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College Funding Plan To Pay For Large Expenses As the cost of a college education continues to skyrocket - even outpacing the annual inflation rate - planning is critical if you want to have the required funds available. Whether you use the funds to finance a child's education or for some other purpose, there are a few ways you can reduce your family's tax bill. Watch Out For The "Kiddie" Tax Children under age 14 pay tax at their parents' highest bracket on the portion of their unearned income (for example, interest and dividends) that exceeds $1,400. There are still some effective ways around this potential stumbling block - Take Advantage of Lower Rates - Choose Growth Instead of Income - Consider Municipal Bonds Put Your Child To Work If you own an unincorporated family business, hire your child. The salary is a deductible business expense, and if your child is under age 18, you do not have to pay FICA tax on the amount. Use The Gift Tax Exclusion You can give up to $10,000 annually to any number of individuals without creating a gift tax liability. If the gift is from you and your spouse - regardless of whose funds are used to make the gift - you can give up to $20,000 to each individual. Consider A Trust To Hold Gifts If you are reluctant to make direct gifts to your children, you can still take advantage of the gift tax exclusion. A qualified minor's trust provides tax benefits and, at the same time, restricts your children's access to the funds. Grandchildren's Education If your grandchildren are in college, pay their tuition directly. You remove the amount of the tuition from your estate, and you still have the flexibility to give each of them an additional $10,000 (indexed annually for inflation) per year without gift tax consequences. Paying For College Start saving now to ensure that you will be able to pay for your children's education. Annual Savings Required This useful table indicates how much you need to save each year to pay for four years of school beginning when a child reaches age 18. Pay Certain Expenses Directly If you would like to make annual gifts to a child more than $10,000, you may still be able to do so without negative gift tax consequences. Tuition payments made directly to an educational institution do not count toward the $10,000 annual limit. Withdrawals From Life Insurance Older life insurance policies required that you surrender a life insurance policy, or make a loan, which would require that you make a non-deductible interest payment. However, the newer form of life insurance, universal variable life, may contain a withdrawal privilege. Cash Flow Help To educate yourself about college financing, you should have three major goals: minimize your expected family contribution by understanding how needs analysis works; maximize your chances for financial aid by applying early, accurately and asking the right questions; and ease the cash flow crunch caused each semester when the tuition bill arrives in the mailbox. - Ask questions about a college's financial aid offerings - Position the student for a good financial aid package - Try for an academic scholarship - Look for athletic scholarships - Stay in state - Consider cooperative education - Check the military offerings - Mix it up - Accelerate - Understand need analysis - Do not panic - Borrow against the house - Take advantage of teacher-mania - Increase the standard college costs - Negotiate the aid package - Investigate commercial loan sources - Investigate commercial payment plans - Consider investing in EE Savings Bonds - Save for Retirement - Sacrifice Back to top Plan To Pay For Large Expenses As the cost of a college education continues to skyrocket - even outpacing the annual inflation rate - planning is critical if you want to have the required funds available. Whether you use the funds to finance a child's education or for some other purpose, there are a few ways you can reduce your family's tax bill. Shifting income to a child to take advantage of the lower tax rates is one way to build your family's wealth. Special income tax rules apply to children under age 14, so you will need to plan carefully. Back to top Watch Out For The "Kiddie" Tax Children under age 14 pay tax at their parents' highest bracket on the portion of their unearned income (for example, interest and dividends) that exceeds $1,400. There are still some effective ways around this potential stumbling block: Back to top • Take Advantage of Lower Rates Even if your child's income is not earned, the first $700 is tax free, and the tax rate on the next $700 of income is only 15%. Back to top • Choose Growth Instead of Income You can avoid the kiddie tax if your child invests in growth stocks or growth mutual funds that pay low dividends. As long as they are held until after the child turns 14, the capital gain is taxed at the child's rate, not yours. Back to top • Consider Municipal Bonds Interest on these securities is federally tax exempt to owners of any age. However, they generally do not offer an opportunity for growth with reasonable chance for earnings more than the inflation rate. Ownership of individual bonds may require coupon clipping, and there is the inconvenience of timing sales or redemptions. Furthermore, bond income is relatively low. Back to top Put Your Child To Work If you own an unincorporated family business, hire your child. The salary is a deductible business expense, and if your child is under age 18, you do not have to pay FICA tax on the amount. The first $26,250 (2000) of taxable earned income received by a child is taxed at 15%, regardless of who might be the employer. This concept is called tax leverage - removing income taxed at a higher rate and causing it to be taxed at a low rate. Back to top Use The Gift Tax Exclusion You can give up to $10,000 annually to any number of individuals without creating a gift tax liability. If the gift is from you and your spouse - regardless of whose funds are used to make the gift - you can give up to $20,000 to each individual. You should definitely consider a gift program if your children are 14 or older because their unearned income is not subject to the kiddie tax. Here are some other ideas about how you can make the most of your gifts: • Give your children property that is likely to appreciate in value. Both the current value and any future appreciation would be removed from your estate. • If you plan to sell appreciated property, give it to a child age 14 or older. The gain on the sale will then be taxed at the child's lower rate. Back to top Consider A Trust To Hold Gifts If you are reluctant to make direct gifts to your children, you can still take advantage of the gift tax exclusion. A qualified minor's trust provides tax benefits and, at the same time, restricts your children's access to the funds. Back to top Grandchildren's Education If your grandchildren are in college, pay their tuition directly. You remove the amount of the tuition from your estate, and you still have the flexibility to give each of them an additional $10,000 (indexed annually for inflation) per year without gift tax consequences. Back to top Paying For College Start saving now to ensure that you will be able to pay for your children's education. The table below indicates how much you need to save each year to pay for four years of school beginning when a child reaches age 18. It assumes today's annual cost for public and private colleges are $6,200 and $12,600, respectively. It also assumes that the education costs will increase 6.5% annually and the investments would earn 8% net after taxes. For example, if a child is now eight there are ten years remaining before the child enters a private college with a current cost of $12,600; the sum of $7,110 would need to be saved each year for a total of $71,100. Back to top Annual Savings Required
Back to top Pay Certain Expenses Directly If you would like to make annual gifts to a child more than $10,000, you may still be able to do so without negative gift tax consequences. Tuition payments made directly to an educational institution do not count toward the $10,000 annual limit. However, this exception does not apply to amounts paid for room and board or books. Furthermore, if you pay the student instead of the school, none of the amount qualifies under this special rule, even if the money is used for tuition. The same exclusion applies to payments made directly to providers of medical services - including medical insurance premiums. If the expense is reimbursed by insurance, it does not qualify. Back to top Withdrawals From Life Insurance Older life insurance policies required that you surrender a life insurance policy, or make a loan, which would require that you make a non-deductible interest payment. However, the newer form of life insurance, universal variable life, may contain a withdrawal privilege. This enables you to make a tax free withdrawal from the policy. The amount that is withdrawn will no longer earn interest, but you will not have to pay any. However, this advance is taken into consideration if the policy is surrendered. For this reason, many persons are now using variable universal life insurance as a funding vehicle for education. Back to top Cash Flow Help To educate yourself about college financing, you should have three major goals: minimize your expected family contribution by understanding how needs analysis works; maximize your chances for financial aid by applying early, accurately and asking the right questions; and ease the cash flow crunch caused each semester when the tuition bill arrives in the mailbox. Back to top • Ask questions about a college's financial aid offerings Is there a low cost loan program? Middle income assistance? Can families pay tuition in installments? Does the school have any prepayment bonuses? Does it offer incentives for academic achievement? How about retention awards or discounts for student leaders? Back to top • Position the student for a good financial aid package Position the student for a good financial aid package by having them apply to schools where their test scores and grades place them in the top 25% of the class profile. Colleges give their best packages - those rich in grants - to the most desirable applicants, and the worst aid packages - those heavy in loans - to the students who barely meet the admission threshold. Back to top • Try for an academic scholarship Thousands of colleges now offer awards to bright students. Some of these awards cover all college costs. Students who have test scores that are 20 or 30 points short of qualifying them for an academic award should take a good SAT preparation course. It may bring them within the magic range. It is certainly worth investing possibly $500 in a course when the pay-off can be ten times as great. Back to top • Look for athletic scholarships Look for athletic scholarships, or, better yet, a financial aid package with a lot of grant money. Remember that coaches need back-up players as well as first stringers. Back to top • Stay in state Students who leave their home state are apt to lose eligibility. Back to top • Consider cooperative education Every state has schools that sponsor programs. Students can alternate formal studies with work that is in their field of career interest. Participants have earned, on the average in recent years, $8,000 per year. However, the students may need five years to complete their degree. Back to top • Check the military offerings The National Guard, in particular, has been inventive and generous with student aid. Active duty requirements are relatively minimal. The monetary help is considerable. Back to top • Mix it up Some students spend the first year or two at a low-cost community college. They study hard, then transfer to a four-year college for the last years. They have the prestige of a good school's degree, but at half the cost. Back to top • Accelerate Do four years of college work in three or earn college credits through advanced placement or life experience. Both techniques save money. Students can find out about advanced placement examinations and CLEP tests from the College Board. Back to top • Understand need analysis By knowing how Uncle Sam determines family contribution, families can present their financial picture in a more favorable way. For example, they can reduce their reportable assets by making large purchases and paying cash. Families should not spend frivolously, but if they need a new refrigerator or a new car, they should go ahead and spend! Also, families can cut their per student contribution in half by having more than one student enrolled at the same time. Does Dad need to finish a degree? Should Junior 1 take a year off and wait for Junior 2 to catch up? Back to top • Do not panic Do not be frightened by newspaper headlines. If the morning paper reads, "The President will cut all student aid," parents should keep their heads and remember Government 101: The President proposes, Congress disposes. Only when the headline reads "Congress votes to kill student aid," should parents let calm give way to hysteria. Back to top • Borrow against the house Take out a home equity loan. Any items you charge against your home, like college tuition, will become part of the mortgage. Now, the interest will be tax-deductible. Back to top • Take advantage of teacher-mania Individual colleges, most states and Uncle Sam all have "forgivable loan" programs for prospective teachers. Borrowers teach three years to cancel their loan obligation. If borrowers decide not to teach after graduation, they must pay back the loan, with interest. Teaching could be combined with part-time continued study toward a master's degree. Back to top • Increase the standard college costs Make sure the entire student's costs are reflected in the student expense budget. Let the financial aid office know if the student has special medical expenses, child care, transportation or any other legitimate expenses that might increase the "cost of attendance" figure. Remember, if that increases, need increases and the student is eligible for more financial assistance. Back to top • Negotiate the aid package Make certain all your requests are reasonable, and that you have documentation to back up all your claims. Most importantly, you and your family should be courteous. Financial aid officers will do everything they can to help, but their actions are heavily regulated by federal, state and institutional bureaucracy. Angry confrontations will accomplish nothing, except maybe cause students to lose their award altogether! Back to top • Investigate commercial loan sources They all have similar terms. For example, parents can borrow up to $20,000 per year less a guarantee fee equal to 5% of the total loan amount. Repayment begins 45 days after the loan is made, although borrowers can defer paying back principal for up to four years while the student is enrolled. The interest rate is adjusted frequently, and equals the prime lending rate plus up to 2%. Interest payments are not deductible, and the rates can become quite high. Families should look to these loans as a last resort. Back to top • Investigate commercial payment plans Many schools participate in commercial plans that allow families to pay their tuition bill in installments. Families determine how much they will need at the beginning of each semester. The commercial organization makes that lump sum payment to the school. The family, in turn, makes monthly payments to the commercial organization, along with an annual fee, say $60, for the service. Back to top • Consider investing in EE Savings Bonds Interest payments on EE Savings Bonds purchased by parents after December 31, 1990 will be exempt from taxes if the proceeds are used to pay for tuition. Uncle Sam restricts the full benefit to couples whose combined income when they redeem the bonds is under $81,100. The tax break disappears completely when income reaches $111,100 (the corresponding numbers are $54,100 and $69,100 for single parents). Back to top • Save for Retirement Families with younger children should not stop saving for retirement just because they are worried about escalating college costs. There are two excellent reasons: 1. Money that parents accumulate in retirement plans is generally tax-deferred, so it will accumulate faster. 2. While no one can predict the future, Uncle Sam currently excludes from the needs analysis the money families save in retirement plans, thus removing these savings from the equation that determines eligibility for financial aid. Back to top • Sacrifice This does not mean large sacrifices, but some families may have to substitute poached salmon at Chez Froggy's with fillet of fish at the local fast food chain. It may be appropriate to trim plans for vacation trips or a major purchase and drive less expensive cars a bit longer. Back to top |