The Planning Process: Education Funding
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.
Setting up a custodial account in your child's name with a mutual fund company and making regular contributions to that account can help you towards reaching your child's college funding goals. Custodial accounts have significant legal and tax implications. For one there is the "kiddie tax, " which taxes the investment income of children over $1900 at their parent's top federal income-tax rate if the child is under age 18 and the child's earned income does not exceed one-half of the child's own support for the year, or, a full-time student who was under age 24 at the end of the tax year and the child's earned income does not exceed one half of the child's own support for the year (excluding scholarships).
Coverdell Education Savings Account
If your income isn't too high you can contribute up to $2000 a year to an Coverdell Education Savings Account for each of your children or grandchildren under age 18. All withdrawals (including investment earnings) that are used to pay the child's qualified education expenses are income-tax free. The $2000 contribution limit is phased out with income between $95, 000 and $110, 000 (individuals) or between $190, 000 and $220, 000 (married couples filing jointly).
Prepaid Tuition Plans
Many states and individual colleges offer tuition prepayment plans. With these plans, you make a series of payments or pay a lump sum now for your child's education. In return, the plan guarantees that your investment will cover the child's expenses when he or she is ready to attend. Some plans lock in the cost of future education at today's prices. Before choosing this route, though, be sure to find out what will happen to your investment if your child doesn't attend the sponsoring college.
Never Too Late
If your child will be starting college within the next couple of years or has already started, there are still financing methods available for you to consider.
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 will receive based on your financial situation. Also, your child should apply for all available governmental or private grants and scholarships.
Your child's aid package may include loans from the federal or state government, the college or a commercial lender. The loan offers may vary considerably, depending on the program, so be sure to carefully check the interest rates and terms of each. Home equity loans, retirement plan withdrawals, and the cash value of your life insurance are other possible loan sources you might consider.
If you do take out a qualified higher education loan, up to $2,500 of the interest paid is tax deductible. (Certain restrictions may apply. ) You also may be eligible for the American Opportunity Tax Credit and the Lifetime Learning Credit. The American Opportunity Tax Credit is worth up to $2,500 a year for each student's years of eligible post-secondary education expenses. The Lifetime Learning Credit is available for up to $2,000 of qualifying expenses paid for each year of education. Both of these credits are phased out at higher income levels, however.
While it's best to get an early start, it is never too late to plan for the cost of your child's education. For assistance, call your professional financial advisor. He or she can help you plan today for your child's education tomorrow.