An Early Start
If your child is young, establishing a savings plan now can put time on your side. Consider alternatives to the traditional savings account.
Investment vehicles. Setting up a custodial account in your child's name and making regular contributions to that account can help reach your college finance goals and possibly minimize income taxes, as well. Choose investments with a potential for high long-term results, such as growth stock investments. Because these investments pay little or no current income, you may be able to avoid the "kiddie tax"—a tax on investment income of children under age 14, above the $1,500 level, at their parent's top federal income-tax rate.
Educational IRAs. If your income isn't too high, you can contribute up to $2,000 a year into an Education IRA for each of your children or grandchildren under the age of 18. All withdrawals—including investment earnings-that are used to pay the child's qualified education expenses are income-tax free. The $2,000 contribution limit is phased out with income between $95,000 and $110,000 for individuals or $190,000 and $220,000 for married couples filing jointly.
Qualified Tuition Programs
Section 529 of the Internal Revenue Code authorizes two types of tax-favored qualified tuition programs.
Pre-paid Tuition Plans. Many states and individual colleges offer tuition pre-payment plans. With these plans, you make a series of payments or pay one lump sum now for your child's future education. The plan guarantees that your investment will cover the child's expenses when he/she is ready to attend. Some plans lock in the cost of future education at today's prices. Though, before choosing this route, be sure to find out what will happen to your investment if your child doesn't attend the sponsoring school(s).
Education Savings Accounts. Unlike pre-paid tuition accounts, only states may sponsor education savings accounts and generally be used for expenses at any qualified school nationwide. These accounts provide you with a tax-free way to invest for a child's education. It is important to note, however, that there is no guarantee that funds in an education savings account will be enough to cover the future costs of tuition.
The fees, expenses and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee a college-funding goal will be met. Earnings must be used to pay for qualified higher education expenses to be federally tax-free. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient's marginal rate and subject to a 10% penalty. By investing in a Plan outside your State of residence, you may lose any State tax benefits. 529 plans are subject to enrollment, maintenance and administration/management fees and expenses.
Never Too Late
If your child will be starting college within the next couple of years or has even already started, there are still financial methods available at your disposal.
Financial Aid. Most schools have a limited pool of funds, so you should file financial aid forms as soon as possible. Generally, the school will calculate how much aid your child receives based on your financial situation. Also, your child should apply to the wealth of government and private grants and scholarships.
Loans. Financial aid may come in the form of a loan from a state or the government. Loans vary greatly, so careful research and consideration should be done to choose the best options for interest rates and terms.
Tax Incentives. If you choose to take out a qualified higher education loan, up to $2,500 of the interest paid is tax deductible this year, barring certain restrictions.
A child's continuing education is an aspiration for every parent. Having the proper tools and funding to create that dream is part of our plan. For more information, please use our financial calculators and don't hesitate to schedule an appointment.