Education Planning
Too quickly the diapers and bibs seem to become jeans and high-priced sneakers. Often, during these fast-paced years, parents are so focused on the near-term needs of their families that they put off preparing for long-term goals, including planning for the costs of a child’s college education. Prepare now in the hectic early years so you’ll be in better financial shape later.
Coverdell Education Savings Account
Coverdell Education Savings Accounts (CESA), formerly known as Education IRAs, allow you to make annual non-deductible contributions designated to an investment account. Starting in 2003, the contribution limit is $2,000 annually. This reflects a significant increase, which was previously limited to $500 per year, per child, since the Education IRA’s introduction in 1997. These accounts are allowed for children up to age 18. The money will grow tax-deferred, and withdrawals for qualified education expenses for that tax year are not subject to federal taxes. If any balance remains in a Coverdell Education Savings Account after all expenses are paid, the account can be transferred to another eligible family member. If an account is not transferred prior to the recipient reaching age 30, the account will be converted to a regular investment account, with income taxes and a 10% penalty due. Advantages:
Money grows tax-deferred
Withdrawals for up to the child’s amount of qualified education expenses for that year are exempt from federal taxes.
Rollovers to other children are permitted.
Considerations:
Must withdraw the money before beneficiary turns age 30
Limits on adjusted gross income
May affect financial aid eligibility
529 Plans
529 Plans are Section 529 State Savings Plans. They allow states to offer investors professionally managed, tax-advantaged portfolios to help meet rising college expenses through investment management firms. These state-operated, qualified tuition plans are designed to help families save for future college costs. As long as the plans satisfy a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant (Section 529 of the Internal Revenue Code), such as tax-deferred accumulation and tax-free withdrawals.There are two general types of 529 plans: prepaid tuition plans and college savings plans. The states offering pre-paid tuition contracts covering in-state tuition will allow you to transfer the value of your contract to private and out-of-state schools, although you may not get full value depending on the particular state. If you decide to use a 529 plan, the full value of your account can be used at any accredited college or university in the country, along with some foreign institutions. The college savings 529 plans are managed by mutual fund companies and investment management firms.
Advantages:
No income restrictions on eligibility of donor gifting money to 529 Plan.
Estate tax benefits to donor (removed from donor’s estate).
Donor can gift forward $55,000 in the first year or $11,000 annually per donee in 2002 (indexed thereafter) without tax consequences.
Larger contribution amounts (up to $250,000).
Donor is in control of account.
Before investing in a 529 Plan, investors should carefully consider whether their home state offers tax or other benefits available only to the state sponsored plan.
Beneficiaries remain qualified for HOPE Scholarship and Lifetime Learning Credit.
Tax-deferred accumulation and tax- free withdrawals (when solely used for qualified education expenses).
529 Plans provide for wide range of investment styles, including: growth, aggressive growth, balanced, income, and capital preservation.
Considerations:
Prepaid tuition plan is designed only to match rate of tuition inflation of in-state public universities, whereas college savings 529 plan is flexible depending on investment selections and returns.
The number of eligible colleges may be restricted in some states with the prepaid program; the 529 College Savings Plan has no restrictions.
529 prepaid tuition program contributors cannot make a contribution to a Coverdell Education Savings Account in the same year.
10% IRS penalty on earnings for non-qualified education expenses distributions starting
after 2003.
Custodial Accounts
UGMAs and UTMAsThe Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Account (UTMA) let you transfer small and medium-sized investments to minor children for tax advantages.
Advantages:
- Custodian guides account when child is a minor
- Investment income typically is taxed at child’s rate
- Funds clearly designated for child
- No costly legal fees or reporting requirements
Considerations:
- Transfer of assets is irrevocable
- Child gains control of account when reaching majority age (18 or 21)
- Assets may be counted when applying for financial aid
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