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College Tuition Blues

By: Investor Solutions

By: Investor Solutions, Inc.

Experiencing college tuition blues, you don’t have to sweat it anymore; Uncle Sam has taken steps to help you avoid the “Tuition Shock” when helping your child with college funding! The enactment of the Economic Growth & Tax Relief Act of 2001 by President Bush will add some significant tax breaks for those expecting to encounter future college expenses.

Education Savings Accounts (Formerly Education IRA-s):

Starting January 1, 2002, your allowable annual contribution increases from $500 to $2000 per child. Withdrawals are tax-free as long as the assets are used for qualified higher education expenses prior to the beneficiary reaching age 30. Deadline for making an Education IRA contribution is April 15th of the following year.

Contribution Phase out:

Filing Status Full Contribution Partial Contribution No Contribution
Single AGI under $150K AGI $150-160K AGI over $160K
MFJ AGI under $190K AGI $190-220K AGI over $220K

Section 529 Plans: Section 529 Plans are State sponsored methods of funding higher education costs usually in the form of College Savings Plans or Prepaid Tuition Plans. The National Association of State Treasurers operates the College Savings Plan Network.

College Savings Plans: Since each state controls how the assets are invested, don’t assume that your state offers the best plan. Some plans allow you to invest more than others and the investment selection may be too aggressive or conservative for your investment style.

One appealing benefit of the Section 529 plan is that you can contribute up to $50,000 in one year to a child’s account in a college savings plan (treated as five separate $10,000 gifts- counted in the current year and the four succeeding years, so no gift tax would be due). Especially attractive to grandparents who are looking to reduce the size of their taxable estates by making gifts to benefit their grandchildren.

Prepaid Tuition Plans: If your worried about the skyrocketing costs of college tuition, this might be a perfect solution for your fears. The Prepaid Tuition Plan allows families to pay for college tuition now, so they can avoid the inflation driven costs of college funding in the future.

Many plans have restrictions on the colleges where the prepaid tuition can be used, however; should your child choose to not attend a college on the list- you would get your money back with interest.

Uniform Gift/Transfer to Minor Accounts: In this scenario, you act as the custodian. Uniform Gift to Minors Accounts (UGMAs) and Uniform Transfer to Minors Accounts (UTMAs) allow you to invest under a child’s name. Many adults find these accounts advantageous because the first several hundred dollars of earnings are not taxed, and the remainder is taxed at the child’s rate, which usually is a lower rate than that of the adult.

Any adult (grandparent, parent, uncle, aunt, etc.) can invest in the UGMA or UTMA for the benefit of the minor. An annual gift more than $10,000 from any one person would be considered a taxable gift and may be subject to the gift tax.

A drawback to the UGMA/UTMA account is once the child turns 18 (21 in some states); the child takes control of the account. Unfortunately, the child may use the money for purposes other than education, regardless of the wishes of the custodian.

Transfer Assets in Parent/Adult name to Legal Age Child: Upon the child-s 18th birthday, parents can encourage the child to open a brokerage account. The adult/parent may then transfer (as a gift) up to $10,000 of securities/cash into the brokerage account of the legal child.

Benefits of this strategy are:

a) It allows the parent/adult to retain control over the assets for a longer period of time

b) Up to $10,000/per year (per person) may be gifted

c) Appreciated securities can be transferred and then sold at the child’s tax rate.

Again, the main disadvantage is that once the assets are in the child’s name the funds are controlled by the child and may be used for purposes other than education as originally intended.

Of course, there are many other methods of financial support for your child/minor’s college education, such as; trusts, 401k’s, and retirement assets (new tax laws are allowing penalty-free withdrawals from some retirement plans as long as the funds are used for qualified higher-education expenses). Don’t forget about researching Scholarships and the Tax Credits.

Beginning in 2002, qualified tuition plan regulations have been relaxed to allow tax-free distributions from Education IRA’s and Qualified State Plans. The definition of family members has been expanded to include cousins, and under the new law- you’ll be able to fund both an Education IRA and a Section 529 Plan in the same year.

To find out more about the individual state sponsored plans near you, contact Investor Solutions, Inc. or visit the state network at www.collegesavings.org