College Financing 101


College might still be in the distant future, but it’s not too early to start thinking about how you’re going to pay for your child’s education. Here are a few interesting facts I found in a recent article in the Wall Street Journal

Over any 17-year period, college costs go up by about a factor of three. The average in-state tuition for a public four-year university for the 2009-2010 school year was $7,020, which means children born in 2009 going to school 17 years later should reasonably expect to pay an average of $21,060. New parents looking to start saving for college now should probably save at least $200 a month from the birth of their child to cover the cost of a public four-year university and $430 for a non-profit four-year university.

The Free Application for Federal Student Aid, or FASFA, determines a student’s eligibility for federal financial aid, which includes Pell grants, Stafford loans and Perkins loans, by looking at the applicant’s “available income.” Available income includes taxed and untaxed income, but excludes some tax credits such as the Earned Income Tax Credit and funds from public assistance such as Temporary Assistance for Needy Families. IRA deductions, child support, and capital gains from investments are included in the calculation.

There are several different types of savings plans designed to help families set aside funds for future college costs.

There are two different types of 529 Plans—a prepaid program and a savings plan. The prepaid plan works like an annuity contract, essentially allowing you to pay for one to four years of college at today’s cost. These don’t tend to be as popular, because the guarantee is usually based on tuition at in-state public schools and most people can’t predict where their kids will ultimately go to school. The savings plan is similar to an IRA or 401(k), where savers invest their contributions in products like mutual funds and can make withdrawals tax-free if the money is used for higher education.

Coverdell Education Savings Accounts – also known as Education IRAs – are trusts that can be used to cover qualified education expenses for college as well as for kindergarten through 12th grade. Currently, the maximum contribution allowed for a Coverdell is $2,000 per year per beneficiary and can be made until the beneficiary is 18 years old, but this is slated to change at the end of the year when a 2001 tax law expires. At that time the contribution limit will fall to $500 a year unless Congress acts to extend the benefit. The law’s expiration also means that withdrawals to pay for K-12 expenses will no longer be tax-free, but they will remain tax free for college expenses.

What is the difference between a 529 college-savings plan and a Coverdell Education Savings Account?  Income-based contribution phase-outs for Coverdells begin between $95,000 and $110,000 for single filers and between $190,000 and $220,000 for those who are married filing jointly. In contrast, there are no income limits for 529 college savings plans, and contributions are considered completed gifts, meaning that generally speaking, an individual can contribute up to $13,000 annually per beneficiary or a married couple can contribute $26,000 annually per beneficiary without incurring a gift tax. A special rule for 529 plans allows a contributor to make five years’ worth of gifts in one year to the plan without incurring a gift tax. Also, tax-free withdrawals from 529 savings plans can be used only for college-related expenses, such as tuition and fees, room and board, books and required supplies.

College savings plans like a 529 or Coverdell can affect financial aid. FASFA looks at both the assets of the parents and the students to determine eligibility for financial aid, and savings plans are generally considered to be assets, not income. However, distributions from savings plans not used for qualified educational expenses would be considered taxable income. College savings plans in either the parents’ or child’s name are reported as parental assets on FASFA, while those held by others like an aunt or grandparent are not reported, despite the child being the beneficiary.

Families often overlook Hope Scholarship Tax Credit, which is a program targeted at middle-income families. The credit is worth up to $2,500 per student per year for qualified higher-education expenses during the first four years of college, and income phase-outs start at $80,000 up to $90,000 for single filers, and $160,000 up to $180,000 for those married filing jointly. As of 2009, the credit is not subject to the Alternative Minimum Tax.

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