College costs continue to rise, and most parents want to begin saving for
their child’s education earlier and earlier. Some even start before the
child is born. So how do you make sure you have enough when your child
is ready to leave for school?
Make sure you understand what your choices
are among the different ways to save and different programs available.
1. Education IRAs.
Total contributions made for the child cannot top $500 a year. Although
Education IRA contributions are non-deductible, earnings on account
investments are not taxed and may be withdrawn tax free to pay the child's
qualified higher education expenses.
Although these are small annual savings,
they could add up over an 18 year period if invested aggressively.
2. Uniform Gifts to Minors Act.
You can set up a trust in your child's name and put money aside for
his or her education. The taxes are then paid at the child's rate once he
or she turns 14 years old.
When contributing to a custodial account under the Uniform Gifts to Minors
Act (UGMA) or Uniform Transfers to Minors Act (UTMA) with either a mutual
fund or a brokerage account -- you must make an irreversible gift.
The custodian is required to manage the
account in a prudent manner for the benefit of the minor and is required
to release control of the funds when the minor reaches the age of
majority.
The custodian should not be the donor of the contributions. If a custodian
who is also the donor dies, the funds in the account are included in the
deceased's estate and might be taxed.
All income or capital gains in the
custodial account are taxable to the child, but the rate will vary,
depending on how much is distributed and at what age. The "kiddie
tax" rules are as follows:
- For the year 2000, for a child under age
14.
- Up to $750 of income is not taxed.
- The next $750 of income is taxed at the
child's tax rate, starting at 15 percent.
- Any amount over $1,500 is taxed at the
parent's marginal tax rate. The brackets may be adjusted from time to
time. Once the child reaches age 14, all distributions are taxed at
the child's tax rate.
- The investment may be used for the
child's support, maintenance, and education and becomes the child's
assets at the age of the majority. Custodial accounts are relatively
easy to set up.
3. Section 529 Plans.
This is a plan for college savings that's sponsored by several states
with varying benefits. You do not have to be a resident of a given state
to participate in its plan, but you should consider your home state's
plan, if available, to optimize tax deferral.
Some plans allow parents and grandparents to contribute up to $100,000
(married) or $50,000 (single) at one time without any gift tax
implications.
These plans allow you to make five years
worth of $10,000 a year gifts all at one time. This is one of the few
plans where there are no income level restrictions.
"Education expenses" under Section 529 are not limited to
tuition payments alone. Room, board, books, required supplies and other
qualified expenses at any post-secondary institution in the U.S. may be
paid from plan earnings.
If the child does not attend college, the investments can be used for
another family member of the same generation as the beneficiary. When
distributions are made, the earnings are taxed at the child's income tax
rate, hopefully 15 percent.
The investments in the various state
programs are managed by large financial institutions, such as Fidelity,
TIAA-CREF, and others.
The investment company invests the funds in
asset pools according to the age of the child. The younger the child, the
more aggressively the funds are invested. As the child approaches college
age, the funds are almost entirely invested in bonds and money market
funds. The downside of this type of plan is that you have no control over
the investments and many of the plans are invested very conservatively.
One of the hidden benefits of these plans is the estate planning aspect. A
gift of up to $50,000 per donor in one year to each beneficiary is a great
estate tax reduction technique. One thing to remember is that if the
distributions are not used for higher education, there is a penalty of
typically 10 percent on the earnings, and the earnings are taxed to the
person who funded the account.
4. Set up an account in your own name.
If you do this, just remember to keep that account separate. Start a
regular investment program and be aggressive when the child is young. As
the dollars grow in the account, add more funds to your portfolio. The
advantage of this type of savings plan is that you maintain control of the
investments and do not have to turn the funds over to your child when they
come of age.
Here are some funds to consider for an aggressive education investment
program:
- Artisan International {ARTIX}
- Harbor Capital Appreciation {HACAX}
- Turner Small Cap Growth (TSCEX)
- Managers Special Equity {MGSEX}
- Northern Technology {NTCHX}
|