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Saving Money For College
While Tuition Costs Are Rising
There are many ways (outside of just straight investing) of saving money for your kid’s college education. I will briefly cover them in this article.
But before I get started, I want to make something very clear. Before you even THINK about putting one red cent towards your child’s college education, you need to have your retirement plan in place. A lot of people make the mistake of putting money away for their child’s future while not having their retirement shored up. Listen, if you have a child and he or she reaches age 18 and have no money, there are a lot of options (student loans, scholarships, grants, part time work… etc.)! BUT... If you get to retirement and you have no money, you have NO OPTIONS! You just can’t retire.
If you pay for you’re kid’s college education and have no money to retire on, then they have to come back and take care of YOU when they get older! So You are doing them a BIGGER disservice by not having money to retire because now they can’t live their lives. Kids college planning is actually step 7 on the list of my 9 steps to financial freedom. Now, let's get right to it.
The Coverdell Educational Savings Account: The Coverdell ESA is an investment vehicle designed to help parents fund their kid’s college education. You can contribute up to $2,000 per year per student. The earnings in this vehicle grow tax free as long as any distribution is used for educational purposes. You choose what you want to invest in inside these accounts.
This account does have an income limit. If you are making between ($95,000 and $110,000)/yr if you’re single or between ($190,000 and $220,000)/yr if filing jointly, then you can only contribute $1,000. And if you make more than that, you can't contribute. But if that happens to be the case, you can just let the child open up a Coverdell ESA and just give them the money to contribute to it.
Now, if you're child is making more than $110,000/yr and is not even in college yet, then put stop reading this article immediately and go sign up for their newsletter! And then send the web address to me (I'm always open to receiving information).
The Roth IRA: If you are going to be at least 59½ years old when your kids or grandkids reach college, then this is a viable investment vehicle. Generally speaking, you can invest up to $5,000 per year in a Roth IRA.
Similar to at Coverdell ESA, there are income limits. These limits can change from year to year. To keep up with these limits, you can go to the following websites Roth IRA Contribution Limits and Roth IRA Conversion Rules
Uniform Gifts to Minors Act (UGMA): This is an account that is placed in your child's name and social security number where you as a parent become the custodian. The advantage of doing this is that the gains in this account are taxed at a lower interest rate than if it had been in your name. In this account you can contribute up to $13,000 per person, per year ($26,000 if your spouse contributes also). Other adults can also contribute to this account.
You can also get involved in a UTMA (Uniform Transfer to Minors Act) which allows for transfer of property (such as life insurance, real estate, pensions etc.) to the minor at the age of 18.
Now if you want to FORCE your child (heaven forbid) to use this money for college, then you may not want to use this type of account. Once the child becomes 18, then that money is hers or his to use for whatever they want to.
Also, having this type of account may hinder you from qualifying for financial aid. So if that is your intention, then you may want to stay away from these types of accounts.
529 College Plan: A 529 College Plan is a state run investment vehicle that you can put money in towards your kid’s college education. The earnings grow tax free. Anyone can contribute to this account, there are no income limitations and you control the access to the account. And if your child gets a scholarship, then that money can be withdrawn without penalty. There are two types of 529 plans (prepaid and savings).
Prepaid plans let you purchase tuition credits at today's rates that can be used in the future (so the performance of the fund will be based on tuition inflation).
In a savings plan, the growth of the fund is based on market performance (depending on what you invest in). To learn about the different types of state plans, visit http://www.savingforcollege.com/
Registered Education Savings Plans (RESP): If you live in Canada, you are going to really like this one. The RESP is an investment vehicle that parents can use to save for their kids college in Canada. The advantage with this account is that you get access to the Canada Education Savings Grant (CESG). The CESP is provided by the Canadian government to compliment the RESP. The government will pay 20% of the first $2500 ($500) of annual contributions into the RESP. A Maximum of $50,000 lifetime can be contributed and the money is available upon withdrawal by a post-secondary student. More info on this is here.
Using these programs can help you save and grow a lot of money towards your children’s college education. Now, if your child happens to be in college already, there are a couple of tax benefits that you may utilize for your benefit.
Tuition and Fees Deduction: This allows you to take a tax deduction for mandatory school fees and college tuition. This is available to anyone who has paid tuition and any other required fees for attending post secondary schools. The maximum that you can claim is $4,000. Parents can claim this on their children as long as they claim their child as a dependent. This deduction isn't available for married couples who file separately.
There are income limits to this also. If your income is $65,000 ($130,000 for joint filers) or less, you can claim the maximum amount of $4,000. If your yearly income is between $65,000 and $80,000 ($130,000 and $160,000 if filing jointly), then you can only claim $2,000. And no deduction is allowed for income that exceeds these numbers.
The American Opportunity Tax Credit (formerly known as the HOPE Scholarship): This provides a tax credit of up to $2,500 per year per student ($3,600 for Gulf Opportunity Zone Act Students) for qualified higher education expenses for the first four years of higher education. So if you have multiple students in the home, you can have multiple tax credits. Now, in order to receive this credit, the student must be pursuing an undergraduate degree or other recognized educational credential.
The following expenses don’t qualify:
- Medical Expenses.
- Room And Board.
- Student fees outside of those required for enrollment or attendance.
- Expenses already paid with tax-free educational assistance or any other tax credit, deduction or educational benefit.
The amount of this credit is 100% of the first $2,000 of qualified expenses and 25% of the second $2,000 of qualified expenses.
The American Opportunity Tax Credit is also partially refundable. So, if you don’t owe any tax at all, you can be refunded up to 40% of the credit. So, if you qualified to receive the total $2500 of this tax credit, and you owed $1000 in taxes, then you could only have $1000 (40% of $2500) of this credit refunded to you (even though the difference between what you owe and the credit is $1500 [$2500 – $1000])
This credit has income limits. If your yearly income is less than $80,000 ($160,000 if joint filing) then you qualify for the full amount. Between $80,000 and $90,000 ($160,000 and $ 180,000 if joint filing), what you can claim begins to phase out. And when your gross income exceeds these numbers, you can no longer receive the credit.
The Lifetime Learning Credit: This credit is very similar to the American Opportunity Tax Credit, so I will point out the differences. This credit provides for 20% of qualified expenses up to $10,000 (for a max of $2,000). Unlike the American Opportunity Tax Credit which phases out between $80,000 and $90,000 dollars, the Lifetime credit phases out between $52,000 and $62,000 ($102,000 and $124,000 if filing jointly).
Unlike the American Opportunity Tax Credit, the student doesn’t have to be pursuing a degree or other recognized education credential in order to receive this credit. The Lifetime Learning Credit is also available for all years of post-secondary education (as opposed to just the first four years) and also courses that help you obtain or improve job skills. This credit is not partially refundable.
You cannot take the American Opportunity Credit and the Lifetime Learning Credit for the same student in the same year. So you will have to figure out which one of these credits is best for you and choose accordingly.
To stay updated on these tax credits (because the numbers do change every year) see IRS Publication 970 at www.irs.gov. You can also call the IRS forms and publications order line at 800-TAX-FORM (800-829-3676).
Well... I hope this all has been helpful.
So until next time,
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