Education Planning

Planning for your children’s education is probably one of the most important goals you will have as a parent. Additionally, college education can be an expensive prospect, likely ranking just below your house in terms of big-ticket items you’ll purchase in your lifetime. That’s why it’s so important to plan for college expenses, just as you would plan for your retirement or a home.

Educational planning involves designing an investment strategy that specifically addresses the educational needs of your family. Specifically, it involves forecasting what those needs will be and helping you create a plan to satisfy those needs. At Risk Management Planning & Insurance Services, Inc., we take into consideration how much time until the start date, if it is either public or private, the investment returns needed to achieve the required capital and if your family qualifies for any type of financial aid. We can help you plan accordingly so that you will be ready for the next stage of your child or grandchild’s educational growth. It’s important to begin saving early to reduce the initial funds required by taking advantage of the power of compounding over time.

Now that you have made the decision to invest the question becomes "How do I invest?" We will design a plan that will help you and your children to achieve your goals.

Start Early

Like almost any investment plan, this is sound advice. Basically, the earlier you start, the longer your assets have to grow. Consider this hypothetical example: You have 10 years before your child enrolls in a public college, and you expect a total bill of $56,440. If your investments return at a hypothetical rate of 10% each year, you’ll need to set aside a little more than $273 each month to reach that goal (a total of $32,760). If you delay the start of your savings plan by just two years, your payments will need to be more than $383 — $110 per month higher — bringing the total invested to $36,768.

So in practical terms, delaying just two years costs $4,008. The longer you wait, the higher this figure may become.

Be Disciplined

Few of us can afford to invest the lump sum that it would take to finance a college education years down the road. That’s why many investors choose to build a college fund one month at a time, often through a regular automatic investment plan.

Funding Options

Savings Plan Trusts: Certain states such as Connecticut, Iowa, Kentucky, Louisiana, Massachusetts, New Hampshire, and New York offer college savings plans. These plans, also known as 529 Plans for part of the United States Code that governs qualified state tuition programs, allow the contributor to save as little or as much as they like on behalf of a designated beneficiary’s qualified education expenses. Contributions, considered gifts by law, may be as little as $25 or as much as $50,000 ($100,000 for joint filers) in one year, of a five-year period, without incurring gift taxes, assuming no gifts are given to the same beneficiary within five years.

These accounts vary from state to state. Some may guarantee a minimum rate of return, others offer tax incentives, and most generally provide favorable tax-deferral and favorable tax treatment upon withdrawal. Currently, money withdrawn for qualified education expenses is taxed at the child’s rate. Beginning in 2002 the law will allow tax-free distributions from state plans for qualified education expenses. Unlike pre-paid tuition plans, the monies from the account may be used at any qualified institution of higher learning within the United States. If your child does not go to college, the money can be used for another family member’s qualified education expenses or you may keep the money and be taxed at your rate plus a 10% penalty. Check with your state’s commission on higher education to see if a college savings plan (529 Plan) is available where you live. If your state does not have a savings plan, many states have opened their plans to non-residents. Several private plans have also been developed.

The Education IRA: Though they’re not at all designed for retirement, these accounts share many of the most compelling tax advantages of regular IRAs.

Starting in 2002, you may contribute $2000 per year for each of your dependent children under the age of 18, although these contributions are not tax-deductible.

Because assets in these accounts are free from current taxation, they may grow faster than assets in regular, taxable accounts. But perhaps the biggest advantage of the Education IRA is that withdrawals to pay college expenses are tax-free.

You may contribute up to $2000 per year per child, but if your income is more than $110,000 ($220,000 for joint filers), this amount may be reduced or even eliminated.

Variable Universal Life Insurance: The cash value accumulated in a variable universal life insurance policy may be withdrawn for a variety of purposes tax-free.

UGMAs: Another popular college funding option is the Uniform Gift/Transfer to Minors Act Account (UGMAs/UTMAs), which allows adults to transfer assets to minors. These accounts may be helpful college funding vehicles because of favorable taxation: once the funds are in the UGMA, all or a portion of the investment income may be taxed at the child’s (usually lower) rate. For children under 14, tax rates vary based on income earned. Income on a UGMA account of a child over 14 is taxed at the child’s rate.

However, investing through custodial accounts is a strategy that might backfire if you’re eligible to receive financial aid, because of the ways many colleges compute a student’s need.

Currently, financial aid guidelines assume that adults will put 5.6% of their assets towards a child’s college expenses. But it’s assumed that 35% of the child’s assets (which include the balance of any UGMA accounts in the student’s name) will be used.

In other words, a college may assume that a student’s parents will use $2,800 of a $50,000 account each year to pay college bills; if the same account is a UGMA in the student’s name, the college may assume that $17,500 will be used. Years of contributing through UGMAs could push your child out of financial aid range.

Prepaid Tuition Plans: Certain states, such as Alabama, Alaska, Colorado, Florida, Massachusetts, Michigan, Ohio, Pennsylvania, Tennessee and West Virginia offer various types of prepaid tuition plans, generally for students attending state schools. Residents of these states can buy a contract or bonds at a fixed price, based on the rates of college tuition today. Payments can be made in lump sums or monthly installments. The state, in turn, invests the money to earn the difference between the amount you are paying and the projected cost of tuition at the time your child reaches college age. Those who sign up are fully protected, as the state assumes all the risk of the investments. Check with your state’s commission on higher education to see if a prepaid tuition plan is available where you live.

Prepaid tuition plans are not for everyone. They mostly attract middle-income families who tend to be more conservative in their investments. Lower-income families using this option may jeopardize their chances for state aid and forfeit money needed for immediate essentials. If you’re interested and a plan is offered in your state, you’ll want to know if it covers only the cost of tuition, or room and board, too. Also, check to see if it applies to other than state schools. Finally, confirm that your original deposit will be returned if your child attends a private or out-of-state college, is not accepted at a state school or chooses not to attend college at all.

Education Tax Credits: These two college-oriented tax credits may make paying for college just a little easier:

The HOPE Credit offers a tax credit up to $1,500 to cover expenses for tuition and fees for yourself, your spouse, or a dependent during the first two years of higher education.

The Lifetime Learning Credit is similar. It offers a credit of up to $1,000 for tuition or fees. This credit may also be used for courses to acquire or improve job skills.

There is an important restriction that goes along with these credits: you may choose only one of these credits; and if you take tax-free withdrawals from an Education IRA, you may use the credit in that year as long as it’s for different educational expenses.

CDs and Bank Accounts: Bank Certificates of Deposit (CDs) and bank savings accounts are two other places to put college savings. Although CDs and bank savings accounts are generally FDIC insured, they generally offer a lower return potential than other investment vehicles and are most appropriate for those with short-term goals.

Which Option Is Best for You? That depends on your own financial situation and financial goals. We suggest you meet with a financial professional at Risk Management Planning & Insurance Services, Inc., who can go over your personal situation and goals carefully, then recommend an appropriate plan.  Also, the above information is not intended as tax advice.  Before implementing any plan please consult a CPA to discuss the tax ramifications of the strategy.