Funding Your Way to a College Education*
Paying for college can be an education in itself. The good news is that there are many ways to fund a college education despite the weakened economy and skyrocketing college costs. Even employers can support the challenge by offering payroll deductions for 529 college savings plans, 401(k) loans, and U.S. Savings Bonds that can be used for educational purposes. Add these to financial aid, scholarships, and tax incentives, and you have many viable options to overcome your financial hurdle.
Start down the road to a college education by communicating with your college-bound child, setting limits on what you can afford and encouraging them to compare different schools. Comparing schools establishes a system for finding the best school at the best price. Financing a child’s education is a partnership, and family members should clarify and assume their respective financial obligations so that there are no unfilled expectations. Creativity also plays a big role when planning ahead. Bridge the gap for students who are unsure about their majors or not quite ready for college by having them commit to a two year program or a less expensive state school with an option to transfer to a private college that may offer more aid. Consider the big picture, including obligations to your other children and retirement to mold your portfolio of savings, investments, and financial aid to meet your needs.
Savings and Investments
Section 529 (Qualified Tuition Programs) are state-sponsored investment programs that allow your money to grow tax-deferred and federal tax-free when used for qualified higher education expenses. Contributions to college savings plans are not limited by income and can be as low as $25 to $50 per month and total more than $250,000 in some states. Anyone can contribute to an individual’s plan that can be used for the beneficiary or member of their family. There are also prepaid education arrangements (PEAs) that allow families to buy all or part of a public instate education at present prices. Many private institutions are also offering similar plans. These plans offer “units” of tuition or a “contract” plan to purchase contracts for one to five years of tuition. Account holders can usually contribute to either of the two plans in a lump sum or in installments. The account can cover another child or family member as long as that child is in the same family as the first beneficiary.
Coverdell Education Savings Account (ESA) allows taxpayers to save up to $2,000 per year for future students under age 18. Contributions are not tax deductible, but earnings remain tax-free if used for tuition, fees, books, and room and board. Earnings can also be used for pre-college education expenses for private secondary schools, uniforms, computer equipment, and other items before the child turns 30. The $2000 maximum contribution is allowed if MAGI (modified adjusted gross incomes) are less than $95,000 for single tax filers or less than $190, 000 if married and filing jointly.
Savings Bonds-All Series I Bonds and Series EE bonds (up to $30,000 per year for single and $60,000 per year for joint filers) purchased on or after January 1990 can be used for a child’s education as long as they are not in the child’s name. The child can be a beneficiary but not the co-owner for the education exclusion to apply. The full interest exclusion is only available to married couples filing joint returns with MAGI (modified adjusted gross incomes) less than $65,600 if tax filing status is single and less than $98,400 when filing jointly. Benefits are reduced for those earning more than these amounts up to $80,600 for single and $128,400 for joint filers. The deduction is not allowed for those earning more than $80,600 for single and $128,400 for joint filers.
Retirement Savings should be used as a last resort since the value of your retirement portfolio is not considered when applying for federal financial aid. 401(k) loans must be repaid in 5 years to avoid interest and penalties. Money can be withdrawn from a traditional individual retirement account (IRA) at any age penalty-free but not tax-free. A Roth IRA allows your original contributions to be withdrawn penalty- and tax-free for higher education. Earnings can be withdrawn penalty-and tax-free for those over age 59 1/2 when their account has been opened for at least 5 years. If not, withdrawals can be taken penalty-free but not tax-free.
Grants (Federal)
Federal Pell Grants are given to those with the greatest financial need and do not have to be repaid. The maximum award is $4731.
FSEOG (Federal Supplemental Educational Opportunity Grants) are awarded to students with the greatest need. FSEOG grants range from $100 up to $4,000 per year.
Academic Competitiveness Grants are awarded to students eligible for Pell grants and complete a rigorous high school program. The grants award up to $750 for freshmen and $1300 for sophomores.
SMART Grants (National Science and Mathematics Access to Retain Talent) are awarded to Pell eligible students for up to $4000 per year for juniors and seniors. The grants are awarded to students majoring in mathematics, technology, physical, computer or life sciences or a foreign language related to national security.
TEACH Grants provide up to $4,000 per year to students who agree to teach at a public or private elementary or secondary school with students from low income families
Filling the Unmet need Through Financial Aid- Seeking financial aid is similar to obtaining a mortgage to purchase a home. Financial aid is a resource to pay the difference between the cost of education and a family’s ability to pay. Applying for financial aid begins with a Free Application for Federal Student Aid (FAFSA)form available on line at www.fafsa.ed.gov or at some high schools, libraries, and colleges.,
Forms (The Two major Ones)
The FAFSA requires information about the student’s and their custodial parents income and assets to calculate a family’s EFC-Expected Family Contribution which is the amount they are expected (but may not be able) to pay. A family’s need (for financial aid) is the difference between the costs of attending a college less the EFC. Those with the most need are likely to receive free money such as grants, low cost loans, scholarships, and work-study. Those with higher EFCs and a smaller unmet need qualify for a combination of need and non need-based financial aid including different types of loans. In both cases students may be awarded merit based aid such as scholarships and grants based on ability, affiliations, accomplishments, and how much the college is willing to attract a particular candidate for admission.
CSS Financial Aid Profile- some private colleges use a form called the CSS Financial Aid Profile administered by the College Board. This form requires significantly more information than the FAFSA and used for awarding institutional aid that the colleges manage from gifts, endowments, etc.
Tax Breaks (Federal Income Tax)
Hope Credit (first 2 years of college) gives taxpayers a tax credit against taxes owed by up to $1,650 per student for qualified educational expenses paid on behalf of the taxpayer, the taxpayer’s spouse, or a dependent. The credit is based on up to 100% of the first $1,100 and 50% of the next $1,100 of qualified educational expenses. The amount of this credit a Hope Scholarship Tax Credit for 2007 is gradually phased out for single filers with modified adjusted gross incomes of between $47,000 and $57,000 ($94,000 and $114,000 for joint returns). The Hope credit cannot be claimed by those with a MAGI of $57,000 or more ($114,000 for joint returns).
Lifetime Learning Credit (after the first 2 years) gives taxpayers a tax credit against taxes owed by up to $2,000 (20% of up to $10,000 of qualified educational expenses per student. Part-timers are eligible, as are working adults who want to improve their job skills. The amount of this credit a Hope Scholarship Tax Credit for 2007 is gradually phased out for single filers with modified adjusted gross incomes of between $47,000 and $57,000 ($94,000 and $114,000 for joint returns). The credit cannot be claimed by those with a MAGI of $57,000 or more ($114,000 for joint returns).
Tuition and Fees Tax Deductions: A taxpayer may reduce taxable income (not taxes owed) by up to $4,000 per year for tuition and fees only at an eligible post secondary institution. Single taxpayers with an MAGI of up to $65,000 ($130,000 for married taxpayers filing jointly) can receive a maximum credit of $4,000. Single taxpayers earning between $65,000 and $80,000 (between $130,000 and $160,000 for married taxpayers filing jointly) are eligible for up to a $2,000 deduction.
Funding Options Make College Possible
The bottom line is that there are many options (at the college, state and local levels ) and tax breaks to soften the blow of paying for college. Start the adventure early by developing a strategy, and be the first in line for available funding. Professional advice is also helpful to ensure that your child gets the best education money can buy.
Originally published in the May 13, 2003 Pay Tech professional journal and further updated by Howard Freedman in 2008.
