How can you properly fund your children's education without draining your current cash flow? What should you do if they are a few years away from college and your education fund won't be enough? How can you increase your chances of getting financial aid? What tax benefits might be available to you? This Financial Guide answers these questions.
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With the costs of a college education rising every year, the keys to funding your child's education are to plan early and invest shrewdly. However, there are steps you can take if you get a late start. Moreover, there are a number of effective techniques for increasing financial aid opportunities and reducing taxes.
According to the College Board, over the most recent decade, the largest one-year increases in average published tuition and fees at public four-year colleges and universities were 11% beyond inflation in 2003-04, and 9.3% beyond inflation in 2009-10. The inflation-adjusted increase was under 1% in 2008-09, and is 4.5% for 2011-12. However, proper planning can lessen the financial squeeze considerably, especially if you start when your child is young. It should also be noted that in 2010-11 the average amount of aid for a full-time undergraduate student was about $12,455, including more than $6,500 in grants that don’t have to be repaid.
Here are some guidelines--geared to parents whose children are no older than elementary school age--for funding your child's education.
Start Saving Early
We cannot emphasize enough that getting an early start is basic to funding your child's education. The earlier you start, the more you'll benefit from the compounding of interest.
When should you start saving? This depends on how much you think your children's education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.
Another advantage of starting early is that you'll have more flexibility when it comes to the type of investment you'll use. You'll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments after time.
Find Out How Much You'll Need To Save
How much will your child's education cost? It depends on whether your child attends a private or state school. In the 2010-2011 school year, the total expenses--tuition, fees, board, personal expenses, and books and supplies--for the average private college are about $35,636 per year and about $15,213 per year for the average public college. However, these amounts are averages: the tuition, fees, and board for some private colleges can cost more than $55,000 per year, whereas the costs for a state school can be kept under $10,000 per year.
Don't forget to add the costs of graduate or professional school to the amount your child will need.
Choose Your Investments
As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different from those used if you start when your child is age 12.
The following are often recommended as investments suitable for education funds:
Series EE Bonds are extremely safe investments. For tax treatment of redemption proceeds used for college, please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.
U.S. Government Bonds are also safe investments that offer a relatively higher return. If you use zero-coupon bonds for your child's education, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don't receive it until maturity.
CDs are safe, but usually provide a lower return than the rate of inflation. The interest is taxable.
Municipal Bonds, if they are highly rated, can provide an acceptable return from the tax-free interest if you're in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child's life.
Stocks contained in an appropriate mutual fund or portfolio can provide you with a higher yield at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.
Deferred Annuities provide you with tax deferral, but the yield may not be acceptable because of the relatively high cost of these investments. Further, amounts withdrawn before you reach age 59-1/2 may be subject to a 10% premature withdrawal penalty.
If you have insufficient savings for your child's education when he or she is close to entering college, there are ways to generate additional funds both now and when your child is about to enter school:
Here is a summary of the possible sources of financial aid. The types of aid and tax implications change frequently, so consult your financial advisor for specifics when you're approaching the time to seek financial aid.
Grants, the best type of financial aid because they do not have to be paid back, are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.
Loans may be need-based, and others are not. Here is a summary of loans:
Work-Study Programs. This is a program that is federally funded and based on the family's financial need. The student works on-campus and receives partly subsidized pay. The receipt of work-study funds does not affect the level of "need" for purposes of need-based grants and loans.
To make a thorough investigation, you should fill out the financial aid application, which you can obtain from the school's financial aid office. You will have to provide tax returns. The amount you are determined to be eligible for depends on your income, the size of your family, the number of family members currently attending college, and your assets.
How To Increase The Amount Of Financial Aid
Here are some strategies that may increase the amount of aid for which your family is eligible:
Detail your financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are, if they are not clear on the application. The financial aid officer may be able to assist you in explaining hardships.
As noted above, education funds should generally be kept in the parents' names because of financial-aid considerations. However, in specific cases, it may be better to keep the investments in your child's name since the tax rate on the income will be less than if they are held in your name. Professional advice should be sought in making this decision.
In the past, parents would invest in the child's name in order to shift income to the lower-bracket child. However, the addition of the "kiddie tax" mostly put an end to that strategy. Now, investment income over $2,000 for 2013 (up $100 from 2012) of children under the age of 19 (or 24 if a full time student) is taxed at the parents' rate. (This threshold is indexed annually for inflation.) Once the child reaches age 19, however, all income is taxed at the child's rate. Of this $2,000, one-half probably won't be taxed due to the availability of the standard deduction while the other half would be taxed at the child's rate.
There are also a number of tax incentives that you might be able to take advantage of. Please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.
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