By Russell Bailyn
The cost of college funding has taken center stage for financial planners in recent years. The reason for this is the dramatic increase in cost, averaging 8% annually for the past 30 years. The average cost for a private college education, including tuition, housing, books, and spending money is approximately $157,000 for a 4-year private university. The costs for a state school are more reasonable, but still alarming at $68,000. These figures could be lower if alternate plans for housing are investigated. While scholarships, grants, and both state and federally funded loans are available to students and their parents, some people like to pay in advance. For this reason we investigate the savings plans which are most conducive to meeting college costs.
Tuition Stabilization Programs
Some schools will offer the rate for the first year of student’s education for all four years if the sum is paid up front. For example, if tuition for a school in 2005 is $21,000, 2006 is $22,500, 2007 is $24,000 and 2008 is $25,500 – a parent could offer the lump sum of $84,000 (4 x $21,000) rather than $93,000 over the course of four years. This is certainly something to consider if you can gather the lump sum.
529 plans are state-based tax-deferred savings accounts. The administration of these plans may vary from state to state but all have several things in common. Most importantly, they allow for larger amounts of money to accrue tax-deferred if used for educational costs than any other college-savings investment vehicle. Generally, although depending on the state of origination, one can contribute up to $11,000 annually or more to a 529 plan. Further, parents control the distribution of money from 529 plans rather than their children which allows for greater control. Any money paid into a 529 plan grows tax-deferred and will incur no penalty when withdrawn if used for qualified educational costs. This is a provision within the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Another great provision of this act allows the money to be transferred in some situations if the person originally designated to receive the money ends up not needing it. In an emergency, the money is still accessible to the parents and contributors of the plan, but a tax-penalty will certainly result.
You can’t save quite as much money in a Coverdell IRA as you can in a 529 plan, but you can still enjoy tax-deferred savings with them. The annual contribution limit for Coverdell’s is $2,000 and withdrawals can be used to pay for any qualified educational expense, not just college.
Custodian Accounts (UGMA & UTMA)
If you’re really ahead of the game, you should also consider how you plan on gifting/giving the funds over to your child to pay for his/her college education. It’s generally a good idea to have funds registered to the beneficiary rather than the adult because of the (presumably) lower tax rate of the child. This can be done under custodian accounts, where the parents contribute money into, and control an account, for the benefit of the child. These custodian accounts generally fit under individual state laws of the Uniform Gift to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). The disadvantage to these sorts of accounts is that the beneficiary must be given the right to possession of the property upon reaching age 18. Occasionally, a child will receive this money and choose not to use it towards college. This can happen and should be considered in setting up these sorts of accounts.
A trust can also be established to take advantage of the $11,000 annual gift tax exclusion. These terms of these trusts are stated by IRC Section 2503(c), which states that “a gift to an individual under 21 will not be considered a gift of a future interest as long as the property and its income are payable to the child at 21.” The two popular trusts for funding education costs are the current income trust and Crummey trust. In the current income trust, income out annually must go the beneficiary with no control rights for the trustee. This is a nice benefit for the people contributing money into the trust. The money can sit in the trust with no stated distribution age. Under the Crummey trust, gifts can be made for the benefit of the child going to college without tax implications or liability under the trustee’s estate. This ensures that the money get used for the designated beneficiary. One problem with the Crummey is that the trust itself may be responsible for paying some taxes.
Often, a provision will exist under a parent’s retirement plan which allows money to be withdrawn for qualified educational expenses. This can be done without incurring the usual 10% penalty (plus taxes) for cracking an IRA before age 59 ½. Look into the details of your plan to see if this is an option.
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