Saving for college more attractive

PHOTO/Ed Bennett/AJOC
VanNortwick.jpg Most of us have seen the statistics. The average cost of a four-year private college education, including room and board, now totals in excess of $100,000.

Projections are that by the time a child born this year begins college, this cost may reach $250,000.

Our federal government has recognized that saving amounts of this size can be a daunting task and has created several tax-advantaged programs to help.

Recently enacted tax law changes make several government approved tax advantaged education investment accounts even more attractive.

There are several improved opportunities for reducing or eliminating the income tax on investment earnings from funds set aside to pay for the college education of family members.

Coverdell accounts

For starters, beginning in 2002, education individual retirement accounts are looking a lot better than in earlier years.

Contributions to an education IRA, renamed Coverdell Education Savings accounts, are now limited to $2,000 per year per beneficiary.

Prior to 2002, the annual contribution limit was $500.

In 2002, the ability to fund such accounts does not begin to phase out until a married couple reaches $190,000, or a single person reaches $95,000 in adjusted gross income for the year.

For those who qualify and who plan on establishing an education fund when a child is very young, a Coverdell account should be considered.

Here are some basic facts about Coverdell accounts, which go into effect in 2002:

Contributions may be made only until the 18th birthday of the beneficiary; Multiple Coverdell accounts can be established for a designated child; Contributions, which must be made before April 15 of the following year, for example, by April 15, 2003 for the 2002 year, are not tax deductible; and Earnings are tax-deferred and ultimately tax-free if used to pay qualified expenses.Qualified expenses now include tuition, fees, academic tutoring, books, supplies, equipment, room and board, uniforms, transportation and supplementary items or services in connection with attendance at a public, private or religious school for kindergarten through 12th grade, as well as college.Note that eligible expenditures include Internet access and related services, as well as computer technology.Normally Coverdell account balances must be distributed by the time the beneficiary child reaches age 30, unless there is a special need such as a physical, mental, or emotional condition, including a learning disability.Failure to spend the funds in the Coverdell account on qualified expenses by the necessary date will result in the application of penalties, and income tax on the accumulated earnings of the account to the founder of the account.Section 529 plansIn my opinion, the most important new college-funding vehicle is the Section 529 plan, which is authorized in two forms: Prepaid tuition programs under which the investment account grows at the rate of inflation applicable to the state’s higher education system; and A college savings plan, which is a state-sponsored mutual fund account under which the value fluctuates based on the underlying investments.I would like to focus on the second aspect of Section 529, the college savings plan.Investments in these college savings plans are nondeductible for income tax purposes when made.Beginning in 2002, distributions from these plans are excluded from gross income for tax purposes if they are used for qualified higher education expenses, defined as tuition, books, room and board and supplies. Regardless of the state plan selected, the funds accumulated can be used to pay for qualified expenses at colleges in other states.Prior to 2002, any earnings or appreciation on the account were taxable to the beneficiary.For estate and gift tax purposes, a donor’s investment in a savings plan is a gift, which means the funds invested are removed from the donor’s taxable estate.However, the donor still retains control over the account in the following ways: The donor can change the named beneficiary, who must be a member of the donor’s family including first cousins starting in 2002, at any time without any negative tax consequences; and The donor/owner of the account can, at any time, withdraw the funds in the account, but the earnings and appreciation are taxable as ordinary income, and a 10 percent penalty must be paid on the income recognized.For wealthy individuals who wish to reduce the size of their taxable estate, Section 529 allows a huge advantage by allowing one-time contributions to college savings plan accounts of up to $50,000, or $100,000 for a married couple. A special tax election must be made to accomplish this large initial gift without negative estate and gift tax consequences.These plans allow the donor the unique opportunity to change the beneficiary designation between family members, including grandchildren.This flexibility is great, especially when dealing with children who don’t attend college, "problem children," or children who are not worthy in the eyes of the donor.Finally, an appealing aspect of the plans is the wide variety of investment options and approaches that are available in each state’s plan.It is also permissible to rollover the funds in one state’s plan to another state’s plan with no tax effect, but this can be done only once per year.The State of Alaska has sponsored its own college savings plan, and more information can be obtained from its selected investment company, T. Rowe Price.In an effort to encourage savings for education, in 2002 the government makes it permissible to fund both a Coverdell account and a Section 529 account for the same beneficiary during the same year.As with Coverdell accounts, Section 529 plan investment earnings or appreciation can become taxable and subject to tax penalties if not used for qualified expenses in the year withdrawn.Estate tax ramifications, gross income limits, marginal tax rates, the affect on the Lifetime Learning and Hope credits, and other factors, such as the effect on student financial aid options, need to be discussed with your tax and investment advisers before entering into an education funding program.Kevin Van Nortwick is a partner with Mikunda, Cottrell & Co. in Anchorage. He can be reached via e-mail at ([email protected]).
Updated: 
12/02/2001 - 8:00pm

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