The cost of higher education is currently outpacing inflation. The College Board estimates college costs grew at a rate of 4.7 percent for the 1999-2000 school year. At the current rate of college inflation, parents of newborns can expect average 4-year college expenses ranging from $102,195 for (on-campus) public colleges to $221,562 for (on-campus) private colleges.
With the escalating cost of higher education, it becomes critical to plan ahead in order to send your children to the college of their choice. There are several options available to help fund your child's college expense. Three options include 529 Plans, Educational IRAs and Custodial Accounts, which can be established to help prepare families for the increasing cost of higher education.
529 Plans (technically known as qualified state tuition plans) allow parents; grandparents and anyone else interested in saving for college to contribute money into a tax-deferred account for higher education. Regardless of income levels, a donor may contribute $11,000 per year per beneficiary or $55,000 in a single five-year period ($110,000 for married couples) without triggering gift taxes. The earnings in college savings plans grow tax-deferred from Federal taxes. When funds are withdrawn they are received Federal income tax-free if used for qualified expenses (tuition, books, room and board). If a child decides not to attend college, you can defer use of the account, change beneficiaries or withdraw the assets. If the assets are withdrawn and not used for higher education, regular taxes and a 10 percent penalty may be imposed on the earnings.
Coverdell Education Savings Accounts (formally Educational IRAs) allow parents, grandparents and others to contribute cumulatively up to $2,000 a year for qualified elementary, secondary school and higher education expenses of a child. Withdrawals from a Coverdell Education Savings Accounts are Federal income tax-free if used for qualified expenses such as tuition, room and board. Beneficiaries of the Coverdell can be transferred to another family member to pay for educational expenses. If the account is not used by age 30 or the funds are not used for higher education, regular income taxes and a 10 percent penalty may be imposed on the earnings.
Custodial Accounts (UGMA/UTMA) are created for a minor usually at a mutual fund company or brokerage firm. This account provides a simple way to transfer property to a minor without the complications of a formal trust. When the child reaches age of majority (18 or 21 depending on the state), the child then has full discretion over the account. Any earnings on the account up to $750 are tax free if the child is under age 14. Earnings from $750 to $1500 will be taxed at the child's tax rate. Earnings over $1500 are taxed at the parent's highest marginal tax rate (for children under 14 years of age). For children over 14, the earnings are taxed at the child's tax rate.
Determining which approach is best can be a difficult task. A financial professional can help you develop a disciplined approach to saving for collge costs. Together, you can determine which college-funding vehicle will work best for your family.
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