GFM JUL 2016
It is projected that, by 2010, a four-year college education could cost between $85,000 and $400,000, depending on whether you choose a private or state-funded institution. Given the magnitude of this expense, you can’t begin to prepare too soon. While you may need the help of student loans, there are other tax-advantaged ways to pay for education to consider that can even include your children and their grandparents in the planning process. These tax-advantaged investments are the Education IRA, Custodial Accounts, and the Section 529 College Savings Plan.
Set up an Education IRA
The Taxpayer Relief Act created the Education IRA, allowing $500 annual contributions per child. There are no mandatory minimum contributions; therefore, the amount that you actually contribute may vary from year to year. Contribution eligibility is based on your family’s adjusted gross income (AGI). Full contributions ($500 annually) are allowed for singles whose AGI is below $95,000 and for married couples whose AGI is below $150,000. Partial contributions can be made by singles whose AGI is up to $110,000 and married couples up to $160,000. However, if you are not eligible to make your own contributions, then someone else may do so on your behalf.
Unlike a regular savings account where earnings are taxed each year, interest accumulated in an Education IRA grows free of taxes. Any money placed in one benefits from the compounding effects of interest and dividends over time. Funds may be placed in virtually any investment available, such as stocks, mutual funds, zero-coupon bonds, unit investment trusts, certificates of deposit, and others. And while not tax-deductible, these contributions may be withdrawn tax-free as long as they go toward higher education costs.
Qualifying higher education expenses include tuition, fees, books, supplies, and equipment for the attendance of your child in an eligible institution, as well as the minimum room and board allowance determined by the institution. These expenses relate to both undergraduate and graduate level courses of the designated student beneficiary. Funds must be distributed before your child turns 30; however, the account can be transferred tax-free to an Education IRA benefiting another family member.
Set up a custodial account under the provisions of the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minor Act (UTMA)
Establishing a custodial account under the provisions of the UGMA or UTMA is another savings option to consider. Each person may contribute up to $10,000 per year ($20,000 per couple) without incurring a gift tax. For children under the age of 14, the first $700 of income generated from these accounts is tax-free. The next $700 is taxed at the child’s own rate, usually 15%. Any income in excess of $1,400 is taxed at the parent’s rate. After the child reaches age 14, any income generated by the account is taxed at the child’s rate.
Though there are no income restrictions to establish this account, a few rules do apply. The transfer of assets into the account is irrevocable and may not be used to fulfill parental obligations. Also, the child actually owns the assets and gains full control of the account upon reaching the age of majority (between 18 and 21, depending upon the state).
Consider a Section 529 College Savings Plan
These state-sponsored savings plans typically have no income restrictions and allow for relatively large contributions that can exceed six figures, in many cases. The funds are invested in a family of pre-selected portfolios according to the age of the child or the years to enrollment in college. While contributions are not federally tax-deductible, they may be deductible on state or local tax returns. Assets in the plan grow tax-deferred until withdrawn for qualified education expenses (tuition, room and board, and supplies). Penalties do apply to non-qualified withdrawals.
Meeting Your Goals—What Now?
A college education is probably one of the largest financial challenges you will ever encounter. There is little doubt that those who prepare by saving while their children are young will be in a better position to afford the education that they and their children want. With consistent contributions made during a child’s first 18 years, your funds can grow to a significant amount that can make a sizable dent when it’s time for college. Plan today to help secure your child’s tomorrow.
Randy Stephens is a Financial and Retirement Plan Consultant for Robinson-Humphrey, a subsidiary of Salomon Smith Barney. He can be reached at 478.471.2299 or firstname.lastname@example.org.
Salomon Smith Barney does not provide tax or legal advice. Please contact your tax or legal advisor for guidance.
12 Reasons to Open an Education IRA Today
Education costs have typically risen two to three times the rate of inflation. Since 1980, tuition at both private and public colleges has risen over 100%, while median family income for those parents in the 45-54 age range has only increased by 22% in the same period.
Decrease in financial aid
Student aid, mostly in the form of loans, has increased 68% since 1980. While the top students will no doubt be able to get into a desirable school regardless of their ability to pay, many “average” students will be expected to pay a higher percentage of their college bill if accepted into those same schools.
A college education is one of the greatest investments you could make. The U.S. Department of Labor notes that in September of 1999, the average annual income of a college graduate was more than 50% greater than that of somebody with a high-school diploma.
More than $64 billion was available to college students in 1998-1999 from federal, state, and institutional sources. After inflation, this is 85% higher than a decade ago; however, two-thirds of this increase in financial aid was in the form of loans rather than grants. Furthermore, most of the increased borrowing is unsubsidized—i.e., the government no longer pays the in-school interest.
Unlike a regular savings account where you pay taxes on your earnings every year, in an Education IRA your earnings grow free of taxes, allowing your funds to benefit from compounding of interest and dividends over time.
All distributions are excluded from gross income if funds are used to cover qualified higher education expenses of the Beneficiary.
There is a strong incentive to use the money saved in an Education IRA for education purposes because a 10% penalty will be assessed, as well as ordinary income taxes, on the earnings portion of the distribution if used for non-education purposes.
Other family members
If funds in an Education IRA are not used by the original beneficiary before age 30, the account can be transferred tax-free to an Education IRA benefiting another family member.
No minimum, $500 maximum
Your savings schedule is flexible with an Education IRA. You can contribute up to $500 annually for each child, or nothing at all; the choice is yours.
The account holder of the Education IRA is in control of the contribution for a child.
Relative or friend, anyone can contribute
Full contributions are allowed for single filers whose AGI is under $95,000 and for joint files whose AGI is under $150,000. If you are not eligible to make contributions, someone else can contribute on your behalf.
Annual contributions add up fast
Annual contributions must be made no later than December 31 of the contribution year.