Coping With College Loans

Paying them down, managing their financial impact.  

Are student loans holding our economy back? Certainly America has recovered from the last recession, but this is an interesting question nonetheless.

In a November 2013 address before the Federal Reserve Bank of St. Louis, Consumer Financial Protection Bureau Assistant Director Rohit Chopra expressed that college loan debt “may prove to be one of the more painful aftershocks of the Great Recession.” In fact, outstanding education debt in America doubled from 2007 to 2013, topping $1 trillion.¹ 

More than 60% of this debt is held by people over the age of 30 and about 15% is carried by people older than 50. The housing sector feels the strain: in a November National Association of Realtors survey, 54% of the first-time homebuyers who had difficulty saving up a down payment cited their college loan expenses as the main obstacle. The ProgressNow think tank believes that education debt siphons $6 billion of new car purchasing power out of the economy per year.^2,3

As the Detroit Free Press notes, the average 2012 college graduate is burdened with $29,400 in education loans. If you carry five-figure (or greater) education debt, what do you do to pay it down faster?⁴

How can you overcome student loans to move forward financially? If you are young (or not so young), budgeting is key. Even if you get a second job, a promotion, or an inheritance, you won’t be able to erase any debt if your expenses consistently exceed your income. Smartphone apps and other online budget tools can help you live within your budget day to day, or even at the point of purchase for goods and services.

After that first step, you can use a few different strategies to whittle away at college loans.

*The local economy permitting, a couple can live on one salary and use the wages of the other earner to pay off the loan balance(s).

*You could use your tax refund to attack the debt.

*You can hold off on a major purchase or two. (Yes, this is a sad effect of college debt, but backhandedly it could also help you reduce it by freeing up more cash to apply to the loan.)

*You can sell something of significant value – a car or truck, a motorbike, jewelry, collectibles – and turn the cash on the debt.

Now in the big picture of your budget, you could try the “snowball method” where you focus on paying off your smallest debt first, then the next smallest, etc. on to the largest. Or, you could try the “debt ladder” tactic, where you attack the debt(s) with the highest interest rate(s) to start. That will permit you to gradually devote more and more money toward the goal of wiping out that existing student loan balance.

Even just paying more than the minimum each month on your loan will help. Making payments every two weeks rather than every month can also have a big impact.

If the lender presents you with a choice of repayment plans, weigh the one you currently use against the others; the others might be better. Signing up for automatic payments can help, too. You avoid the risk of penalty for late payment, and student loan issuers commonly reward the move: many will lower the interest rate on a loan by a quarter-point or so in thanks.⁵

What if you have multiple outstanding college loans? Should one of those loans have a variable interest rate (about 15% of education loans do), try addressing that debt first. Why? Think about what could happen with interest rates as this decade progresses. They are already rising.⁵

Also, how about combining multiple federal student loan balances into one? If you graduated college before July 1, 2006, the interest rate you’ll lock in on the single balance will be lower than that paid on each separate federal education loan.⁵

Maybe your boss could pay down the loan. Don’t laugh: there are college grads who manage to negotiate just such agreements. In fact, there are small and mid-sized businesses that offer them simply to be competitive today. They can’t offer a young hire what the Fortune 500 can when it comes to salary, so they pitch another perk: a lump sum that the new employee can use to reduce a college loan.⁵

To reduce your student debt, live within your means and use your financial creativity. It may disappear faster than you think.

Kim Bolker may be reached at 616-942-8600 or kbolker@sigmarep.com

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

1 - consumerfinance.gov/newsroom/student-loan-ombudsman-rohit-chopra-before-the-federal-reserve-bank-of-st-louis/ [11/18/13]

2 - forbes.com/sites/halahtouryalai/2013/06/26/backlash-student-loans-keep-borrowers-from-buying-homes-cars/ [6/26/13]

3 - realtor.org/news-releases/2013/11/home-buyers-and-sellers-survey-shows-lingering-impact-of-tight-credit [11/13]

4 - tinyurl.com/nouty3k [4/19/14]

5 - tinyurl.com/k29m48y [5/1/14]

Ways to Save for College

Comparing & contrasting the potential of some popular vehicles. 

How expensive will college be tomorrow? The Department of Education projects that by 2030, the tuition cost of obtaining a four-year degree at a public university will surpass $200,000. Staggering? Indeed, but college is plenty expensive already. In 2012, tuition averaged $15,100 a year at public colleges and $32,900 a year at private colleges.¹

A Sallie Mae study finds that today’s students, on average, can only pay for 24% of their college expenses. It is little wonder that student loan debt exceeds credit card debt today.¹

How can you start saving to meet those costs today? With interest rates being what they are, don’t look to a garden-variety savings account. Even if current interest rates soon ascend to 2% or 3%, you would be at a disadvantage even if the bank account was large as tuition costs are climbing more significantly than inflation.

The message is pretty clear: to meet college costs, you need either a prepaid tuition plan or a savings vehicle that taps into the power of equity investing. Let’s look at some options.

Prepaid 529 plans. Offered by states and public colleges, these plans let you buy tomorrow’s tuition with today's dollars. You purchase X dollars of tuition today, and that is guaranteed to pay for an equivalent amount of tuition in the future.

You can do this in two different ways. Some of these prepaid plans are unit plans, in which you pay for X number of college credits or units now with a promise that the same amount of credits will be covered in the future. In other words, you’re locking in tuition at current rates.

As an example, let’s say a year of college at Hypothetical State University requires 36 units. Mom and Dad use a unit plan to pay $7,500 for those 36 units now for their 6-year-old daughter. In turn, the plan promises to pay whatever those 36 units cost when she starts her first semester at Hypothetical State 12 years from now, even though it might be much more.²

The other prepaid 529 plan variant is the contract plan, or guaranteed interest plan. In these prepaid plans, you make a lump sum contribution (or arrange recurring contributions), essentially buying X number of years of tuition. In turn, the plan guarantees to cover this predetermined amount of tuition expenses in the future.²

Usually, beneficiaries of prepaid tuition plans must be residents of the state offering the plan, or prospective students of the college offering the plan. In the wake of the recession, some of these plans are not accepting new investors as some states are worried about underfunding.^2,3

529 college savings plans. These state savings plans allow you to invest to build college savings rather than simply prepay them. Plan contributions are typically allocated among funds, and possibly other investment classes; the plan’s earnings grow without being taxed. The withdrawals aren’t taxed by the IRS either, as long they pay for qualified education expenses.²

You can contribute up to six-figure sums to these 529 plans – there’s a lifetime contribution limit that varies per state. Most of them are open to out-of-state residents. If the market does well, you can harness the power of equity investing through these plans and potentially make a big dent in college costs.²

There are two caveats about 529 plans. Should you elect to withdraw money from a 529 plan and use it for non-approved purposes, that money will be taxed by the IRS as regular income – and you will pay a penalty equal to 10% of the withdrawal amount. 529 balances can also negatively affect a student’s chances for need-based financial aid. In a given school year, that eligibility can be reduced by up 5.64% of your college savings.³ 

Coverdell ESAs. Originally called Education IRAs, Coverdell Education Savings Accounts offer families some added flexibility: the withdrawals may be used to pay for elementary and secondary school expenses, not just college costs. These are tax-deferred investment accounts, like 529 savings plans. Unfortunately, the current annual contribution limit for a Coverdell is $2,000. Any remaining account balance must generally be withdrawn within 30 days after the beneficiary’s 30th birthday, with the earnings portion of the balance being taxable.^3,4,5

Roth IRAs. Yes, it is possible to use a Roth IRA as a college savings vehicle. While the IRA’s earnings will be taxed, withdrawals used to pay for qualified college expenses will not be taxed and will face no IRS penalty. Additionally, if your son or daughter doesn’t go to college or comes into some kind of windfall that pays for everything, you end up with a retirement account. While Roth IRA balances don’t whittle away at a student’s chances to get need-based financial aid, the withdrawal amounts do come under the category of untaxed income on the FAFSA.³

Would a trust be worth the expense? Rarely, families set up tax-advantaged trusts for the purpose of college savings. In the classic model, the family is incredibly wealthy and the kids are “trust-fund babies” bound for elite and very expensive schools. Unless you have many children or your family is looking at potentially exorbitant college costs, a trust is probably overdoing it. The college savings vehicles mentioned above may help you save for education expenses just as effectively, all without the administrative bother associated with trusts and the costs of trust creation.

Kim Bolker may be reached at 616-942-8600 or kbolker@sigmarep.com

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

Mistakes Families Make with 529 Plans

5 common errors to avoid + 2 big factors to consider.

Most families that start 529 college savings plans have done their “homework” about these programs. Missteps are made, though, often with the distribution of 529 plan assets. Here are some of the major gaffes, and the major factors anyone should think about before enrolling.

Assuming a university will withdraw 529 plan assets for you. When the time comes, you have to tell the 529 plan that you need the money and specify the payee. Typically, a 529 program offers you either a check written out to you, to your student, or a payment made directly from the 529 plan to the university. There are two big reasons why a check made payable to the student may be the best option.

*A  529 plan distribution triggers a Form 1099-Q. You most likely want your student’s name and Social Security number on that form, not yours. If your student’s name is on the 1099-Q and your student has qualifying higher education expenses (QHEE) equaling or exceeding the gross distribution figure for that tax year listed on the form, that whole 529 plan withdrawal becomes tax-free and the distribution from the 529 doesn’t show up on the student's Form 1040. If your name is on the 1099-Q,  the distribution doesn’t show up on your 1040. Even if your student’s QHEE equals or exceeds the magic number on the 1099-Q for the tax year, an omission may trigger an IRS notice to you, and you will have to defend the exclusion.¹

*Let’s say you accidentally overestimate your student’s qualified education expenses, or maybe parents and grandparents make withdrawals without each other’s knowledge. In this event, the earnings portion of the distribution is partly or fully taxable. If the distribution is paid out to you, then the earnings are taxed at your federal tax rate. If it is made payable to your student, then the earnings are taxed at his or her federal tax rate, which barring the “kiddie tax” is presumably just 10-15%.¹

Having a payment made directly the school can lead to a second common mistake.

Inadvertently reducing a student’s financial aid potential. When a university takes a direct payment from a 529 plan, its financial aid office may make a dollar-for-dollar adjustment to the need-based aid a student receives. Often, it is viewed the same as scholarship money.¹

Since the IRS bars you from using multiple education tax benefits to pay for the same education expenses, using tax-deferred 529 plan earnings to pay for the first semester of college may disqualify your student for an American Opportunity Credit. You should read up on the IRS income restrictions on education credits or consult a tax professional. Paying the first few thousand dollars in freshman year expenses with funds outside the plan may allow your student to retain eligibility.²

Mistiming the distributions. It can take up to two weeks to arrange and carry out a 529 plan distribution; telling a financial aid office that you are using 529 funds to pay tuition just a few days before a tuition deadline is cutting it close.³ 

Some families withdraw 529 monies during freshman year, which can conflict with federal tax returns. If a tuition payment is due in January, withdrawing it in December will create an incongruity between total withdrawals and expenses. The same will apply if a withdrawal is made in January, but tuition was due in December.³ 

Botching the tax break offered to you on the distribution. To get a tax-free qualified withdrawal from a 529 plan, the withdrawn funds have to be used for qualified, college-related expenses. If the distribution isn’t qualified, it will be considered fully taxable, and you may be hit with a 10% federal penalty plus state and local income taxes. If you withdraw more plan assets than necessary, any excess distribution is also nonqualified. Calculating and withdrawing the "net" qualifying expenses of your student’s college education could help you avoid this last problem, or alternately, you could report the excess 529 funds on the student's 1040.^3,4,5

Ceasing 529 contributions once a student enters college. You can keep putting money into a 529 plan throughout your student’s college years, with the opportunity for additional tax-deferred growth of those savings.²

Finally, two other factors are worth noting. These would be a 529 plan’s expenses and deductions.

Tax deductions represent a key reason why families choose in-state 529 plans. Most states that levy income tax offer 529 programs with deductions or credits for taxpayers. It varies per state. In Michigan, a married couple can deduct the first $10,000 of 529 contributions annually, which leads to a state tax savings of up to $425. Some other states offer no deductions.⁶  

Some 529 plans have different advantages. If your home state’s 529 plan expense ratio exceeds 1%, consider another state’s plan. (You can find objective rankings of 529 plan expenses online.)

Lastly, compare the expenses and fund choices offered by a 529 plan to those of other funds or investment vehicles found outside the 529 wrapper.

Make no mistake, 529 plans offer great potential advantages for households striving to meet future college costs. Just remember to read the fine print, especially as your student’s freshman year draws closer.

Kim Bolker may be reached at kbolker@sigmarep.com or 616-942-8600.  This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 - www.bankrate.com/finance/college-finance/3-ways-to-take-a-529-plan-distribution.aspx [10/5/09]

2 - www.usnews.com/education/best-colleges/paying-for-college/articles/2012/08/01/4-costly-mistakes-parents-make-when-saving-for-college [8/1/12]

3 - www.savingforcollege.com/articles/20101001-5-blunders-by-first-time-529-plan-spenders [10/01/10]

4 - www.foxbusiness.com/personal-finance/2011/11/14/dont-make-your-52-plan-distribution-taxing/ [11/14/11]

5 - www.529.com/content/benefits.html [3/28/13]

6 - www.forbes.com/sites/baldwin/2013/03/27/the-two-step-guide-to-529s/ [3/27/13]

Ways to Save for College

Comparing & contrasting the potential of some popular vehicles.

How expensive will college be tomorrow? The Department of Education projects that by 2030, the tuition cost of obtaining a four-year degree at a public university will surpass $200,000. Staggering? Indeed, but college is plenty expensive already. In 2012, tuition averaged $15,100 a year at public colleges and $32,900 a year at private colleges.¹

A Sallie Mae study finds that today’s students, on average, can only pay for 24% of their college expenses. It is little wonder that student loan debt exceeds credit card debt today.¹

How can you start saving to meet those costs today? With interest rates being what they are, don’t look to a garden-variety savings account. Even if current interest rates soon ascend to 2% or 3%, you would be at a disadvantage even if the bank account was large as tuition costs are climbing more significantly than inflation.

The message is pretty clear: to meet college costs, you need either a prepaid tuition plan or a savings vehicle that taps into the power of equity investing. Let’s look at some options.

Prepaid 529 plans. Offered by states and public colleges, these plans let you buy tomorrow’s tuition with today's dollars. You purchase X dollars of tuition today, and that is guaranteed to pay for an equivalent amount of tuition in the future.

You can do this in two different ways. Some of these prepaid plans are unit plans, in which you pay for X number of college credits or units now with a promise that the same amount of credits will be covered in the future. In other words, you’re locking in tuition at current rates.

As an example, let’s say a year of college at Hypothetical State University requires 36 units. Mom and Dad use a unit plan to pay $7,500 for those 36 units now for their 6-year-old daughter. In turn, the plan promises to pay whatever those 36 units cost when she starts her first semester at Hypothetical State 12 years from now, even though it might be much more.²

The other prepaid 529 plan variant is the contract plan, or guaranteed interest plan. In these prepaid plans, you make a lump sum contribution (or arrange recurring contributions), essentially buying X number of years of tuition. In turn, the plan guarantees to cover this predetermined amount of tuition expenses in the future.²

Usually, beneficiaries of prepaid tuition plans must be residents of the state offering the plan, or prospective students of the college offering the plan. In the wake of the recession, some of these plans are not accepting new investors as some states are worried about underfunding.^2,3

529 college savings plans. These state savings plans allow you to invest to build college savings rather than simply prepay them. Plan contributions are typically allocated among funds, and possibly other investment classes; the plan’s earnings grow without being taxed. The withdrawals aren’t taxed by the IRS either, as long they pay for qualified education expenses.²

You can contribute up to six-figure sums to these 529 plans – there’s a lifetime contribution limit that varies per state. Most of them are open to out-of-state residents. If the market does well, you can harness the power of equity investing through these plans and potentially make a big dent in college costs.²

There are two caveats about 529 plans. Should you elect to withdraw money from a 529 plan and use it for non-approved purposes, that money will be taxed by the IRS as regular income – and you will pay a penalty equal to 10% of the withdrawal amount. 529 balances can also negatively affect a student’s chances for need-based financial aid. In a given school year, that eligibility can be reduced by up 5.64% of your college savings.³ 

Coverdell ESAs. Originally called Education IRAs, Coverdell Education Savings Accounts offer families some added flexibility: the withdrawals may be used to pay for elementary and secondary school expenses, not just college costs. These are tax-deferred investment accounts, like 529 savings plans. Unfortunately, the current annual contribution limit for a Coverdell is $2,000. Any remaining account balance must generally be withdrawn within 30 days after the beneficiary’s 30th birthday, with the earnings portion of the balance being taxable.^3,4,5

Roth IRAs. Yes, it is possible to use a Roth IRA as a college savings vehicle. While the IRA’s earnings will be taxed, withdrawals used to pay for qualified college expenses will not be taxed and will face no IRS penalty. Additionally, if your son or daughter doesn’t go to college or comes into some kind of windfall that pays for everything, you end up with a retirement account. While Roth IRA balances don’t whittle away at a student’s chances to get need-based financial aid, the withdrawal amounts do come under the category of untaxed income on the FAFSA.³

Would a trust be worth the expense? Rarely, families set up tax-advantaged trusts for the purpose of college savings. In the classic model, the family is incredibly wealthy and the kids are “trust-fund babies” bound for elite and very expensive schools. Unless you have many children or your family is looking at potentially exorbitant college costs, a trust is probably overdoing it. The college savings vehicles mentioned above may help you save for education expenses just as effectively, all without the administrative bother associated with trusts and the costs of trust creation.

Kim Bolker may be reached at kbolker@sigmarep.com or 616-942-8600.  This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – money.usnews.com/money/blogs/my-money/2012/07/25/how-much-will-you-need-to-send-your-child-to-college-in-2030 [7/25/12]

2 – www.axa-equitable.com/plan/education/529-plans/529-vs-prepaid-tuition.html [2011]

3 – money.cnn.com/101/college-101/savings-plan.moneymag/index.html [1/10/13]

4 – money.msn.com/tax-tips/post.aspx?post=9dba01a0-b233-4e6e-97ef-aecbc62188e3 [1/9/13]

5 – www.irs.gov/uac/Coverdell-Education-Savings-Accounts [9/11/12]

OUT-OF-THE-BOX WAYS TO PAY FOR COLLEGE

Today’s average student borrower takes out more than $25K in loans. Education debt has reached record levels in America – more than $1 trillion. In the face of those numbers, parents and students are looking for assorted ways to pay for college without incurring big liabilities.¹  In addition to grants, loans, merit-based aid and your student holding down a job, there are other ways to reduce college cost – some little recognized.

First, how expensive will college be? Can you project the total cost of your student’s college education? Assuming five years in school (which is the average for today’s undergrads) and no change in majors along the way, can a financial aid officer give you a ballpark figure? If not, an online resource such as Alltuition.com may be able to estimate it for you.^1,2 

Presumably, you opened a 529 plan or some other form of college savings fund for your student years ago. If those funds aren’t enough, where can you find other resources to meet a projected shortfall?        

What about outright gifts of cash? If you or relatives or friends have the money, that is an option. Will you suffer gift tax consequences as a result? No. If the money constituting that completed gift is used directly to pay tuition expenses at an educational institution, that gift is not taxable. It will not cut into your annual gift exclusion amount ($13,000 for 2012) or your lifetime unified credit (currently set at $5.12 million).^3,4      

One caveat, however: if you make any kind of tuition payment on behalf of your student, that will be characterized as untaxed income on the FAFSA (Free Application for Federal Student Aid). That could wipe out your student’s chances of getting any need-based financial aid. This is why some families elect to put off tuition gifts until a student’s senior year.⁴       

Can you reduce your taxable income to get your student more financial aid? You may be able to do so. If getting federal student aid is your objective, knocking down your taxable income (through moves big and little) might make a big difference.

On the FAFSA, family income matters more than family assets. Retirement account balances, net worth attributable to home values and small businesses – none of this matters, it doesn’t factor into the needs analysis. The FAFSA is used to determine the expected family contribution (EFC), which is the combination of funds that the parent(s) and student can make available for a school year. The gap between the EFC and the expected total education costs of the school year represents the level of financial need weighed in determining federal student aid.⁵ 

So the lower your EFC is, the greater your level of financial need will be – and the greater amount of federal student aid that may be available. This is why many parents and students elect to spend down their combined savings and assets set aside for college during the freshman year. With no assets left for the sophomore year (and by this same logic, subsequent academic years), eligibility for federal student aid is wide open. Of course, you may be also opening a door to potential long-term debt. 

There are other ways to alter your tax picture to get your student some financial aid –aid not linked to lingering debt.

Have you heard of “tax scholarships”? No, not scholarships linked to a state tax credit (though those may be worth a look). These are de facto scholarships that you may be able to create for your student with the help of a CPA or financial advisor (and the IRS). If you can find or arrange new tax deductions this year, you can redirect that money toward your student’s college expenses. Savvy business owners and professionals often make this move. 

What about untraditional scholarships? For example, CollegeNet.com currently offers a “weekly scholarship” running between $3,000-10,000. Collegians themselves decide which applicant deserves the funds. There are other such examples.¹   

Can you negotiate tuition? At first instinct, does that seem rude, uncouth? It may prove smart – and it is done. There are such things as tuition discounts (and grant programs) offered to those who negotiate, even those not eligible for need-based aid. If a university really wants your student, you may have some leverage. 

Are you willing to go the JC route, or the online route? Going to a local junior college for the first two years of study toward a bachelor’s degree can save a student and family tuition, housing and travel and auto expenses, and maybe a little anxiety – if your student decides he or she wants to major in oceanography instead of marketing, you haven’t paid $10,000 or $20,000 a year to arrive at that conclusion. 

Recognizing the costs of housing, commuting and parking permits, some colleges are offering parts of their curriculum online or in more accessible settings – for example, Virginia Tech offers introductory math courses through computer labs and the University of Minnesota’s new Rochester campus uses part of a local shopping mall to hold classes. While taking classes on a computer or at some obscure satellite campus may not give you the full university experience, it may help to reduce expenses.² 

Need help with college planning?  Talk with a financial professional well versed in the matter – sooner rather than later.

Kim Bolker may be reached at kbolker@sigmarep.com or 616-942-8600.  This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – www.dailyfinance.com/2012/04/19/paying-for-college-two-websites-offer-outside-of-the-box-ideas/ [4/19/12]          

2 – www.businessweek.com/printer/articles/70120-student-loans-debt-for-life [9/6/12]        

3 – www.irs.gov/uac/In-2012,-Many-Tax-Benefits-Increase-Due-to-Inflation-Adjustments [10/20/11]    

4 - www.education.com/reference/article/pay-college-saving-understand-gift-tax/ [9/6/12]

5 – thechoice.blogs.nytimes.com/2011/01/11/fafsaq-and-a/ [1/11/11]

Back to School

It's hard to believe August is here already, and that puts many families in back to school mode.  So I thought I'd review college saving plans - the Coverdell vs the 529 plan. Today, some parents are wondering if they should convert Coverdell Education Savings Accounts to 529 college savings plans. With that mind, here is a brief look at how both of these accounts work.

Why have Coverdell ESAs been so popular? Imagine a Roth IRA used only for college savings. That's basically the concept behind a Coverdell. In fact, the Coverdell ESA evolved from the Education IRA.¹¹  

Contributions to a Coverdell ESA aren’t deductible, but you get tax-deferred growth. Contributions must be made in cash. Withdrawals from Coverdells are (currently) tax-free if used for qualified educational expenses such as tuition, fees and books. The funds can also pay for certain K-12 education costs.^1,2

You can allocate Coverdell account assets among many different kinds of investment vehicles, and many banks, credit unions and mutual fund providers offer these accounts. However, Coverdells have some drawbacks. The annual contribution limit to a Coverdell is $2,000, and an individual taxpayer with modified adjusted gross income above $110,000 cannot contribute to a Coverdell (the MAGI limit is $220,000 for joint filers, with phase-outs kicking in at $190,000).^2,3

Aside from a limit on annual contributions, there are also some age requirements. The Coverdell ESA beneficiary must be younger than 18 when the account is set up and the money in the account must be spent or transferred before the beneficiary turns 30. At that point, the funds will have to be withdrawn and taxes and a 10% penalty may be assessed on the withdrawal. (If a beneficiary has special needs, contributions after age 18 and retention of the account assets after age 30 may be allowed; see IRS Publication 970 for details.)^1,2

Big changes are scheduled for Coverdells in 2013. Unless Congress intervenes, these accounts will be a lot less attractive next year. Beginning in 2013:

• The annual contribution limit will drop from $2,000 down to $500.
• Distributions will be tax-free only if you don’t claim a Hope or Lifetime Learning Credit in the same tax year.
• No withdrawals may be used to pay for K-12 education expenses.⁴

All this has many parents thinking about shifting their Coverdell funds to a 529 plan.

Thinking of moving Coverdell assets into a 529? You can do a rollover from a Coverdell ESA to a 529 plan without incurring any tax penalties as long as the 529 plan will have the same beneficiary as the present Coverdell account.⁵

Earnings from a 529 plan can be distributed tax-free (assuming they are used for qualified education expenses). Contributions are taxed.⁶

You can go one of two ways with a 529:

• You can prepay tuition at today’s rates (at a qualifying college or university) through a 529 prepaid tuition program.
• You can save to pay tomorrow’s college tuition through a 529 savings plan which gives you tax-deferred growth. Most people prefer this option for its flexibility and asset accumulation potential.⁷

You can put much more money into a 529 annually than a Coverdell. Many 529 plans allow annual contributions of more than $200,000. Some do have “lifetime” limits on total contributions. Regular contributions must be in cash.^8,9

A 529 plan has no phase-outs. You will never be too rich to put money into a 529 plan. There are no income restrictions affecting plan contributions.⁶

Need to remove some money from your taxable estate? A 529 plan gives you an option to do just that. In 2012, a contribution of $13,000 a year or less to a 529 plan qualifies for the annual federal gift tax exclusion. So you and your spouse can take advantage of this, andso can your relatives. So can anyone. In fact, any taxpayer can contribute up to five times the annual gift tax exclusion to a 529 plan (in 2012, $13,000 x 5 = $65,000) without incurring gift taxes or eating into the unified credit, as long as that taxpayer refrains from making other cash gifts to the 529 plan’s designated beneficiary for the next five years. (For married couples filing jointly, this limit is $65,000 x 2 = $130,000.) This $65,000 will only be included in the donor’s taxable estate if the donor dies within the aforementioned five-year period.^6,8

Other nice features. As the owner of a 529 plan, you retain control of the assets and have the power to change the designated beneficiary (each 529 plan may only have one). You can even start multiple 529 plans in different states.^6,8,10

You may wish to move assets from a Coverdell ESA to a 529 plan. You certainly will want to keep up with developments affecting these accounts and other education savings options. Your financial consultant can help you stay informed.

Kim Bolker may be reached at kbolker@sigmarep.com or 616-942-8600.  This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. Marketing Library.Net Inc. is not affiliated with any broker or brokerage firm that may be providing this information to you. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is not a solicitation or a recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – irs.gov/newsroom/article/0,,id=107636,00.html [10/5/11]

2 – irs.gov/pub/irs-pdf/p970.pdf [2/14/12]

3 – personal.vanguard.com/us/insights/article/coverdell-esa-extend-03012011 [3/1/11]

4 – edwardjones.com/en_US/products/education_saving/coverdell/index.html [6/28/11]

5 – law.cornell.edu/uscode/search/display.html?terms=529&url=/uscode/html/uscode26/usc_sec_26_00000530----000-.html [2/16/12]

6 – www.irs.gov/newsroom/article/0,,id=213043,00.html [6/15/11]

7 – smartmoney.com/spending/deals/the-529-basics-10676/ [2/3/10]

8 – learn.bankofamerica.com/articles/money-management/529-college-savings-plans-explained.html [6/28/11]

9 – investopedia.com/university/retirementplans/529plan/529plan1.asp [9/28/10]

10 – schwab.com/public/schwab/planning/college_planning/529_plan/faqs [9/7/10]

11 – www.fool.com/money/allaboutiras/allaboutirasglossary.htm   [2/16/12]

Education Savings Accounts

A Coverdell Education Savings Account (or ESA) is an education savings tool that works for elementary, secondary, and post-secondary education.  This would be an account you would use to begin saving for a child’s private K-12 education.  You can contribute up to $2000 per designated beneficiary (aka child) under the age of 18 per year (with special exceptions for a special needs beneficiary).   As long as the designated beneficiary uses the funds for qualified education expenses, the earnings within the account grow tax free.  Examples of qualified education expenses are books, tuition, and fees.  Talk to your accountant for a full listing of what is considered a qualified education expense.  If the beneficiary uses the funds for something other than education (like a car or home purchase), those earnings may be taxable to them.

College Planning

August for me is “Back to School” mode.  Kids from elementary school age through college begin preparations for the new school year.  When I was in school, I loved this time of year.  Education is a growing expense in this country, particularly on the collegiate level.  Knowing which types of education funding accounts are available and how they work is an important distinction.  In the next couple weeks we will explore the following different education funding tools:

• Coverdell Education Savings Accounts
• 529 plans

 While college planning is important, it should not jeopardize your own retirement planning.  Some families put a higher emphasis on saving for their children’s college and while that is a noble financial goal, it cannot come at the expense of your own retirement.  A college student can loan themselves through college – you cannot loan yourself through retirement.