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COLLEGE SAVINGS 101

8 smart college money moves in '08

01/03/2008

QUESTION:
8 smart college money moves in '08

ANSWER:
There are eight things to keep in mind if you are saving for college in the coming year.

1. Grab a state income tax deduction. More than 30 states offer a generous tax benefit -- either a state income tax deduction or, better yet, a tax credit -- for residents making contributions to a 529 plan. What better way to boost your college fund?

Make sure you understand the rules in your own state. In many states, the benefit is restricted to those using the home-state 529 plan. And you may want to take steps to maximize the tax savings by opening multiple accounts or by spreading your contributions over more than one year. Even with a child close to college age, it can make sense to open a 529 account, as most states do not impose a minimum holding period.

Use 529 college-savings-plan estimator to see if these plans are right for you.

2. Steer clear of the kiddie tax. Saving income taxes by investing in your child's name becomes a more difficult proposition in 2008. Recent tax law changes expanding the so-called "kiddie tax" will result in higher taxes for millions of American families.

What is the kiddie tax? It is a levy assessed when your child's total interest, dividends, capital gains and other "unearned" income in excess of $1,800 (in 2008) is taxed at the rate of your tax bracket, not your child's. Previously, the kiddie tax ended when a child turned 18. But in the future, the kiddie tax will be imposed on full-time college students up until the year they reach age 24.

One remedy to the kiddie tax is to arrange your investment strategy so as to avoid having your child recognize more than $1,800 in unearned income. If you have children who are now between the ages of 18 and 22, you might even want to trigger capital gains before the end of December, since children in that age bracket are not subject to 2007's kiddie tax, but will be subject to the 2008 tax.

For younger children, avoid socking away too much in a Uniform Transfers to Minors Act (UTMA) and instead use tax-free 529 plans and Coverdell education savings accounts. Another potential remedy under the 2008 kiddie tax involves children ages 18 to 23 -- they escape the extra tax if their wage income exceeds one-half of their total support. The calculation of "support" can get tricky so you may want to discuss this with a tax professional.

3. Be grateful for grandparents. Surveys suggest that many grandparents are happy to help finance their grandchildren's college education. But grandparents are also concerned about having enough money to maintain their own lifestyles in retirement, and about keeping an adequate cushion for other needs, such as future medical expenses.

A 529 plan can be the perfect solution to this dilemma, for one simple reason: the account owner can request a withdrawal of money from a 529 plan at any time and for any reason (subject to tax and 10 percent penalty on the earnings). Of course, most grandparents will never seek a refund, and will eventually use the funds for the intended purpose of paying college bills.

Most 529 plans also permit grandparents and other third parties to make contributions directly to an account already established by the parent, a useful approach for grandparents with no desire to become account owners.

4. Go for the scholarship money. 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 will also turn up some opportunities -- just be sure you are comfortable with how your personal information is used.

The most valuable scholarships and grants are those offered directly by the college your child will be attending. According to the College Board, institutions provided more than $20 billion in institutional grant aid for undergraduate students in the 2006-07 school year, and a significant portion of this money went to students without regard to their financial need.

Above-average high school grades, challenging course selections, unique backgrounds or interests, and musical or sports prowess are among the characteristics for which colleges are willing to pay.

5. Plan ahead for financial aid. Interest rates on government-subsidized loans are headed lower, making them even more attractive as college-financing tools. For the school year 2011-12, eligible students receiving a subsidized Stafford Loan will lock in a 3.4 percent interest rate.

Also, expect to see the government expanding the list of post-graduate professions eligible for income-contingent repayment schedules and loan forgiveness. Demonstrating financial "need" through the Free Application for Federal Student Aid (FAFSA) application process thus becomes more important. Steps you take now can enhance your child's financial aid prospects in the future.

For example, avoid placing investments in your child's UTMA, because those assets will count heavily against aid eligibility.

However, while it is good to plan ahead, don't spend too much time preparing 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.


6. Start saving early. With college costs increasing at an average annual rate of close to 6 percent, it's best to start a college savings fund early in your child's life. The monthly college savings budget is $623 if you plan to fully fund four years at a private college currently costing $25,000 per year and begin saving when your child is 1 year old.

However, waiting until your child is 11 to begin saving will require you to save $1,047 per month. These projections assume 6 percent annual cost increases, a 7 percent after-tax annual investment return, and monthly deposits continuing through the month of college graduation.

Don't despair if such savings targets seem out of reach. Any amount you can set aside for college now will help reduce the amount of debt you or your child take on in the future.

7. Keep your retirement fund for retirement. Most financial planners agree that your own retirement should be your first savings priority. Take full advantage of an employer match of your contributions to a 401(k) plan and strongly consider setting aside money each year in a Roth IRA if you are eligible to do so.

When it comes time to pay for college, you may be tempted to tap retirement accounts to pay college bills. But in most situations, you will be better off keeping retirement accounts intact and taking out loans for your child's college expenses. Distributions from 401(k) plans and IRAs will not only hurt your child's eligibility for financial aid in the following year, but may increase the chances that you become financially dependent on your children later in your life.

8. Use rewards programs. Everyone likes "free money." Several companies now 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.

The largest such rewards program is the Upromise Rewards Service, and others include Futuretrust, Little Grad, and BabyMint. Fidelity Investments offers a 529 rewards American Express card that includes 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.

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