COLLEGE PLANNING
Funding a child's college education is a significant undertaking. To help you with that process, we've included several articles on the topic:
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If you have any questions or would like help designing a
college savings plan, please contact us at:
1-800-553-6700 or CSIC@CapitalSecurities.com
Preparing
for That Expensive Degree
There are two basic approaches to funding your children's college education costs. You can ignore the entire subject, hoping for the best when your children reach college age. Or you can actively prepare for those costs so that you have more options available. The steps involved in the second approach include:
1. Estimate how much you'll need to send your child to college.
The amount can vary significantly depending on whether you're aiming for a public, private, or Ivy League college. For instance, for the 1999-2000 school year, the average annual cost is $10,909 at a public university and $23,651 at a private university (Source: The College Board's Trends in College Pricing, 1999). Once you know the total amount needed, you can calculate how much you need to save on an annual basis to help you reach that goal.
2. Review other sources of college funds.
If you can't save the entire amount needed to meet your goal, consider other sources - you may expect your child to work part time to help defray costs or financial aid may provide assistance. Also, many colleges offer merit scholarships that are awarded without regard to financial need. A variety of student loans and government-sponsored loans are also available, offering attractive interest rates. The older your child is, the easier it will be to determine how much you can expect from these other sources.
3. Decide whether you want to save in your name or your child's name.
If you expect to qualify for financial aid, you may prefer saving in your name, since only 5.6% of your assets must be used for college, while 35% of your child's assets must be used. If you don't expect to qualify for financial aid, you can make gifts of up to $10,000 per year ($20,000 if the gift is split with your spouse) to each child federal income tax free. By making a gift, you remove those assets from your estate and any income on those assets become taxable to your child. If your child is under age 14, he/she is subject to the "kiddie tax" rules - in 2000, the first $700 of investment income is federal income tax free, the second $700 is taxed at the child's marginal tax rate (typically 15%), and the remaining investment income is taxed at your highest marginal tax rate. If your child is 14 or older, all investment income is taxed at his/her marginal tax rate. Keep in mind that once your child reaches legal age, he/she can use the college savings as he/she wishes, which may or may not include a college education.
4. Set up a savings program.
Make saving a part of your monthly routine, using investment strategies that are compatible with your risk tolerance. Monitor your progress at least annually, making changes when necessary.
5. Start now.
Due to the large amounts involved, funding a college education is a significant undertaking. Don't ignore this goal, hoping that financial aid will pick up the bulk of the tab. For most families, a significant portion of any financial aid will come in the form of loans and work-study programs. Incurring substantial debt to put your children through college can make it more difficult to save for your retirement. Thus, it's important to start saving now for your children's college education.
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Tips
for Funding College Costs
With the cost of a college education so high, it's easy to become overwhelmed by the prospect of funding a college education. But don't panic. There are a number of strategies to consider that can help:
 | Start investing as much as you can, now. First,
figure out how much you need to save annually to help you meet your goal. If
you're tempted to postpone your savings, run the numbers again, assuming you
wait a few years. The increase in your annual savings amount may be
startling. If you can't save the entire amount needed to fund a college
education, remember that you can use other sources, such as borrowing or
financial aid. Therefore, your goal may be to accumulate 30%, 50%, or some
other percentage of the total cost of college.| Adjust your mix of investments over time.
College costs have been increasing several percentage points more than
overall inflation, making it important to select investments that will stay
ahead of these increases. However, as your child gets close to college age,
you need to take steps to help you protect your principal by shifting to
more conservative investments. | Consider using a Roth individual retirement
account (IRA) to help fund college costs. Provided you have other
means to save for retirement, you might want to use a Roth IRA (if you're
eligible) to save for college costs. If you and your spouse each contribute
$2,000 to a Roth IRA every year for 18 years and earn 8% annually, you'll
have a combined college fund of $149,800. Your total contributions of
$72,000 can be withdrawn without paying federal income taxes or federal
income tax penalties. If you're under age 59 1/2 when
withdrawals are made, you'll have to pay ordinary income taxes on $77,800 of
earnings. But since you're withdrawing the money for college costs, you
won't have to pay the 10% federal income tax penalty. And if you're over age
59 1/2 and the Roth IRA account has been open for a
least five tax years when withdrawals are made, you may not have to pay
federal income taxes on the earnings. (This example is provided for
illustrative purposes only and is not intended to project the performance of
a specific investment.) | Examine Education IRAs. Although you
can only contribute $500 per year for each child (if eligible), you may
still want to utilize this option. Before investing, be aware of all the
restrictions. For more details, see the article, "A Look
at Education IRAs." | Look into prepaid tuition programs and college
savings plans. Prepaid tuition programs guarantee funds to cover
tuition at your state's public colleges and universities, while college
savings plans invest your money in stocks, bonds, or mutual funds, allowing
you to withdraw the funds to pay higher-education expenses at any college or
university. Earnings grow tax deferred until withdrawn to pay
higher-education expenses and then are taxed as income to your child, who
will typically be in a lower tax bracket than you. | Realize that education credits may reduce the
cost of college. The Hope Scholarship Credit is a nonrefundable
tax credit equal to 100% of the first $1,000 of qualified tuition and
related expenses and 50% of the next $1,000 of tuition and related expenses
(for a maximum credit of $1,500) paid for a taxpayer, spouse, or dependent
for the first two years of post-secondary education. The credit can be
claimed for more than one student in a given year. The Lifetime Learning
Credit is a nonrefundable tax credit equal to 20% of up to $5,000 of
qualified tuition and related expenses (for a maximum credit of $1,000) for
post-secondary education, including courses to acquire or improve job
skills. The $5,000 limit will increase to $10,000 starting in 2003 (for a
maximum credit of $2,000). The credit is a per taxpayer credit and can be
claimed in any year eligible expenses are incurred. Both credits are phased
out for joint filers with modified adjusted gross income (AGI) between
$80,000 and $100,000 and for single filers with modified AGI between $40,000
and $50,000. | Become familiar with the financial aid system. If
you expect financial aid to help with college costs, make sure you
understand the system. You should know how to apply, what types of aid are
available, and how your expected family contribution is calculated. | Encourage your child to participate in the
process. Maintaining good grades and participating in
extracurricular activities may make your child a more desirable candidate
for college. He/she may then be eligible for a wider range of grants and
scholarships. You may also expect your child to work part time to fund part
of his/her college education. | Find out if your child's grandparents want to
help contribute. Since payments made directly to your child's
college aren't considered part of the annual $10,000 gift exclusion, this
may be a good way for grandparents to transfer part of their wealth to
grandchildren. | Investigate borrowing options. Borrowing
can put a significant strain on your finances, usually at a time when you
should be concentrating on saving for retirement. However, if you need to
borrow, there are a variety of loan options available, with the federal
government offering several attractive alternatives to students and their
parents. | |
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A
Look at Education IRAs
Wondering if you should utilize an education IRA to help fund your child's college education? Before doing so, you should be aware of the restrictions involved:
| Annual contributions are limited to $500 per beneficiary under age 18.
Although this is in addition to the $2,000 limit for other types of IRAs,
many view the amount as too small to bother with. For example, if you invest
$500 per year starting when your child is born, earning 8% annually, you
would have $18,725 when your child turns 18. While not an insignificant sum,
it will hardly pay for four years of college at that time. (This example is
provided for illustrative purposes only and is not intended to project the
performance of any specific investment.)| Although contributions aren't tax deductible, earnings on the
contributions grow tax deferred until distribution. Earnings can be
withdrawn tax free when used to pay for qualified higher-education expenses
of the beneficiary, which include tuition, certain room and board, books,
and other supplies. However, in any year that funds are withdrawn for this
purpose, the taxpayer cannot use a Hope Scholarship Credit or a Lifetime
Learning Credit. | The education IRA may be considered the child's asset for financial aid
purposes, thus reducing the amount of financial aid received. | Eligibility to make contributions is phased out at adjusted gross income
levels of $95,000 to $110,000 for single taxpayers and $150,000 to $160,000
for married taxpayers filing jointly. | Distributions must be made before the beneficiary turns 30. Any funds not
used for qualified higher-education expenses are subject to normal income
taxes and a 10% penalty. However, the balance can be rolled over to another
education IRA for another family member, including the beneficiary's child,
sibling, nephew, niece, certain in-laws, and their spouses. | Any year funds are put into a prepaid tuition plan, contributions can't be
made to an education IRA for the same child. | |
Despite these restrictions, you may still want to consider an education IRA. In particular, those with incomes so high that they won't qualify for the Hope Scholarship Credit, Lifetime Learning Credit, or other financial aid should look into education IRAs. If your income exceeds the limits for making contributions, you can ask grandparents or other relatives with income less than the limits to contribute for your children. Your child can also make contributions to his/her own education IRA, since there is no earned income requirement for contributions.
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Getting
Your Share of Financial Aid
For the 1998-99 school year, over $64 billion in financial aid was distributed, with an average award of $6,085 per full-time student (Source: The College Board's Trends in Student Aid, 1999). With so much money at stake, you should understand the financial aid process.
To determine if your family qualifies for aid, you need to complete a needs analysis. After January 1 of the year your child will enter college, you must fill out the "Free Application for Federal Student Aid" as well as any other forms required by the colleges your child is applying to. The forms are used to calculate your expected family contribution, or the amount you're expected to pay annually toward college costs. Be forewarned - the formula assumes a frugal lifestyle and does not take actual expenses into account. In general, after adjustments for taxes and other factors, colleges expect students to contribute up to 70% of their income and 35% of their assets each year, while parents are expected to pay as much as 47% of their income and 5.6% of their assets (Source: Educational Testing Service, 1999).
Your contribution is a fixed amount and remains the same regardless of the cost of the college your child attends. Also, the amount is a family contribution amount and does not change based on the number of children attending college.
When college costs exceed your required contribution, financial aid officers try to find aid to make up the difference, using grants, scholarships, work programs, and student loans.
Some factors that can affect your contribution amount include:
| College savings. Carefully evaluate
whether assets designated for college should be placed in your child's name
or your name. While only 5.6% of your assets must be used for college, 35%
of your child's assets must be used. Compare the tax savings generated from
transferring income to your child with the possible reduction in financial
aid.| Debts. Loans
against assets, such as mortgages, home-equity loans, and margin loans, are
deducted from your net worth, while consumer loans are not deducted. | Assets. Your net worth, as defined by
the financial aid system, includes your home, bank accounts, stocks, bonds,
and mutual funds, but not retirement funds, insurance, or annuities.
However, individual colleges may have different criteria for certain assets. | Investment sales. If you expect to
sell assets such as stocks to pay for college, keep in mind that any capital
gains will be included in income. To be excluded from financial aid
formulas, your investments would have to be sold before January of your
child's junior year of high school. | |
Your financial aid package can vary significantly between schools, so it's typically best to apply to several colleges. When evaluating the aid package, look at the types of aid offered as well as the amount. Grants, which do not have to be repaid, are more desirable than loans, which must be repaid.
If there have been significant changes in your financial situation since you filled out the forms or you don't think the college evaluated your situation properly, let the college know.
Before accepting a financial aid package, find out the answers to these questions:
| How was my expected family contribution, financial need, and award package
determined?
| What financing options are available to help fund my expected family
contribution?
| What are the terms and conditions of the aid package?
| Are there any conditions for renewal of the aid package?
| How will my aid package change from year to year? | |
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Copyright © 2000. These articles intend to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.
FR1999-1230-0004