How do I fund my child's college education ?

As you can see from the above figures,  the price of college is daunting.  Even though inflation has been low in recent years, the cost of a college education continued to spiral upward.   So much so that, some schools raised tuition rates to double that of inflation!  As the table above indicates, a child born in 2008 could face college costs ranging from $188,422 for four years at a public university, to more than $385,558 for a degree from a private institution. 

Should you choose to invest to cover part or all these costs, the key is to commit money for your child's future now.

1. Estimate tuition costs and set your target.

2. Estimate how much you will need to build for the future.

3. Avoid the tax crunch, use one of the tax advantaged approaches.

4. Choose the right investments.

Information for the table above was derived from The College Board, 2007 figures as reported by the Franklin Templeton Web site. We updated the figures by using an inflation of 5%.

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    What are the usual strategies?

Most financial planners agree that investing a consistent amount at regular intervals may be one of the best ways for investors to build assets over time and reduce the average cost of their investment. This strategy  is called Dollar Cost Averaging. With Dollar Cost Averaging, you invest a fixed dollar amount on a regular basis, regardless of the market's direction. For example, if you were invested in a mutual fund and were regularly investing a fixed dollar amount, you would automatically buy more shares when the price is low and fewer shares when the price is high. As a result, you would have paid less than the average price per share for the period in which your shares were purchased.

(Information presented in the brochure "Franklin Templeton College Costs Planner" by Franklin Templeton.)

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    What is a Coverdale IRA ?

It is an educational IRA named after Senator Coverdale who sponsored the legislation.  Parents or others may contribute up to a combined total of $2,000 per year, per student to an Education IRA (EIRA) on behalf of a college-bound child. Contributions are made after tax and are not deductible. Investment earnings and qualified withdrawals are tax-free, provided that certain requirements are met. No contribution may be accepted after the date on which the beneficiary reaches the age 18, and the EIRA must be distributed by the time the beneficiary reaches age 30. Such distributions will be tax-free and penalty-free only if used for qualified education expenses. Because no contributions may be made to an EIRA during the same tax year that a contribution is made to a qualified state tuition program for the same child, you may want to investigate your state's tuition program, if available. The exclusion of qualified EIRA withdrawals from taxation affords the potential for greater after-tax returns for the college bound.

Advantages:

- Earnings on the investment are tax-free when used for qualified education expenses.

- Amounts not used by the time the beneficiary reaches 30 can be transferred to another family member to retain the account's tax-free status.

Disadvantages:

- Contributions are limited to $2,000 per year.

- Money in the EIRA is treated as the student's when qualifying for financial aid.

- Depending on the mutual fund company, bank or brokerage firm you use, the account may or may not become the property of the student when he or she reaches the age of majority.

- Tax-free withdrawals cannot be made in the same year in which a HOPE scholarship Credit or Lifetime Learning Credit is claimed.

(Information from "How will I pay for my child's college expenses?" by Kemper Funds).

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  What is a 529 plan?

A 529 plan is a college investment program that is operated by the state and receives special federal tax benefits under section 529 of the Internal Revenue Code. Forty-six states now have 529 Plans, and the vast majority of them are less than two years old. Twenty-three states invite anyone to invest, regardless of which state they live in.

Benefits:

- federal tax-deferred earnings.

- income shifting from parents' tax bracket to college student's.

- possible state benefits including tax deductions, asset protection, even scholarships.

Did you know...

- you can open an account in one, two, or even a dozen different states?

- it may not matter where in the U.S. the child attends college?

- investment options currently range from an inflation-indexed CD to an S&P 500 index fund?

- the tax benefits are available no matter how high your income is?

- you can even set up accounts for yourself, no matter how old they are?

- assets can be removed from the contributor's taxable estate, but remain completely revocable?

(Information taken from "The 529 Plan Report" by Terri Robson, BonaCom Publications.)

 

AAP offers 529 plans through six different investment companies.  Set up an appointment with us and we'll match you up with the one best suited for your personal situation.

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    Are there alternative strategies?

Yes. It's called income shifting. The concept of income shifting is based on the fact that almost all children have a lower tax bracket than their parents for both earned and unearned income. Most of our clients have income from interest, wages, and some capital gains.  The capital gains  - and some dividends - are taxed as high as 15% . However, the tax rates of your children ( if they are over age 14), are likely  to be between 0% and 10% in all categories of earned and unearned income. This is after their $1,900 exemption.

There are two ways to shift income to children. The first, and most powerful, can be used primarily by families or individuals who control a business, whether it's a traditional business, or even a home-based "second" job. The second method involves gifting investments that have increased in value. The children may then sell these gifts and pay for the gains at their lower tax rates. Once a child reaches college age, there are educational tax credits available that can markedly reduce or eliminate any tax burden resulting from income shifting.

Another alternative, is through the tax treatment accorded life insurance by the IRS Code.  Recall, growth of cash value inside an life insurance policy is tax deferred. Typically, you would buy a large death benefit, higher yielding cash value policy, and fund it with your invested assets.  When your child enters college you then take out a loan against the cash value in the policy.  There are four benefits to this strategy.                   

First, should you pass away prematurely, the death benefit can be used to fund the college education.

Second, by funding it with your other investments, you have removed that money from reporting on the forms for financial aid.

Third, the growth of the cash value is tax deferred and continues even on the amount you have loaned to yourself.  This makes the loan relatively inexpensive to you.

Fourth, your life insurance policy remains in place even though there is a loan against it (although the death benefit may be reduced).

This strategy uses a smart concept of multiple use of the same dollar for different goals, i.e., security for the family, more flexible college funding, and reduced taxes on money growing within the policy.

 As an independent insurance agent affiliated with numerous life insurance companies, our financial professional will broker the policy which is cost effective and right for you and your strategy.

 

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