Funding College - What Are Your Options?
With the price of an undergraduate education skyrocketing, it's little wonder that college tuition oftentops the list of families' financial concerns. Instead of letting the high cost of college intimidate you, however, it's far smarter to create a savings plan and then put it into action. Below are a few of the powerful programs that can help you fund future college costs.
Coverdell Education Savings Accounts
One option is the Coverdell Education Savings Account (ESA), formerly known as the Federal education IRA. A Coverdell ESA allows families with adjusted gross income of less than $220,000 ($110,000 for single filers) to contribute up to $2,000 of after-tax income per student each year. As long as these funds are used for higher education, they are not taxable. (Benefits disappear for families earning more than $220,000 annually, or singles earning $110,000 per year.)
Contributions: Any individual who meets adjusted gross income (AGI) requirements can make a non-deductible contribution on behalf of a child under the age of 18. The AGI requirements are $95,000 for single taxpayers and $190,000 for married taxpayers. The $2,000 annual contribution limit is phased out for single taxpayers with AGI of $95,000 to $110,000 and for joint filers with AGI of $190,000 to $220,000. Although a child may be the beneficiary of any number of Coverdell ESAs, the total contributions for the child during any tax year cannot exceed $2,000. Contributions to a Coverdell ESA may be made until the due date of the contributor's federal income tax return, without extensions.
Withdrawals: Distributions are tax-free as long as they are used for qualified education expenses, such as tuition, books, fees, etc., at an eligible educational institution. This income exclusion is not available for any expenses for which the Hope Credit or the Lifetime Learning Credit is claimed for that student. If the distribution exceeds education expenses, a portion will be taxable to the beneficiary and will be subject to a 10% tax penalty. Exceptions to the penalty include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.
If there is a balance in the Coverdell ESA at the time the beneficiary reaches 30 years old, it must be distributed within 30 days. A portion representing earnings on the account will be taxable and subject to a 10% penalty. The beneficiary may avoid this tax and penalty by rolling over the full balance to another Coverdell ESA for another family member.
Section 529: College Savings Plans
Another attractive option is the Section 529 college savings plan. 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.
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.
There are two types of 529 plans: prepaid and savings. Prepaid plans (sometimes called guaranteed savings plans) are offered in 18 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.
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.
With the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 529 plans gained their current popularity and tax advantages. Prior to EGTRAA, 529 plans grew tax-deferred and distributions from 529 plans for qualified higher education expenses were taxed at the beneficiary's federal income tax rate. After EGTRAA, 529 plans still grow tax-deferred but distributions from 529 plans for qualified higher education expenses are exempt from federal income tax. The 529 plan provisions of EGTRAA, originally set to expire after 2010 due to a sunset provision, were made permanent by the Pension Protection Act of 2006. This permanency means you can save in a 529 plan knowing that your withdrawals 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.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, this information should be coordinated with individual professional advice. Source: Financial Visions, Inc.
