Start a college fund: 8 strategies
Section 529 Plans.
A Section 529 Plan is a tax-advantaged investment plan, issued and operated by a state or educational institution which helps families save for college. Section 529 Plans1 are named after the tax code that governs them. Almost all 50 states offer these plans, and rules vary by state. In many cases, you don’t have to be a state resident to take advantage of them; in fact, you can invest in multiple 529 Plans in multiple states, if desired.
Please contact your Registered Representative for more information on 529 Plans and/or obtain the appropriate Plan Disclosure Statement and the applicable prospectuses for the underlying investments of the 529 Plans we have available. Investors are asked to consider the investment objectives, risks, charges and expenses of a portfolio carefully before investing or sending money. The Plan Disclosure Statement and prospectuses contain this and other information about the plans and their underlying investments. Please read this material carefully before investing or sending money.
There are two types of 529 Plans:
College savings plans.
- Generally, college savings plans offer tax-deferred earnings; distributions from qualified state tuition plans are tax free if they are used to pay for qualified higher education expenses (some states offer tax exemptions and deductions, so check around). However, the earnings portion of any non-qualified withdrawal are subject to federal income taxes, applicable state income taxes, and an additional 10% federal tax. Maximum contribution amounts range from state to state. Please keep in mind that the underlying investment options are subject to market risk and will fluctuate in value. Check the IRS website and contact your tax professional for the current contribution amounts, and more details regarding income limitations. If an investor or a beneficiary of a 529 Plan is not a resident of the state which issues the 529 Plan he or she is considering, he or she should consider before investing whether his or her home-state 529 Plan provides state tax and other benefits only available to in-state taxpayers investing in the plan.
Other 529 Plan details include:
- You can name yourself the account owner and beneficiary in planning for your own educational expenses. (You can also withdraw funds for non-educational expenses, but the earnings may be subject to ordinary income taxes, and a 10% federal tax penalty.)
- You can also rename beneficiaries. Some states allow the account owner to be a friend as well as a relative.
Potential investors of 529 Plans may get more favorable tax benefits from Plans sponsored by their own state. Consult your tax professional for how 529 tax treatments would apply to your particular situation.
Keep in mind that there are fees, expenses, and tax ramifications associated with 529 Plans that you should take into account before choosing one. State tax treatment varies.
Pre-paid tuition plans.
- Some universities have set up programs where college expenses may be paid in installments over many years, or in a lump sum prior to attending the school. Based on age, age of beneficiary, and number of years of college tuition purchased, the advantage is that you can lock in the current price. Any earnings are tax-deferred, and distributions are excludable from gross income if used to pay for qualified higher education expenses.
Coverdell Education Savings Accounts.
With a Coverdell Education Savings Account (formerly known as Educational IRAs), you can make contributions for each child, until he or she is 18.
There are contribution limitations and income eligibility requirements. Money contributed to a Coverdell Education Savings Account may grow, tax-deferred, and may be withdrawn—free from federal income tax—for any qualified higher educational expense incurred by the child before age 30. After that time, the balance remaining must be distributed to the beneficiary. Any gains will be taxed as ordinary income and will incur a 10% penalty tax. State taxes may also apply. The account owner can retain control of the money in the account, if desired. The beneficiary can even be renamed in some cases. Check the IRS website for current contribution limits.
Uniform Transfers to Minors Act(UTMA) and the Uniform Gift to Minors Act(UGMA).
These custodial accounts allow you to set up an account in the child’s name. You can make transfers to an UTMA/UGMA account on a per-child, per-year basis. Check the IRS website for current contribution limits. Check with your tax advisor, prior to making any decisions.
Setting up an UTMA/UGMA account in a child’s name is easy. The account will involve a custodian; your registered representative can guide you in completing the application. Separate accounts are required for transfers to each child. Be sure to provide the child’s Social Security number (not that of the person making the gift or of the custodian). The custodian will have full authority to make decisions, including control over the assets. Since transfers must be permanent, parents can’t gain access to the money for their own use. Also, all assets in the UTMA account will belong to the child when he or she reaches the age of majority. You may also want to consider the possibility that assets held in your children’s name(s) may affect the level of financial aid they’ll be eligible to receive when they apply to schools.
These days, most people borrow at least a portion of the money needed to cover college expenses. You may want your children to look for student loans with special rates and repayment terms. For details on all these options, check out the U.S. Department of Education’s site at www.ed.gov or www.college.gov.
- The federal government offers Parent Loans to Undergraduate Students (PLUS loans), where eligible parents can borrow the full amount of the undergraduate tuition education, including room and board and any other eligible school expenses minus any aid their dependent child receives from the federal government. The interest rates do not exceed 7.9% (as of July 1, 2010).
- Stafford Loans, named for Vermont Senator Robert Stafford, are low-interest loans for eligible students. You can apply at any financial institution or the U.S. government, depending if they are Direct or FFEL (the Federal Family Education Loan) Stafford loans.
- Named after former Kentucky representative Carl Perkins, a Federal Perkins Loan is a low-interest (5%) loan for both undergraduate and graduate students. With this campus-based loan program, the school acts as the lender using a limited pool of funds provided by the federal government.
Interests on student loans may be deductible as well. To read more about student loans from a tax standpoint, go to the "Forms and Publications" section of the IRS website.
You may want to take a look at your permanent life insurance policies, such as whole life, universal life, and variable universal life, which offer cash value accumulation in addition to their essential financial protection. Over the long term, the cash value accumulation may be significant enough to be borrowed against to help fund a portion of college expenses if it is determined that the full death benefit is no longer needed. And the interest rates may be a lot lower than a bank loan. In addition to accruing interest, policy loans against the cash value reduce the available death benefit and cash value by the amount of the outstanding loan and interest.
Please note: Loans from life insurance policies that are treated as modified endowment contracts for federal tax purposes are taxable to the extent of the gain in the policy and, if the owner has not attained the age 591/2 may also be subject to a 10% penalty tax.
The guarantees and protection of a life insurance policy are based on the claims-paying ability of the issuer.
You can invest money in an account earmarked for your child’s education costs. Generally, it is better to invest when the child is young (less than 5 years old).
Many people buy zero-coupon Treasuries—known as STRIPS (Separate Trading of Registered Interest and Principal of Securities)—as they are backed by the U.S. government and are non-callable, which means they can’t be called, or redeemed, before the maturity date. STRIPS are not issued or sold directly to investors; they can be purchased and held only through financial institutions and government securities brokers and dealers. Interest earned on STRIPS is taxable in the year it is earned.
There are also savings bonds, including the Series EE Savings Bonds, or education bonds.
Please note: Your NYLIFE Securities registered representative does not offer STRIPS or education bonds.
The U.S. Department of Education has the following Student Financial Assistance Programs:
- A Federal Pell Grant, unlike a loan, does not have to be repaid. Pell Grants are awarded only to undergraduate students who have not earned a bachelor’s or professional degree.
- There are also Federal Supplemental Educational Opportunity Grants, or FSEOGs, for $100-$4,000 a year. These grants are awarded to students in need of financial aid. All U.S. students are eligible. Priority is given to Pell Grant recipients. These grants do not need to be paid back.
For more information, visit the U.S. Department of Education’s Web site at www.ed.gov.
Tax credits are better than tax deductions, as you subtract the credit from your total taxes due. Check the IRS website for the current credits amounts, and more details regarding credits.
- The Hope Credit is a tax credit to help with the first two years of tuition of post-secondary education. It is available to tax payers and their dependents.The maximum credit is $1,800.
- The Lifetime Learning Credit is for post-secondary education students. The maximum credit is $2,000 per tax return.
With both programs, your income must not exceed a certain amount to qualify. Also, note that these two credits can’t be claimed if you use an IRA to pay expenses in the same tax year.
There are billions of dollars available each year in scholarships, grants, and work-study programs. Financial aid to middle income families may be tough to come by, but some universities may be more willing to offer generous financial aid packages.
There are thousands of financial aid programs available. They fall into three general categories:
- federal, state and campus-based grants (grants are free money generally offered on a financial-need basis);
- student loan programs (from special rate guarantees to special repayment schedules); and
- "special situation" scholarships (given for achievement without regard to income or assets).
It’s certainly worth contacting your child’s high school and prospective college financial aid office to see if you’re eligible.
Your role in providing financial support to pay for your children’s college education is crucial. Life insurance can help assure that, if you die and, as a result, your income is lost, your children’s dreams of a college education need not be lost as well.
The information in this article is for educational purposes only and is not intended to be an offer for any specific product. Neither New York Life nor its affiliates or financial professionals are in the business of offering tax advice. You should consult with your professional advisors to examine tax aspects of any topics presented.
1 Securities offered by properly licensed Registered Representatives of NYLIFE Securities LLC (Member FINRA/SIPC) A Licensed Insurance Agency, 51 Madison Avenue, New York, NY 10010. NYLIFE Distributors, LLC, Distributor.