Planning for College Costs

Bruce H. Bokor

BBokor

Do you have plans that your newborn child will go to one of the Ivy League colleges? If so, the projected cost of attending one of those colleges is $425,000 in today’s dollars. If college costs keep increasing as they have for the past 30 years, the anticipated price of 4 years of tuition alone will more than double at the private colleges and will nearly triple at public universities for a child born in 2012. On average, the inflation adjusted prices projected from the College Board for a bachelor’s degree in 2012 dollars will total approximately $232,000 for four year private college for tuition and fees alone and nearly $81,000 for tuition and fees at an average priced public university.

Unless you are positive that your child is a world class athlete, an academic genius who will be guaranteed a full scholarship or a talented musician or artist who could easily obtain a scholarship for a school for the arts, you should consider planning, starting now, for the next 18 years. I know that it is more difficult now because of lower wage growth, smaller returns on conservative investments and an overall decrease in your net worth, but waiting until times get better is probably not the best decision. You should start now. The longer you wait, the more money you and your child will have to earn or borrow to finance your child’s education.

The next items you should consider are:

1. Your options to save for these college expenses
2. The tax breaks which may be available to you

Section 529 College Savings Plans

For most people, the best way to save for a child’s college education is through a 529 savings plan. With this plan, you deposit after-tax money, generally with a stock brokerage house or bank, but any earnings on the deposited money are income tax free as long as such funds are eventually spent on tuition, room, board, fees, books, supplies and equipment used for a college education. Contributions do not generate an income tax deduction. These plans are set up by every state, and you do not have to invest in the plan established by the state of Florida. In addition, the funds need not be spent at a college or university located in Florida or even a college or university located in the state where you have established your 529 plan. Because states generally are not interested in operating an investment business, states have partnered with different stock brokerage houses and financial institutions to handle these 529 plans. States generally limit the total amount of contributions that can be made to such a plan based upon the cost of seven years of post-secondary education (including undergraduate and graduate education). These limits may range from $150,000 to $350,000. Take a look at www.savingsforcollege.com, which is a directory of college savings plans and advice. A contribution to a 529 plan is treated as a gift to the child who is the beneficiary of such plan. Therefore, a gift to such a plan is gift tax free where a contributor makes a $13,000 annual contribution to such a plan, and a husband and wife can make an aggregate contribution of $26,000 by using their respective annual gift tax exclusions based on 2012 limits.

Congress was concerned about persons who have started “late” in funding these college educations, and they have allowed donors to “frontload” contributions to the plan by making up to five years’ worth of annual exclusions gifts ($65,000 per donor or $130,000 per married donors for 2012) in a single year to a child’s plan. Anyone can contribute to a child’s 529 plan, and you can encourage others, such as grandparents or uncles and aunts, to contribute to your child’s 529 plan. You may, as the donor of a 529 plan, change the beneficiary of the 529 plan without penalty. Therefore, if your oldest child has not used all of his or her funds in such plan and has no further higher educational costs, the remaining funds can be transferred to another “family member”, which includes siblings, grandchildren, parents and similar beneficiaries. Lastly, if you are in need of funds, you can withdraw money from the 529 plan at any time, but you will have to pay income taxes and a withdrawal penalty.

Uniform Gifts to Minors Act (UGMA)

This is a custodial account which is established under the law of a state, and funds are set aside (generally with a brokerage house or a bank) for a minor under a state statute. You, as the donor, appoint a custodian to control the account until the child reaches the age of trust termination (which is usually age 18 or 21 depending on state law). You will make an irrevocable gift of funds to the account, and the account now belongs to the minor. You use the minor’s social security number for the holdings in the account. The custodian invests the money, and the concept is to allow these funds to grow over time through contributions and earnings so that there are sufficient funds to pay for the child’s college educational expenses. These contributions are treated as gifts subject to the same current $13,000 annual gift tax exemption by a donor to each recipient. If you are married, the $13,000 amount can be doubled. There is no “frontloading” option as in a 529 plan using five years’ worth of annual exclusions, but if you wanted to make a larger gift beyond your annual exclusion amount, you could do so by utilizing some of your lifetime gift tax exemption.

When a child reaches the age of majority in that state (Florida’s age is 18), the child is entitled to and can demand the funds in the account. The funds are not earmarked for educational purposes. In Florida, there is statutory authorization for the custodian to transfer the account to a 2503(c) Trust, which I will discuss later. Any income generated within the UGMA is taxed to the child, subject to a “kiddie tax”. Under the kiddie tax, unearned income (interest and dividends) of a child exceeding $1900 (for 2012) will be taxed at your marginal income tax rates. This “kiddie tax” applies to 18-year old persons (until the year the child reaches 19) and to students under the age of 24 who do not earn more than one-half of their support. The initial $950 is tax free, the second $950 is taxed at your child’s rate, and the excess “unearned” income is taxed at your marginal rate. For financial aid purposes, a custodial account is treated as an asset of the child.

2503(c) Trust

This type of trust is designed to hold gifts in trust for your child until your child attains the age 21. A gift to this trust qualifies for the gift tax annual exclusion, but any property and income must be distributed to the child when the child turns age 21. Unfortunately, the trust funds cannot be earmarked for solely educational purposes, and the trust is treated as an asset of the child for financial aid purposes.

Coverdell Education Savings Account

These accounts are essentially trust accounts created exclusively for paying qualified educational expenses for a designated beneficiary. The income in these accounts accumulate tax free, and any distributions are not subject to federal income tax as long as such distributions are made for qualified educational expenses. The maximum cumulative contribution to all Coverdell accounts is $2,000 per beneficiary per year. Any contributions must be made before the beneficiary attains age 18. A Coverdell account may be rolled over to another family member if the account documents allow for such a transfer. Non-qualified withdrawals from a Coverdell account are subject to taxes for ordinary income and are subject to a 10% withdrawal penalty. The contribution amount to a Coverdell account may be reduced or phased out entirely if you make too much money. For a single person, the phase out starts at $95,000 of adjusted gross income, and the phase out benchmark starts at $100,090 for married couples. Coverdell accounts are treated as an asset of the parent or other account owner and are not treated as an asset of the child for financial aid purposes. Funds in a Coverdell account, however, cannot be revoked and returned to the donor (unlike a Section 529 plan).

United States Savings Bonds

United States EE and II savings bonds purchased after 1989 by a person at least 24 years old may be redeemed when a bond owner, the owner’s spouse or the owner’s dependants use such redemption proceeds for college tuition and fees. The tax free nature of these proceeds are phased out based upon your adjusted gross income, and you should consult IRS Publication 550 to determine the income figures for a particular calendar year.

Florida Pre-Paid College Plan

There are numerous pre-paid college plans, but I will limit the discussion to the Florida Pre-Paid College Plan. This plan has approximately 1,000,000 Florida families seeking to “freeze” the future cost of attending one of Florida’s public institutions. Enrollment is generally accomplished during the period beginning in October and ending at the end of January. A beneficiary must be a Florida resident for the 12 months prior to enrollment, and custodians of an UGMA can actually participate in the plan. For the 2011-2012 enrollment year, the prices range from $6,791 for the two-year Florida College Plan for an 11th grader and as much as $49,283 for the four-year Florida University Plan for a newborn. Dormitory plans can be purchased separately for up to four years. There are various plans which can fund between 60 credit hours and 120 credit hours for a beneficiary. If you child decides to go to an out-of-state institution (which must be a not-for-profit institution which is accredited) or an in-state private college, the funds in the plans may be utilized to attend those institutions. Funds from a 529 plan cannot be rolled over into any of these pre-paid plans. If the child does not utilize all of the funds in the plan, a cancellation refund or a scholarship refund may be made to the account owner.

Pay As You Go

This is certainly the most simplistic plan. If you have done little or no planning for your child before he or she goes off to college, you can make gifts directly to your child subject to the $13,000 (or $26,000) annual gift tax exclusion amount. Furthermore, if you make tuition payments directly to the educational institution, those payments are also considered to be tax free gifts to the child. Payments for room and board, books and fees do not qualify for this gift tax exclusion. Generally, parental contributions are considered when applying for financial aid. You may be able to withdraw funds from your IRA without penalty to pay for qualified higher education expenses. A penalty is generally imposed if you withdraw funds from an IRA before you reach age 59 ½, but this 10% early withdrawal penalty is waived if the funds are used to pay qualified higher education expenses for you, your spouse, your children or your grandchildren. These qualified higher education expenses include tuition, fees, books, supplies and equipment as well as room and board if the student is enrolled at least half-time in a degree program. Although the penalty is waived, you are still taxed on any withdrawal of theses funds. These funds are not included in the student’s financial aid need analysis. Of course, if you have utilized any of the other plans and such plans do not provide enough funding for a child’s college expenses, the “pay as you go” option may be one of your only alternatives to satisfy any deficiencies in any of the plans.

Miscellaneous Option and Tax Incentives

Be sure to go to www.savingforcollege.com for certain other options and tax incentives, such as the possible income tax deductions for tuition and fees, the American Opportunity Tax Credit and the Lifetime Learning Credit.

Take Away

Now that you are possibly very confused and have reached the conclusion that maybe your child will be one of those star athletes or talented musicians, take heart that every little bit helps. There are little things out there that can help you. Take a look at the Fidelity 529 College Rewards American Express card option which gives you a 2% “payback” on all purchases as long as you deposit that “payback” amount in your Fidelity 529 account. Tell your parents that, in lieu of giving expensive computer games, toys and clothing to your children, they should make smaller gifts and contribute money to a 529 plan. Be realistic with your children when they reach the age of college application time. Your child’s dream college may be too expensive, and that child may not qualify for a scholarship or loan money. The more affordable colleges and universities may be a better option with the “dream school” being an option for post-graduate education. Consider having your child apply to at least one dream college so that the child will know that he or she will be at least considered, but also have the child apply to at least one school where you can afford the cost of that institution. Quantify the anticipated costs by going to Google and search “funding college expenses” or something similar to find a calculator to compute the college costs. After you have made your calculations, do not wait. If you wait, it is only going to get harder and more expensive. Although we probably do not “owe” anything to our children, we do feel some gratification in trying to help them get a head start in life. Some statistics are “eye opening”. Workers with a bachelor’s degree earn an average of $51,200 per year while those with a high school diploma earn less than $28,000 per year. Workers with an advanced degree make an average of $74,600 per year, and those without a high school diploma average $18,700 per year. Start those college funds now – you will be happy you did.