CHAPTER 7 Educational Planning Chapter 7: Educational Planning 1

CHAPTER 7

Educational Planning

Chapter 7: Educational Planning 1

Saving for: child’s education Tuition and fees at private 4-year schools rose 4.4% in the current school year to $26,273, according to a survey released by the College Board. Charges at public 4-year universities spiked over 6% for both in-state and out-of state students, to $7,020 and $18,548, respectively.— CNN/Money.com, October 20, 2009

The average debt for a graduate is now $23,000, that’s up from $13,000 12 years ago. — CBS News, November 5, 2009

Starting early makes a BIG difference.


COLLEGE COSTS

Educational expenses represent one of family’s biggest costs

College expenses have nearly tripled in last 15 years

Estimates of how much 4-year colleges cost are available from public and private sources

Planners should emphasize that parents: Who have time can capitalize on magic of compounding Do not have to save it all because saving is only one of

five ways to pay for college


Chapter 7: Educational Planning 4education needs analysis

COLLEGE SAVINGS PLANS UGMA AND UTMA

Custodial Accounts in Child’s Name

Inexpensive Way of Making Gift to a Minor Without Expense of Trust

Drawbacks Taxable Irrevocable gift Minor takes possession at majority


COLLEGE SAVINGS PLANS Coverdell Education Savings Account (Coverdell

ESA): Features Represent nontaxable gifts to beneficiary and may be tax-

free when distributed Distributions represent original contributions

and earnings Cover qualified educational expenses

Tuition Room and board Books Any education not just post-secondary


Coverdell ESA Features

Current limits Max $2,000 (based on income) Only one account permitted per

Social security number If more than one person contributing

this can require some coordination Donor can be anyone

Nothing says that I cannot give a gift of 2K to my parents, and they can contribute to the Ed IRA


Coverdell ESA Features (Contd.)

If not used for qualified educational expenses, it is subject to income tax and 10% penalty

Money can be rolled over into a new ESA for a different beneficiary


ESA Features (Contd.)

If rolled over within 60 days of distribution and new beneficiary is below 30 and member of original beneficiary’s family, distribution is not taxable

Distribution is tax exempt when taxpayer claims Hope credit (American Opportunity Credit 2012) or Lifetime Learning credit for a beneficiary, if not claimed for the same expense

If beneficiary reaches 30, funds remaining in ESA are assumed distributed and are subject to 10% penalty


Section 529 Plans

Every plan must meet regulations of Section 529 of IRC to become qualified state tuition program (QSTP)

Regulations describe rules state programs and taxpayers must follow to comply with Section 529


Section 529 Plan Benefits

QSTP earnings are tax-deferred

529 Plans allow for high contribution limits – up to about $300,000

Distributions are excluded from gross income

Tax-exempt status extended to qualified private institution programs

Contributions to Section 529 treated as completed gift for estate and gift tax purposes


Section 529 Plans Benefits (Contd.)

The $14,000/$28,000 (2013) exclusion can be leveraged to $70,000/$140,000 (2013)

Replacement of current beneficiary by new beneficiary is permissible

Tuition credits can be transferred tax free from one qualified tuition program to another program for the same beneficiary

Beneficiary can still claim Hope scholarship (American Opportunity credit 2012) or Lifetime Learning credit. Education expenses qualifying for credit can be paid for with 529 plan withdrawals.

Favorable tax treatment has been made permanent – it was scheduled to sunset in Jan. 2011.


FORMS OF SECTION 529 PLAN

PREPAID TUITION PLAN Guarantees that money saved today

will match growth in tuition inflation at state-run colleges

COLLEGE SAVINGS PLAN Contribute to a pool of money

managed by state treasurer or outside investment advisor. Funds can be used at any accredited school for tuition, board, books and supplies


SECTION 529 PLAN DRAWBACKS Needs long time to derive benefits

Treated as income to the child, which can hurt chances for receiving financial aid

Provides limited investment choices and little flexibility in creating special portfolios

Not certain where they got this information Programs are “sponsored” by many large companies, with many

choices. KY TIAA-CREF OH Putnam Do not need to use the “program” sponsored by your state. In fact

some state plans are not as good as others


SECTION 529 PLAN DRAWBACKS Difficult to get out of a plan

10% penalty on 529 distributions included in income


BEST PLACES TO INVEST COLLEGE FUNDS

Best Places to Invest College Funds

Nature of Plan

529 Plans UGMA/UTMA Coverdell ESA

A 401(k)-type savings plan sponsored by most states that offers a limited choice of investment

A custodial account that lets you invest on behalf of the child.

Like other IRAs, this is a tax-deferred plan to set up thru a financial service firm.

Maximum contribution per account

Varied by state – as much as $300,000 over the plan life.

Unlimited, subject to Annual Maximum Contribution Per Donor

$2,000 per year, through 2012. Contributions must stop when child turns 18.

Limitations on Income

None

None

Adjusted gross income limits apply.

Age limitation

Varies by plan

None

No contributions after age 18. All distributions must be made by age 30.

Annual maximum contribution per donor

$65,000 (2012) per beneficiary in the first year of a five-year period to avoid federal gift tax consequences ($130,000 per couple)

$13,000 per beneficiary ($26,000 per married couple) to avoid federal gift tax consequences (2012)

$2,000 per beneficiary per year (2012)

Taxes

Investments are tax-deferred. Earnings withdrawals will be free of federal income tax.

First $950 free of federal income tax. Next $950 taxed at the child’s rate. Above that at parent’s rate until child reaches age 18.

Investments are tax-deferred, and withdrawals are tax-free for qualified education expenses.

Investments

Many state plans offer only 3 or 4 investment options, and once money is invested, it’s difficult to move.

You decide where to establish the account, and which stocks, bonds or mutual funds to invest in.

You decide where to establish the account, and which stocks, bonds or mutual funds to invest in.


INVESTMENT STRATEGIES FOR EDUCATION FUNDING

Develop investment strategy aimed at maximizing returns for preferred risk level

Diversify across three asset classes: stocks, bonds, and money market securities

Match time horizon of the asset and the liability


INVESTMENT STRATEGIES FOR EDUCATION FUNDING


INSTRUMENTS OF EDUCATIONAL INVESTMENT ALTERNATIVES

Zero Coupon OptionSavings Bonds for EducationTreasury Inflation-indexed

SecuritiesLow-load InsuranceCollegeSure CDSection 2503 (c) Minor’s TrustChapter 7: Educational Planning 19

COLLEGE FUNDING CALCULATION

Cost of Attendance

Less: Expected Family Contribution

Equals: Student’s Financial Need


FAMILY’S EXPECTED CONTRIBUTION Current Federal Direct Student Loan

Program has cut in half the fees on all subsidized Stafford Student Loans

In analyzing family’s student loan application, expected family contribution is used by processing firms

Worksheets Available to Calculate Expected Contribution Amount


FINANCIAL ASSISTANCE

Grants and Scholarships

Student Loans

Work Study Programs


MAJOR SOURCES OF STUDENT AID

Source: College Board’s Trends in Student Aid 2011

http://trends.collegeboard.org/downloads/Student_Aid_2011.pdfChapter 7: Educational Planning 23

REPAYMENT OF STUDENT LOANS

Deferment

Forbearance

Graduated Payment

ConsolidationChapter 7: Educational Planning 24

TAX RELIEF ACT OF 2001

Employer-Provided Education Assistance 5250 annually

Student Loan Interest Distribution Some tax credits available

Deduction for Higher Education Expenses Expired December 2011


EDUCATION TAX INCENTIVES

American Opportunity Credit (2012); Hope Scholarship

Lifelong Learning Credit

Below-the-line Tax Deduction (subject to 2% AGI floor)


Documents

CHAPTER 7 Educational Planning Chapter 7: Educational Planning 1