return were not eligible for the deduction. In addition, you could not deduct those expenses that were claimed for the Hope Credit or Lifetime Learning Credit, or that had been paid for with distributions from a Section 529 Plan, education savings account, or savings bonds whose interest you deducted for paying college expenses.
For 2004 and 2005, the maximum allowable deduction increased to $4,000. For persons earning more than $65,000 and not more than $80,000, the allowable deduction was cut in half to $2,000. (For married persons filing jointly, the respective limits were $130,000 and $160,000.) For single taxpayers earning more than $80,000 or married filing joint taxpayers earning more than $160,000, no deduction was available.
The Tax Relief and Health Care Act of 2006 extended the tuition deduction through 2007. The deductible amounts and income limitations remain the same as they were for 2004-05.
The money that you invested in yours, your spouse's, or a dependent's higher education translates into direct tax savings. The new tax deduction was an above-the-line deduction. This means you didn't have to itemize or limit the deduction to amounts that exceeded 2% of your AGI.
The following table calculates the tax savings and future value for two investors. One investor is in the 25% tax bracket. The other investor is in the 28% tax bracket. Both investors can earn a 5% rate of return. Future value is calculated for a five-year period for a taxable and tax-exempt account. Value of $4,000 tax deduction for 25% and 28% tax brackets: | Tax bracket: | 25% | 28% | | Adjusted gross income: | $30,000 | $55,000 | | Qualified expenses: | $3,000 | $3,000 | | Tax savings: | $750 | $840 | | Savings interest rate: | 5% | 5% | | Future value (5 years): | -- | -- | | Tax-exempt account: | $957 | $1,072 | | Taxable account: | $902 | $1,010 | | If you are in the higher bracket, $4,000 in deductions saves you $1,120 in taxes this year. Invested in a tax-exempt account at 5% compounded yearly, this amount grows to $1,429. Invested in a taxable account at 5%, it grows to $1,337.
Next, we'll take a look at prepaid tuition plans. These plans allow investors to pay college tuition in advance for their children or other beneficiaries. Tax credits for education The Hope Credit and Lifetime Learning Credit are two tax credits available to offset college expenses, for you, your spouse, or your dependent. A tax credit provides a dollar-for-dollar reduction in the amount of federal income taxes that you owe.
For example, if you owe $2,000 in income taxes and have a $1,000 tax credit, you cut your tax bill in half. In general, you cannot receive a refund for the portion of a tax credit that exceeds the amount of federal income taxes that you paid.
The Hope Credit can be used for expenses incurred in the first two years of college, up to $1,800 a year in 2008. The amount of the credit is indexed for inflation.
The Lifetime Learning Credit applies to tuition costs for undergraduates, graduates, and those improving job skills through a training program. In 2008, this credit is 20% of up to $10,000 in qualified expenses, or a maximum of $2,000. Neither the amount of qualified expenses, nor the credit amount, is indexed for inflation.
The 2001 tax law coordinates the use of these education credits with education savings accounts and qualified state tuition programs (QSTPs). QSTPs include prepaid tuition plans and college savings plans.
You can receive tax-free distributions from education savings accounts or QSTPs without affecting your use of the Hope or Lifetime Learning Credit. The only stipulation is that you don't claim the credit for expenses that you pay with these tax-advantaged accounts. (Distributions from an education savings account or QSTP are excluded from income when calculating the credit.) You must complete IRS Form 8863: "Education Credits" if you use either credit.
To help you calculate your credit, the IRS requires the school that you attend to mail a Form 1098T: "Tuition Payments Statement" by Feb. 1.
Use of the Hope Credit and Lifetime Learning Credit phase out at higher incomes. For taxpayers filing a single return in 2008, the tax credits begin to phase out when modified adjusted gross income (MAGI) reaches $48,000. For couples filing a joint return, the credits begin to phase out when income reaches $96,000. These credits phase out completely when income reaches $58,000 for single persons, and $116,000 for married persons filing a joint return.
Student Loan Repayment Armed with a college diploma and plans to find your first job, it will soon be time to face another reality -- paying back your student loans.
Student loans usually have a grace period of six to nine months. (Stafford Loans have a grace period of six months. Perkins Loans have a grace period of nine months.) In theory, a grace period gives you enough time to find a job and secure a source of income to repay your student loans.
Student lenders offer a variety of loan repayment plans limited only by lenders' marketing prowess. A standard repayment plan requires you to make regular monthly payments. At first, most of your payment perhaps all of it, will go to repay any accrued interest. A graduated repayment plan allows you to make larger payments after an initial period. Most loan-repayment plans let you set up an automatic-payment plan that deducts payments from a checking or savings account.
The repayment period for most student loans is 10 years. If you make smaller-than-required monthly payments, your loan term will increase and you will pay more interest. If you make larger-than-expected monthly payments, your loan term will decrease and you will pay less interest. You may be able to deduct up to $2,500 of your interest expense on student loans on your federal income tax return. As a result, you will pay a lower after-tax interest rate.
You may also wish to consolidate your student loans using a federal consolidation loan. Sallie Mae and other lenders offer these loans as a means of combining all of your student loans into one loan with a single payment.
The interest rate ceiling on a federal consolidation loan is currently 8.25%. The interest rate is calculated as a weighted average of loan amounts, rounded up to the nearest one-eighth (0.125%, 0.25%, 0.375%, 0.5%, etc.) of a percentage point. Generally, rate ceilings are slightly higher for federal consolidation loans issued before Nov. 13, 1997.
Another repayment option is loan serialization. Loan serialization requires your lender to buy any other of your student loans and stack them. You repay the most expensive loan first, then move on to the next-most expensive loan. For example, if you have a 7% and 6% Stafford Loan, you pay off the 7% Stafford Loan first and, next, repay the 6% loan. Certain types of student loans, including Perkins Loans, cannot be serialized.
Whatever you do, don't suddenly stop making payments on your student loans. If you do, you will become delinquent and damage your credit history. If you continue to be delinquent, you will eventually default on your student loan, adversely affecting your hopes of borrowing from the federal government again, even for your own children's college. Defaulting on a student loan is, simply, a very bad idea.
If you face a financial hardship such as a job loss or a major expense, you should contact your lender immediately and request a loan deferment or forbearance. Either of these steps will allow you to temporarily stop making loan payments, or perhaps pay a lesser amount. Unpaid interest accrues during the period that you receive a deferment or forbearance.
You may be able to have some of your student loans forgiven if you work in public service. The Peace Corps and its domestic sibling, AmeriCorps, together with some military service options, have debt-forgiveness programs.
If you file for personal bankruptcy under Chapter 7 of the U.S. Bankruptcy Code, you may have your debts forgiven. However, a personal-bankruptcy filing remains on your credit history for ten years.
This tutorial has aimed to provide information that is useful in seeking financial aid and other forms of financial assistance to attend college. Several options for receiving financial aid exist, including loans, grants, scholarships and Work-Study.
Other sources of financial assistance require a greater degree of self-reliance. These sources include military service and part-time work. Combined with traditional sources of financial aid, you, a child or grandchild should have the resources to pay for college. Room-and-board considerations When your child begins college, it is often their first time living outside of your home and supervision. While you may anguish at first over the loss of daily interaction, your concern is likely to shift to ensuring that he or she lives in a safe and comfortable home that creates the right environment to learn. Primary options for room and board in college include: - Living at home. Living at home is an economical way to pay room and board for at least a part of your child's college education, particularly if they plan to attend a community college. Hundreds of thousands of frugal students obtain as many credits as possible at a local community college before transferring to a state school as a legally domiciled resident.
- On-campus housing. On-campus housing used to consist of a single, simple option -- the residence hall, or student dormitory. It wasn't too long ago that a luxuriant dorm room consisted of wall-to-wall carpeting and central air conditioning.
Today, campus housing options are greater. In a quest to lure and retain students, colleges and universities spend millions of dollars to build town home-style campus housing. These living facilities, generally the most expensive housing options, are replete with Internet connection, cable TV, security gates, workout gyms and covered parking.
For parents and students unwilling or unable to pay top-dollar for this kind of campus housing, the student dormitory remains a reliable candidate for campus housing. Colleges and universities have renovated many of their dorms to upgrade basic amenities, including cable access. It's often hard to beat a primary feature of dorm housing -- proximity to classrooms and dining halls. This proximity often makes owning a car unnecessary for dorm residents.
Some schools require that new students live on campus and go without a car for a certain period. Another requirement of many campus-housing programs is participation in a meal plan. Meal plans come in many varieties and often provide great value.
Demand for campus housing often exceeds the supply of dorm rooms. As a result, many schools use a lottery system to assign dorm rooms. Some schools aim to accommodate students from far-flung corners of the state, region or country. At other schools, preference is given to a certain class of students, whether freshmen or juniors and seniors. As part of a campus visit, you will want to stop in at the school's student housing office to explore on- and off-campus options and costs.
According to Trends in College Pricing 2007, published by the College Board, room and board costs at private schools average $8,595 for the 2007-2008 school year, up 5.0% from the previous year. For state schools, the average cost for room and board rose 5.3% to $7,404 for the 2007-2008 school year.
- Student apartments. While a mandatory year of dorm life or limits on freshmen owning a car may be the well-intended objectives of campus housing programs, some students (and their parents) chafe at such restrictions.
An alternative to living on campus is living off campus. A first alternative may be to live in an apartment complex or cluster of homes that rents primarily to student-tenants. These student apartments are often adjacent or close to campus, perhaps within a short biking distance.
Living off campus gives students more flexibility in how much to spend on rent and whether to participate in a meal plan. They can elect to split utilities and other expenses with a sibling or other roommate. Of course, transportation needs mount once a student moves off campus.
A downside of student apartment living, however, is often the lack or absence of supervision, that could ultimately lead to a few boisterous and unruly students making more nuisance than dorm resident managers are willing to tolerate.
- Housing in the broader community. A second alternative of off-campus housing is living in the broader community. Of course, living beyond the one or two concentric rings that tend to surround a college campus puts a whole other perspective on student life. It's less likely that bar-closing times will interfere with sleep or study that sometimes plagues those living in student apartments close to campus. Students who live in the broader community, away from campus, often enjoy more peace and quiet. However, they also tend to face higher transportation costs.
If you attend a state university as a domiciled resident of that state, you will avoid thousands of extra dollars a year in out-of-state tuition. State universities receive revenues, in part, from their state treasuries and often have a mission of educating resident students. To pay for the cost of educating students from other states, they routinely charge out-of-state tuition.
Some states participate in regional programs that accept students from other states in the region at a discount to the full cost of paying out-of-state tuition. These programs include the Western Interstate Commission for Higher Education (WICHE) and New England's Regional Student Program.
For purposes of financial aid and saving with such tax-advantaged vehicles as a Section 529 plan or education savings account, room and board expenses are usually considered a qualified higher education expense. As a result, these expenses can be paid with the proceeds of student loans or proceeds from these tax-advantaged accounts. An exception may be certain prepaid tuition plans. While these plans are often lumped into Section 529 plans with college savings plans, their funds are often earmarked for tuition-only purposes. You may wish to check with the administrator of a state's prepaid tuition plans. |
