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College Funding Strategies

The number one financial worry of most Americans has traditionally centered on whether they will have enough money to live on in retirement. According to some public opinion polls, however, that concern has been replaced with “Will I be able to afford to send my child to college?”

With college costs rising faster than inflation, it’s never too early to plan for your children’s education. Yet with so many savings options and tax incentives now available, making the best choice for your family can be difficult.

Ghirardo CPA can help. We can advise you on the different options, including their advantages and disadvantages. We will also explain how to deal with annual funding limits, and handle coordination between savings plans and financial aid. We can also assist in completing the federal application for student aid or the FAFSA form.

Education funding strategies need to incorporate your personal income tax considerations. Because we develop lasting relationships with our clients, we work to understand your goals and objectives and ensure these are reflected in your education funding choices.

Ways You Can Save For College:

Qualified Tuition Programs (section 529 plans)

Savings Account Plans – Most states have programs that allow for prepayment of higher education costs. Distributions from these programs are tax-free. Funds are held in a special account for the child you designate as beneficiary. Investment options vary between states and your child is usually not required to attend college in that state. Although contributions are made with after-tax funds, this vehicle allows tax-free income and growth of contributions (some limits apply). These benefits, once set to expire in 2010, were recently made permanent by the Pension Protection Act of 2006.
Prepaid Tuition – The same program that allows contributions to an account to be used for future college expenses (529 plans), also provides for the purchase, at today’s cost, of prepaid tuition at individual state (public) and private colleges and universities. Contact the college of your choice for details.

Other Ways to Save

Coverdell Education Savings Accounts – (formerly Education IRAs) are tax-advantaged ways to save for a child’s education. Individuals can contribute on behalf of any child to a CESA that can be used to pay for elementary, secondary, or higher education. Annual contributions cannot exceed $2,000. Withdrawals are tax-free if used for qualifying education expenses. Proceeds may not be exempt from state or local taxes. Adjusted gross income limits apply.
Roth IRA – With the increasing annual amounts allowed as contributions to a Roth IRA ($4,000 for 2007, $5,000 if age 50 or over, limits apply), you could consider one for college funding. You can withdraw up to the total amount contributed (but not the earnings) tax-free and without penalties if used for education. The earnings would be tax-free after the IRA holder reaches age 59 ½.
Zero Coupon Bonds – These are long-term bonds that pay interest at maturity. Interest would be taxable at the maturity date unless the bonds were in a tax-deferred vehicle, such as a Coverdell or Roth IRA. Because of tax complexities involved if these bonds are issued at a discount, consult your financial advisor before purchasing.
Variable Life Insurance – If there is an identified need for life insurance, a Variable Universal Life policy can provide flexible funding, tax deferred growth and tax-free withdrawals (for any purpose). The policyholder makes the choice of investment funds; for example, growth stocks, aggressive growth stocks, money market funds, bonds and real estate securities.
Savings Bonds – Issued by the U.S. Treasury Department, I Bonds and Series EE Savings Bonds accrue interest monthly at a variable rate, and the interest is compounded semiannually. You receive your earnings when you redeem an I Bond or Series EE Savings Bond, and your earnings may be excluded from federal income tax (already excluded from state tax) if you use both principal and interest to pay for qualified higher education expenses in the year you redeem the savings bonds.
UGMA OR UTMA – You may save tax dollars by transferring assets to your children. You can maintain assets in a child’s name through a Uniform Gift to Minors Act or Uniform Transfer to Minors Act account. In these accounts, if the child is under 18, some of the unearned income is tax-free (adjusted annually). Unearned income over that amount is generally taxed at the parents' top marginal rate, but reverts to the child’s rate after he or she turns 18.

In addition to the savings plans above, the government offers several college related tax incentives. The Hope Scholarship Credit allows a tax credit for some expenses of the first two years of college. Beyond the first two years, individuals can use a Lifetime Learning Credit for additional post-secondary education expense. These credit amounts are adjusted annually and are phased out at certain AGI levels. Some of these benefits may not be combined. IRA withdrawals can also be used to pay for qualifying educational costs without incurring the 10 percent penalty for premature withdrawals before age 59½. Interest paid on college loans may be tax-deductible up to a certain amount.

At Ghirardo CPA, we can help you sift through the many education-planning opportunities available and assist you in making the right choice for your family.