If your children are young, there are a number of savings plans you can use to pay for college: custodial accounts, savings bonds, prepaid college tuition programs, Roth IRAs, and tax reductions for education.
Custodial account. An account in which the child is the owner but the parent controls the account. UGMA accounts and UTMA accounts are both custodial accounts.
• UGMA stands for Uniform Gift to Minors Act. It allows you to give your child up to $10,000 a year without a gift tax. Depending upon the state, the parent controls the account until the child is between 18 and 21 years of age.
• UTMA stands for Uniform Transfer to Minors Act. Although these accounts are similar to UGMA accounts, the parents control the money for a longer period of time.
The main thing you need to be aware of when establishing an account in your child’s name is that it could lessen your eligibility for financial aid. Money you put in your child’s name will count against you six times more than money kept in your name.
Savings Bonds (series EE). The Education Bond Program initiated by the Treasury Department in 1990 allows you to partially or completely exclude from federal income tax the interest earned on Series EE Savings Bonds issued after January 1990.
You can qualify if:
• The bonds are registered in your name rather than your child’s name
• You pay higher education expenses at an eligible institution or state tuition plan in the same calendar year in which you redeem the bonds
• You meet the following income guidelines:
You can find additional information about the education bond program in:
IRS Publication 17, Your Federal Income Tax
IRS Publication 550, Investment Income and Expenses
IRS Publication 970, Tax Benefits for Higher Education
Prepaid College Tuition and Savings Programs
Many states and colleges have innovative savings programs. The programs are designed to make saving for college easier and encourage families to save for college rather than rely on Government aid.
The 2001 Tax Act provides a tremendous opportunity for individuals to save for education through these savings programs. Participating states and educational institutions must meet the requirements of Section 529 of the Internal Revenue Code. The plan is therefore called a 529 plan. It is up to each state and institution to decide whether to offer a 529 plan and what it will look like.
There are two general types of 529 plans: prepaid programs and savings programs. State prepaid tuition contracts that cover in-state tuition allow the donor to transfer the value to private and out-of-state schools. Depending on the state, you may or may not get full value when you transfer. A 529 savings program, on the other hand, allows the full value of the account to be used at any accredited college or university in the country. Since 529 plans became exempt from federal taxes in 2002, the market for them has exploded. The plans are operated at state level but are managed by an investment firm. You must decide which one is best for you.
Before you decide, you should:
• Read and understand all the terms and conditions of the state or college program that interests you
• Determine exactly what fees you must pay
• Check out what happens to your savings if your child decides not to go to college, wants to attend a college in a different state, or is not accepted at the college selected
• Find out what expenses are not included and develop a plan to meet those expenses
• Ask your financial advisor if the program is right for you and your financial situation
Roth IRAs
If you are single and earn less than $95,000 in adjusted gross annual income or if you are married and earn less than $150,000, you can invest up to $3,000 per person in a Roth individual retirement account each year. The amount increases to $3,500 for 2005-2007 and in 2008, $5,000 can be invested. The Roth IRA can grow tax-free and be tapped without penalty for qualified educational expenses.
Tax Reductions for Education
The Taxpayer Relief Act of 1997 created four educational incentives: the Hope Scholarship, Lifetime Earning Credit, Education Savings Accounts, and Student Loan Interest Deductions.
The Hope Scholarship is a tax credit. It reduces the amount you must pay on your federal income tax. You can claim $1,500 per tax year for each child who is attending school at least half-time. Your child must have completed less than two years of school, and you must owe taxes and file a tax return.
The Lifetime Learning Credit is for people who are not eligible for the Hope Scholarship or who have used their two years of eligibility. You can take 20 percent deduction of tuition and fees (up to $2,000) after grants, scholarships and fellowships have been subtracted.
Education Savings Accounts (ESAs) are available to people who earn less than $110,000 per year (single) or $220,000 per year (married, filing jointly). You can make nondeductible contributions of up to $2,000 per year per child to the Education Saving Account until your child is 18 years old. The amount you can contribute depends upon your income. If the student has qualified higher education expenses, he/she can withdraw the amount tax-free. All withdrawals must be made within 30 days after the student reaches age 30.
Student Loan Interest Deductions allow people in certain income brackets to take a tax deduction for interest payments on qualified education loans. For 2004 and 2005 the annual dollar limit is $4,000. The annual deduction for those in higher income brackets is limited to $2,000.
This savings information was taken from Internal Revenue Service Publication 970, Tax Benefits for Education.