A few tips on saving for college

Everyone knows the options or basic methods of saving for college, but here are a few tips that you may not know. (For those of you who are not familiar with the basics, I have listed them at the bottom).

FIRST TIP-All parents, regardless of income, should apply for financial aid.

The reason why every parent should apply for financial aid (the FAFSA form-Free Application for Student Financial Aid) is that colleges use the FAFSA not just to determine financial aid eligibility, but some also use it to screen for merit money. "Merit money," also known as "tuition discounts"—is NOT need-based at all. Rather, this is money that colleges give out to lure certain types of students. As a matter of fact, merit money is more likely to be awarded to affluent kids. Today, most schools will discount their tuition to the kids they really want. The average tuition discount at private four-year colleges and universities is 33.5%. Certain schools are aggressive dispensers of merit money—public schools too, not just the private schools. At the University of Florida, 57% of its students recently received "merit money." (The reason is politics-schools that are aiming for higher ratings from U.S. News & World Report are able to attract the cream of the crop by offering them merit money.) The University of Florida had more freshman National Merit Scholarship winners than all other schools except Harvard. At Tulane, the average merit award to its students was recently $19,000 –that's a $19K discount from the regular tuition price.

NEXT TIP-Understand what assets count in the financial aid formula (and which don't count). For those parents that will qualify for "need-based" financial aid—here's a tip—not all assets count equally. You can start planning early on to qualify for some "need based" financial aid. For example, you can own a home on Tahiti Beach in Cocoplum (Coral Gables) and have a couple million in IRAs and 401ks, and your child may still qualify for some financial aid (need-based) assistance. Federal aid rules permit families to shield certain assets by using the so-called Asset Protection Allowance. (How much money you can shield can depend on whether a household has one or two parents, and the age of the oldest parent, among other criteria.) In addition to the Asset Protection Allowance, depending on how an account is titled, it will "count" towards financial aid eligibility in different proportions. Parent assets are counted towards the families "Expected Family Contribution (EFC)" towards the college expense at 5.64%. However, assets titled (or presumed titled) in the child are included from 35 to 50% of the value of the asset.

The following chart shows the basics (but I also include whether it's considered a "parent asset" or a "child asset," and the tax consequences.)

How to Save

Advantages

Disadvantages

Tax advantaged investments-

 —U.S. Savings bonds

•There are no income taxes on the income from the bonds if they are used for qualified college expenses and your income isn't too high
•Deemed "parent asset" provided child is not a named co-owner (but can be named a beneficiary)
•Very conservative investment -low interest rate return
•The tax exclusion is phased out at higher income levels**

 —Coverdell Education Savings Accounts

· Similar to 529 plans (but formed under Section 530 of the I.R.C.), because the income is also tax deferred if used for qualified education expenses, but is broader than a 529 plan because it can also be used for other education expenses, such as elementary, secondary or college),tuition, books, uniform, etc.

· The rules for investments allowed in Coverdell accounts are the same as those for IRAs.

· Considered a "parent asset"

· Low annual maximum contribution limits—currently $2,000 can be contributed per year per child

· Must be disbursed on qualified education expenses by the time the beneficiary is 30 years old or gifted to another family member below the age of 30 in order to avoid taxes and penalties.

529 College Savings Plans  

· Tax deferred savings

· Tax free withdrawals, as long as used for qualified college expenses

· No income or age restrictions

· Not limited to your state

· Deemed a "parent asset"

· High maximum contributions

· Can only be used for qualified education expenses

· Investments are limited to those offered by the plan—administered by the State and the investment management is outsourced or is done by the State Treasurer

· Have been notoriously high in hidden fees (management fees, investment fees, etc), though legislation is being introduced to require more transparency and fees have been decreasing

529 Prepaid Tuition Plan

· Guarantees your child's tuition will be paid based on today's costs (regardless of how much tuition costs climb)

· Deemed a "parent asset"

· No guarantee that your child will get into that college

· Limited to certain schools within the state and may not include private schools

· Check plan for consequence if child doesn't go to college, usually, money is returned with no (or minor) income  

Custodial account

· Ease of opening account

· Can be used for other expenses (not limited to education expenses)

· Deemed "child asset"

· Parent loses control of the money at 21 years of age (child can use the money to buy a Ferrari)

· Income is taxed annually

Irrevocable Trust

· Provides most flexibility, options and discretions with respect to investment and withdrawals (not limited to education expenses—can be used for the unexpected jail bond-just kidding)

· Parent can retain control of asset for as long as parent desires

· As a tax attorney, this is difficult to admit, since the attorneys' mantra is "defer, defer, defer [the payment of tax]," but, if properly invested, an irrev trust portfolio can achieve better returns even on an after-tax basis. (Caveat, if you're not going to actively manage the money (e.g. have a financial planner), then your after-tax returns may not merit the advantages of the flexibility  

· Deemed a parent asset

· Initial cost to set up-need a trust agreement

· Pays taxes annually

· Contributions are limited to $13,000 per donor per year (but easy to get around) (with two parents, can contribute $26K per child/year, with grandparents, can contribute $52K per child/year

**(Tax exclusion for savings bonds begins to be reduced for individuals with a $67,100 modified adjusted gross income (AGI) and is eliminated for AGIs of $82,100 and above, and for married taxpayers filing jointly, the tax exclusion begins to be reduced with a $100,650 modified AGI and is eliminated for AGIs of $130,650 and above.)