College Savings Ideas

How can you save for the cost of higher education? Here are some ideas that can help regardless of how close you are to that first tuition payment.

Based on the mathematics of compound interest, we should start our college savings and retirement funds the day we start our first job. There are more than a few obstacles in the way; food, shelter, paying off your own college loans and raising children.

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The best approach is to start a plan as soon as possible. Part of the plan includes having a set amount deducted from your paycheck for the purpose of college funding. If you don't see it, you won't spend it and a great place for your college fund is a 529 College Savings Plan.

The 529 College Savings Plan provides key advantages in savings. First, the earnings are allowed to accumulate tax-free. Second and more important, there is a 10% tax penalty on the earnings if the funds are used for purposes other qualified expenses. I like the penalty for two reasons, it is more difficult to withdraw money when you have to pay a penalty and even harder to tell the kids your new boat was once their college fund.

The 529 Plan can be funded with up to ,000 per beneficiary per year, the beneficiary can be changed and the account is controlled by the parents. For financial aid purposes the account is considered an asset of the parents and not the child which provides a lower weighting in the financial aid process. I highly recommend that every parent and child research and understand the financial aid process.

The 529 Plan is also an excellent estate planning option for the grandparents since they can use the annual gift exclusion of ,000 (in 2007) to fund a non-taxable gift or can elect to fund up to ,000 with a special five-year election. A couple can fund twice these amounts. For most of us, an automatic deduction of a much lower amount is the most likely mode of funding.

Other savings options include the use of the Coverdell Education Savings Account (ESA). Annual contributions may not exceed ,000 per beneficiary per year, the beneficiary must be under the age of eighteen and the taxpayer's ability to fund a Coverdell ESA is phased out. Like the 529 Plan, the earnings are tax-deferred and are not taxable if they are used for qualified expenses.

U.S. savings bonds issued after December 31, 1989 may qualify for interest exclusion if they are in the name of the purchaser who is over the age of 24 and used to pay for the qualified higher educational expenses of the taxpayer, their spouse or dependents. The interest exclusion is phased out for at higher income levels.

Just to add another level of complexity, qualified expenses for all three savings options are different as are the phase limits for the Coverdell ESA and the interest exclusion on U.S. savings bonds.

My preference is the 529 Plan as it provides greater flexibility in terms of who can fund the accounts and the higher funding amount. The 529 Plans are offered by several low cost investment managers. Keep in mind that a key element in increasing your investment returns is to keep fees and expenses to a minimum.

Once the children start their higher education you may qualify for a few important tax breaks. Naturally they are limited based on income.

There is the HOPE Credit. Individual tax payers are allowed to claim a credit against their Federal income taxes up to ,650 in 2007 for the first two years of a student's post-secondary education or certificate program at an eligible institution. The student must also be enrolled on at least a half-time basis. The credit amount and income limitations are indexed for inflation.

The HOPE Credit is on a per-student basis. If you have more than one child in college even the IRS feels sorry for you; however, the HOPE Credit is phased out for taxpayers with a modified adjusted gross income between ,000 and ,000 (,000 and 0,000 for joint returns).

The Lifetime Learning Credit is available to students enrolled in an eligible education institute. Enrollment can be less than half-time as long as the student is taking undergraduate or graduate classes to acquire or improve job skills. The Lifetime Learning Credit can be used to reduce your Federal income taxes by up to ,000. The credit is based on 20% of the qualified tuition and fees paid during the year. The Lifetime Learning Credit is phased out using the same limits as the HOPE Credit.

The credits cannot be combined. You cannot use the HOPE Credit and the Lifetime Learning Credit for the same child in the same year. You can use the HOPE Credit for one child and the Lifetime Learning Credit for different children in the same year.

If you have eligible work-related educational expenses and include the expenses in your itemized deductions you cannot use the Lifetime Learning Credit for those expenses.

Student loan interest is another potential tax savings. Rather than being a tax credit, up to ,500 student loan interest is deductible from taxable income. As with other deductions, this one is also subject to phase out.

If the tax aspects seem overwhelming, your tax preparer or several of the tax software packages will determine how to get the most from the various credits and when the credits are phased out.

My final recommendation is to get a jump start on saving by understanding your options, what is available for tax benefits and to research the financial aid process. There are several excellent sources of information on the financial aid process. I particularly like the services of Octameron.Com. They have several inexpensive books that will greatly help you understand both the admissions and financial aid process.

College Savings Ideas

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