Bricks for Building Your College Funding Plan
Building a Future for College Students
College costs continue to skyrocket – at a pace that far exceeds the rate of inflation. But there is a bright side to planning for college expenses, and it’s getting a little brighter all the time – thanks to federal tax breaks that can make paying for college more affordable. The key point to remember is that you can create a college funding plan brick by brick by combining a variety of investment accounts, tax benefits and financial aid sources. Here is a quick guide to get you going:
- 529 Plans – State-sponsored versions of these plans are now available in all 50 states, and you aren’t limited to the plan of your own state. In a 529 Plan, you set aside after-tax dollars on behalf of a beneficiary, and earnings grow on a tax-deferred basis. Distributions are not taxed, if taken for qualifying education expenses. As the account owner, you maintain control of the account and may change beneficiaries, subject to restrictions. In addition to state-sponsored plans, private colleges also may set up a form of Qualified Tuition Plan that allows tuition to be prepaid.
- Education Savings Accounts—These accounts allow annual after-tax contributions of up to $2,000 per child per year. Distributions made for qualifying education expenses are tax free, and the costs of high school or elementary school tuition may qualify.
- Loans or Withdrawals from Permanent Life Insurance—Parents often find it convenient to fund part of college costs by taking loans or withdrawals from permanent life insurance contracts – i.e., life insurance with a cash value. In most contracts, loans may be taken tax free.
- Traditional IRA Withdrawals—If you have a Traditional IRA, you can make penalty-free withdrawals for purposes of paying qualifying college expenses for your child, grandchild or spouse (or even yourself). Ordinary income tax will apply on the amount withdrawn.
- Roth IRA Withdrawals—If you have a Roth IRA, you can make income tax-free and penalty-free withdrawals equal to your contributions (i.e., basis). Withdrawals in excess of your basis are distributions of earnings and are subject to ordinary income taxes unless you are over age 59 ½ and your Roth IRA has been open for at least five years, however, the 10 percent early withdrawal penalty will not apply if the withdrawal is used to pay for qualified higher education expenses.
- Federal Tax Credits—Many parents can use federal tax credits to meet a portion of the children’s educational costs. The American Opportunity Tax Credit applies in the first four years of post-secondary education. It’s a tax credit of up to $2,500 and applies to the cost of tuition, fees and course materials. Up to 40 percent of the credit (a maximum of $1,000) is refundable – meaning even if you owe no income tax for the year, you can get up to $1,000 back from the government if you qualify for this type of credit.
- Deductible Interest on Student Loans—If your child needs education loans and you repay them, you may qualify to deduct up to $2,500 of the loan interest per year.
- Employer-provided Education Benefits—Some companies have set up programs that allow the organization to contribute education benefits on behalf of workers and their children. Federal law currently allows up to $5,250 of employer-provided education benefits to be excluded from taxable income.
- Financial Aid—Today, more and more students are applying for financial aid. In most cases, students must demonstrate financial need to qualify for this type of assistance.
Your financial professional can help you learn more – and help you identify specific solutions that may work best to help you reach your long-term financial goals, based on your personal situation.