BY RANDY STEPHENS
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 for you 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 And while not tax-deductible, these contributions may be withdrawn tax-free as long as they go toward higher education costs.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.