This week America’s Financial Expert, Ellie Kay, is teaching us about affording college education without a boatload of school loans!
In addition to the guest posts this week, Ellie Kay is also giving away 2 copies of her Living Rich for Less book and 2 copies of her Little Book of Big Savings book! But that’s not all! Since we’re talking about a “living with less” mindset for affording college, I’m going to be giving away 2 copies of our Living With Less So Your Family Has More book this week! To enter just comment on one or more posts this week. Each comment will give you an additional entry into the book drawings!
Now that we’ve exhausted the creative alternatives to pay for college, let’s take a look at some traditional methods. Saving for college is as individualized as your dreams. College aspirations vary from family to family and even from child to child. It will also vary based on different factors such as your income level, the number of children you have, the amount of college savings in existence, scholarships, federal aid availability, and the number of years left before a child starts college. Here’s a guide to the most popular investment tools:
UGMA – Uniformed Gifts to Minors Act – Parents of young children, can start saving now for education but do it the tax-smart way. By investing in a UGMA in a child’s name, income is taxed at the child’s marginal tax bracket rather than the parents. The account must be registered in the child’s name. An adult (usually a parent or grandparent) serves as custodian and is responsible for investing and managing the assets. But the child is the “beneficial owner,” meaning the assets really belong to the child. At age 18 (in most states), control of the assets must be turned over to the child (which could be a disadvantage for this plan when it comes to financial aid qualifications.)
- All states offer UGMAs, and many have adopted the Uniform Transfers to Minors Act, or UTMA, as well (a “T” not a “G”). A UGMA allows children to own stocks, bonds, mutual funds, and other securities; while a UTMA allows the children to also own real estate. Under UTMA, parents can delay giving the assets to the child until age 21.
For example, if your bouncing, beautiful 3-year-old daughter has interest income of $700, the tax on that is zero. If she had income of $1,400, the next $700 is taxed at her 10% rate. If you’re in the 28% bracket in 2009, the tax on the $1.400 total would be around $400. Your daughter is only paying $70, so you’ve just saved $350 more for her college education.
EE USSavings Bonds If income from these bonds is used to pay for education expenses, then that interest may be excluded from taxes. But this exclusion is phased out beyond certain income levels.
Zero Coupon Bonds The interest on these bonds is deferred until they mature, when it is paid in a lump sum. Parents do have to pay income tax on interest as it accrues each year the bond is held. It’s often wise to “ladder” these bonds, where the bonds come to maturity in each year of the child’s college career.
529 Plan – This is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant (Section 529 of the Internal Revenue Service found at www.irs.gov ). 529 plans are usually categorized as either prepaid or savings, although some have elements of both. Every state offers a 529 plan and it’s up to each state to decide what it will look like you can go to www.findaid.org to review your state plan. Educational institutions can offer a 529 prepaid plan but not a 529 savings plan (the private-college Independent 529 Plan is the only institution-sponsored 529 plan thus far). Parents can invest in any state’s plan, no matter where they live and regardless of what plan they choose, their beneficiary can attend any college or university in the country. What’s more, grandparents or other benefactors can contribute money to a 529 plan. However, they may crimp a child’s ability to get financial aid in the future. It is important to review the state ratings for residents and non-residents as some are rated better than others. These plans are growing in popularity and it is projected that there will be a total of $175 billion to $250 billion invested in 10 million to 15 million accounts by the year 2010.
Coverdell Education Savings Accounts. The Coverdell ESA will allow up to $2,000 of pretaxed income to be invested annually. If the modified adjusted gross income is less than $95,000 as a single tax filer, or $190,000 to $220,000 as a married couple filing jointly in the tax year in which the money is contributed. The $2,000 maximum contribution limit is gradually reduced if the modified adjusted gross income exceeds these limits. There are limits on how much can be invested based on income and the funds must be spent before the child turns thirty. This education IRA will not interfere with the parents’ ability to invest in a tax-deferred annuity in their own retirement account. But it will count heavily against the student when financial aid packages are calculated.
Because Coverdell IRA funds can be rolled over into a 529 without penalty, parents can sidestep its principal drawbacks—the age limit and the fact that the IRA counts as the child’s asset, which can adversely affect his ability to receive need-based loans. Therefore, a Coverdell account may be the best single investment option for parents whose income is below $50,000. The accounts are easier and less expensive to set up than 529 plans and people in this lower tax bracket aren’t usually able to take advantage of the maximum lifetime contributions allowed under a 529, which range from 110K to 305K because they don’t pay that much tax in the first place.
Prepaid Tuition Plans. A 529 prepaid plan is one that is offered an individual states or educational institution and they are prepaid similarly to a 529 plan but they are less risky. They allow parents to pay tomorrow’s expenses at today’s prices either by the year or by the credit hour. The drawbacks are that even though parents can often transfer some of these plans to other state colleges or private tuitions—those schools do not guarantee the same services and prices. Thus, college students could come up short. Contributions to prepaid plans might also reduce a student’s eligibility for financial aid on a dollar-to-dollar basis, more than with a 529 plan. If the child does not attend college, the contributions are refundable but there might be a cancellation fee and/or loss of interest earned. It’s important to compare 529 plans to find the plan that works best for different families, you can go to www.savingforcollege to review the latest updates on these various plans. These plans are best if 1) parents don’t expect to qualify for financial aid, 2) parents are conservative or novice investors and 3) parents understand the risks.
Financial Aid Office The university’s financial aid office is a clearinghouse of information. A good aid office will not only help students determine what loans they qualify for, but they will steer them to participating lenders who are offering the best terms and service. Parents can do their own assessment by using the “Paying for College” web page calculator found at payingforcollege.com .
Filling out the FAFSA (Free Application for Student Financial Aid form found at www.fafsa.ed.gov ) is the first step in applying for aid that includes: 1) need-based guaranteed loans (Stafford Loans are variable while Perkins Loans are fixed.) 2) Grants—the Pell Grants and the Federal Supplemental Education Opportunity Grant each provide a gift of up to a designated amount per student per student year. 3) Work-study. Students can receive up to $2,000 per year, 25% of it matched by the participating institution, from the federal work-study program.
Some other options that the financial aid office might offer is a tuition deal when your student is a Freshman. Some schools may allow you to lock in your student’s tuition for four years if you are willing to pay more the first year. By choosing that option, some families are saving a boatload of money by the time their student is in their junior and senior years because many universities have raised tuition every single year by as much as 8%. The only caveat is that if you leave the school you don’t get a refund on the premium you paid in that first year.
There are also state loans and grants available and the financial aid office should be able to quickly asses the student’s eligibility.
Millions of dollars of scholarship money go unclaimed every year. This is free-lunch money that parents or prospective students who are willing to do some detective work may find more quickly than they think. Salliemae.com has over 1.9 million scholarships to research valued at 16 billion dollars! Make this your child’s part time job—investing 3 to 4 hours a week, filling out scholarship forms. Your child, for example, could write a 500 word essay on skateboarding or other areas of interest—there are thousands of scholarships that go unused every year because kids don’t apply for them. Don’t forget to have students apply to local civic organizations and community scholarships as well—the high school counselor should have a list of these scholarships.
What about you? Did you have any college scholarships? If so, how did you earn them? Can you share a story of a college student you know who received a hefty scholarship that covered most of their college expenses?