Working (and solving) the Educational Savings Puzzle
September 13th, 2007 | by rachel |
“The main difference between real-life puzzles and artificially constructed ones is that the former have no identifiably correct solutions, while the latter always do.” - Will Shortz
Many parents would argue that the puzzle of saving for education is the most challenging one they face. As with any puzzle, it can be worked in more than one way. Treating this issue like a jigsaw puzzle may help. It can be addressed systematically and, no matter the order in which they are assembled, there will be a clear picture when all the pieces are connected.
THE CORNERS: These pieces are the anchors and the boundaries of the issue for your family. Once they are set, every other piece of the puzzle is relative to these.
- Time Frame - How many months and/or years do you have before you will have to pay educational expenses?
- Education Type - Will you need money for elementary and secondary education or just college? Is there a chance that someone will skip college or choose an alternative type of education?
- Budget - Is your monthly budget stretched to the limit now? If so, when and how will that budget pressure be relieved?
- Student Ability - Do your children have the ability and the motivation to go to college?
Once the corner pieces are in place and connected, the puzzle framework is set. Now, it’s time to move to the middle pieces and this is definitely the messy part! In order for the puzzle to be complete (and clear), lots of small pieces have to fit together in just the right way. Here are some of the pieces you will need:
529 PLANS - There are 2 types of 529 plans, the savings plan and the prepaid tuition plan. Both types are state sponsored although there are only 18 states that sponsor a prepaid tuition plan. The 529 savings plan allows contributions to be made to a 529 account. Those contributions grow tax free and remain tax free as long as the money is used for qualified educational expenses. The prepaid tuition plans allow purchasers to lock in a current tuition rate for particular schools. Most 529 plans have set-up and maintenance fees associated with them and they are treated as parental assets for purposes of financial aid calculations.
COVERDELL EDUCATIONAL SAVINGS ACCOUNT (ESA) - These accounts were originally known as “Education IRAs”. They are accounts that are set up to provide for educational expenses in the future. Money from Coverdell accounts can be used for elementary and secondary expenses. Money in these accounts grows tax deferred and all education withdrawals must be made before the child is 30 years old. There are income and contribution limits associated with these accounts! Unused money can be transferred to another beneficiary in the family and it is possible to contribute to a Coverdell account AND a 529 account in the same year.
CUSTODIAL ACCOUNTS (UGMA and/or UTMA): There are 2 types of custodial accounts. A UGMA is a “Uniform Gift to Minors Account” and a UTMA is a “Uniform Transfer to Minors Account”. These accounts were not created to fund education, necessarily so they allow the beneficiary of the account to have greater control over the money that is held in them. These accounts provide a way for minors to own securities and additional types of property without having formal trust agreements. All gifts to these accounts are irrevocable and these accounts cannot be transferred to other beneficiaries. Money from these accounts can be rolled into 529 Plans and there is no maximum contribution limit. The biggest problem with these accounts is that there is no guarantee that the assets will be used for educational funding.
U.S. SAVINGS BONDS - Series EE and Series I Bonds grow tax deferred and they have some exclusion from federal income tax when proceeds from the bonds are used for tuition expenses at eligible institutions. There are limits on the amount that can be invested in bonds as well as income limitations when the bonds are cashed. Depending on when the bonds are purchased and who is using them, they can be calculated as either a parental asset or a student asset for financial aid purposes.
Each of these puzzle pieces have tax implications while also playing a role in the awarding of financial aid for your college student. Before you make a commitment to ANY of these plans, you need to be sure to investigate and understand the tax and financial aid implications of all of them.
There is lots of information about planning for educational expenses. Look for more details here…
www.ed.gov, www.collegeanswer.com, www.529solutions.com, www.529s.com, www.bankrate.com, www.sec.gov/investor/pubs/intro529.htm, www.collegesavings.org, http://apps.finra.org/Investor_Information/Smart/529/000100.asp, www.futuretrust.com, www.upromise.com, www.savingforcollege.com, www.finaid.org, www.401kid.com
With a little luck and the right timing, your educational savings puzzle will come together completely and look just like the picture on the puzzle box!