Marta V. Plampin

Whether your child is getting ready for kindergarten or the final year of high school, it’s smart to start preparing now for higher education expenses. With college costs steadily on the rise, the importance of a comprehensive college funding plan has never been greater. In fact, according to the New York-based College Board, the average annual costs at public and private colleges are more than 50 percent higher than what students paid just 10 years ago. Thankfully, there are a number of steps you can take to offset these rising costs.

Investments May Help

If your youngster won’t be entering college for five or more years, consider using a taxable investment account to generate college funds. As long as you don’t sell investments in the account, you’ll only owe annual taxes on the dividends or interest you earn, if any.

Who’s name to put on the investment is key. For children 14 and older the income is taxed at their rate which is probably less than the parent’s rate. For children under 14 it is taxed at the parent’s rate.

When it’s time to withdraw from the account, any investments sold that have been held for more than one year will be taxed at the long-term gains of the child or parent, depending on who owns it.

There is also a new five-year gain rate that applies to taxpayers in the 15 percent tax bracket (which is the bracket that children are usually in) for assets held more than five years. As a result, an existing 10 percent long-term capital-gains rate will fall to eight percent on stocks and other investments held more than five years. This rate applies to the part of net capital gains that would be taxed at 15 percent if there were no capital-gains rates. This may provide an incentive for some parents to begin investing at least five years before money for education is needed. There is another thing to keep in mind for stocks that have been held for more than five years and have risen dramatically. If a parent sells the stock, he would pay a 20 percent capital-gains tax. But, if the investment is given to a child who will be age 14 or older before the end of 2001, the child can sell the stock and the gain will only be taxed at an eight percent rate if they are in the 15 percent tax bracket. In this case, the father’s cost basis and holding period would carry over to the child.

Before deciding to transfer assets, you should consult with a financial or tax advisor who can counsel you on the advantages and disadvantages in regards to your situation.

Different IRAs Provide Different Benefits

Two types of individual retirement accounts (IRAs) are commonly used to fund college costs: the Roth IRA and the Education IRA. If you qualify, you can individually invest up to $2,000 a year in a Roth IRA and any earnings grow tax-free if certain conditions are met. Withdrawals of contributions can be withdrawn income and penalty tax free. If any earnings are withdrawn, those earnings are income taxable, but are not subject to early withdrawal penalty tax. While the Education IRA also allows for tax-deferred contributions and tax-free withdrawals if used for education, however because it has the same income limits as the Roth IRA not everyone can contribute. Also, it has several restrictions which may limit its usefulness. For example, the maximum amount you can contribute annually to an Education IRA is $500, as opposed to $2,000 for a Roth IRA. In addition, you cannot claim the Hope or Lifetime Learning Credit in any year you withdraw from an Education IRA and elect tax-free treatment of that withdrawal. Also, you cannot contribute to an Education IRA in the same year that you contribute to a 529 plan. That means that any contribution to an Education IRA would be an excess contribution subject to a six percent penalty, unless removed appropriately. Excise tax applies each year the money stays in the Education IRA.

Consider Tax and Tuition Credits

The federal government introduced the Hope Scholarship and the Lifetime Learning credit in 1997 to assist students and parents with the costs of higher education. The Hope Scholarship can be used in your child’s first two years of college and is worth a maximum of $1,500 in tax savings per student. The Lifetime Learning credit can be used for 20 percent of expenses incurred in the third year of school and beyond. The maximum annual credit is $1,000 until 2003, when the maximum credit will go up to $2,000.

Financial Aid Can Have a Positive Impact

Need-based financial aid, such as government grants, can be useful when it’s time for your child to begin college. And, financial aid can help cut down on the amount you’ll need to save for college over the long run. To get a general idea of the potential benefits to your family, call for a free financial aid guidebook from the U.S. Department of Education, 1-800-4FED-AID. Or visit the department’s Web site at :

Complex Formula Determines Net Worth

Financial aid eligibility for a student’s freshman year in college is based in part on the parents’ and student’s taxed and untaxed income received during the calendar year beginning January 1 of a high school student’s junior year, and continuing through December 31 of his or her senior year. Consider these tips if your youngster will apply for financial aid in the near future:

– The lower your family’s assets and income, the greater the calculated need. Consumer debt from sources such as credit cards and personal and car loans isn’t considered when figuring your family’s net assets. So, if you can afford it, you may want to use your savings to pay off such debts.
– Notify the school’s financial aid office about anything unusual in your family’s financial situation. If you encounter unexpected financial circumstances, such as high medical expenses or an inheritance that artificially inflates your income, write a letter to your school’s financial aid office explaining the situation. Such conditions may be taken into account when reviewing your overall net worth.

State Plans May Be Worthwhile

Another college funding tool to consider may come from your own state government. Many states sponsor college savings plans that allow families to prepay tuition costs (and, in some plans, room and board expenses as well). Although the options vary from state to state, the advantage of many of these plans is that they may limit your risk while also giving you greater potential returns than a money market account. Often, extended family, such as grandparents and other relatives, can add funds to the state plan.

These plans allow you to save for college funding tax-deferred until the money is withdrawn for college expenses. When funds are withdrawn, the earnings portion of any withdrawal will be included in the student’s gross income and taxed at the student’s rate.

To find out about your state’s program, call the College Savings Plans Network toll-free at
1-877-CSPN-4-YOU, or visit the organization’s Web site at http://www.collegesavings.org.

Put Your Funding Plan on the Fast Track

If the number of available college funding options has you wondering where to begin, consider turning to a professional investment advisor. You’ll learn how it may be possible to simultaneously invest for multiple goals and advise you on the best investment strategy. You’ll also be able to discuss the merits of various college Marta V. Plampin

Personal Financial Advisor
American Express Financial Advisors Inc.
(847) 993-1534

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