As a new year dawns, Americans face a host of new economic challenges. Here are nine great moves you can make during a difficult time to save for a college education in 2009.
With the market at depressed levels, now could be a great time to cash out from a taxable investment account and move the money into a 529 plan or Coverdell education savings account. In these accounts, future earnings and growth are tax-deferred and distributions are tax-free when used for qualifying college expenses.
If the sale of your existing investments results in a net capital loss, you may be able to offset as much as $3,000 of ordinary income on your tax return. If you’ve already established a 529 account or ESA and determine that it is worth less than your contributions, talk to your tax professional about the possibility of liquidating the account and claiming the loss as a miscellaneous itemized deduction on your Form 1040.
If your child has a Uniform Gift to Minors Act account or Uniform Transfer to Minors Act account that has appreciated in value and you’re thinking about selling the investments in that account during 2009 — perhaps to pay college bills — be mindful of the tax and financial-aid consequences.
Under the “Kiddie Tax,” a child’s 2009 unearned income in excess of $1,900 is taxed at the parents’ marginal tax rate. The age requirements have changed so that college students as old as 23 are now at risk.
One strategy for avoiding the Kiddie Tax is to spread out their gains over multiple years and avoid triggering more than $1,900 in investment income in any one year. Another possible remedy: Children ages 18 to 23 escape the extra tax if their wage income exceeds one-half of their total support. Calculating “support” can get tricky, so you should discuss this with a tax professional.
The recognition of gains also affects a college student’s financial aid eligibility, as income of a student above a $3,750 allowance is assessed at a 50 percent rate in the federal aid formula.
If you live in one of the 35 states that provide their residents with a state income tax deduction for contributions to a 529 plan, you have a great opportunity to reduce your taxes and save for college at the same time.
Even with a child in college or close to college age, it can make sense to open a 529 account now and use it to pay a tuition bill due next month.
Be sure you understand the deduction rules in your state, including limits on the amount you can deduct, contribution deadlines and any restrictions relating to the account setup. Most states require you to invest in your state’s own 529 plan to qualify for a deduction, but residents in five states — Arizona, Kansas, Maine, Missouri and Pennsylvania — can deduct contributions they make to any state’s 529 plan.
A great way to boost your child’s college savings account is to invite your family and friends to direct their holiday and birthday gift money into your 529 plan. A number of 529 plans and online registries are not only promoting the idea, they also are making the process easy with gift coupons.
For example, Upromise Investments has launched a feature called “Ugift” in nine of the 529 plans it manages (in seven states). Anyone with an account in a participating Upromise-managed 529 plan can invite donors to contribute directly to the 529 account by returning a coupon along with a check.
Another alternative is a free online registry called Freshman Fund that accepts third-party contributions by check or credit card and transmits the money to any 529 plan the parent decides to use. Or simply visit your 529 plan’s Web site and look for its special friends and family gifting promotions.
According to the College Board, the average private-college undergraduate received more than $7,400 in institutional grants for the 2006-07 school year, while the average full-time undergraduate at public colleges and universities received more than $1,000. A significant portion of this money went to students without regard to their financial need.
When it comes time to choose a college, find out which schools will pay for your child’s stellar high school grades, challenging course selections, unique backgrounds or interests, or musical or sports prowess.
Also, remember that private organizations dole out more than $3 billion in scholarships each year. Begin your scholarship search by checking with the guidance department at your child’s school. Free online scholarship search engines also will turn up some opportunities — just be sure you are comfortable with how your personal information is used.
Demonstrating financial “need” through the FAFSA application process becomes more important as interest rates continue to drop on subsidized Stafford Loans. Steps you take now can enhance your child’s financial aid prospects in the future.
For example, avoid placing investments in UGMA or UTMA custodial accounts because those assets will be counted heavily against aid eligibility. But don’t spend too much time planning for financial aid before your child reaches high school. Chances are the eligibility formulas, as well as your personal financial situation, will change significantly by the time your child gets to college.
With college costs increasing at an average annual rate of close to 6 percent, it’s best to start your college savings fund early in your child’s life.
If you begin when your child is born and set aside $200 each month in an account earning 6 percent annually, you’ll have enough to cover approximately 22 percent of the cost of attending four years at a private college (current average “sticker” price of $34,200), or about 52 percent of the cost of attending four years at your public university (current average “sticker” price of $14,400).
If you wait until your child is 6, you’ll have to invest $250 per month for the same coverage. And if you start at age 12, you are looking at $350 per month. If these savings targets seem out of reach for you, don’t despair. Any amount you can set aside for college now will help to reduce the amount of debt you or your child take on in the future.
When it comes time to pay for college, you may be tempted to tap your retirement accounts to pay college bills. But in most situations you will be better off keeping your retirement accounts intact and taking out loans for your child’s college expenses.
Distributions from 401(k)s and IRAs will not only hurt your child’s eligibility for financial aid in the following year, but they may increase the chances that you become financially dependent on your children later in your life.
Everyone likes “free money.” Several companies offer rewards programs that link directly to one or more 529 college savings plans. Over time, your purchases can generate rebates that add up to hundreds, and potentially thousands, of extra dollars for your child’s college education.
Upromise offers the largest such rewards program. Others include Futuretrust, Little Grad and BabyMint. The Fidelity 529 Rewards American Express Card offers a 1.5 percent rebate on your card purchases for direct deposit to any one of the five Fidelity-managed 529 plans.
Just remember, the programs are “free” only to the extent you don’t end up spending more than you normally would for goods and services.