This depends on how much you think your children’s education will cost. The best way is to start saving before they are born. The sooner you begin the less money you will have to put away each year.
Example: Suppose you have one child, age six months, and you estimate that you’ll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you’ll need to save $3,500 per year for 18 years (assuming an after-tax return of 7 percent). On the other hand, if you put off saving until the child is six years old, you’ll have to save almost double that amount every year for twelve years.
Another advantage of starting early is that you’ll have more flexibility when it comes to the type of investment you’ll use. You’ll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments in the long-run.
It depends on whether your child attends a private or state school. For the 2014-2015 school year the total expenses–tuition, fees, board, personal expenses, and books and supplies–for the average private college are about $42,419 per year and about $18,943 per year for the average in-state public college. However, these amounts are averages: the tuition, fees, and board for some private colleges can cost more than $60,000 per year whereas the costs for a state school can be kept under $10,000 per year. It should also be noted that in 2013-14 the average amount of aid for a full-time undergraduate student was about $14,180.
According to the College Board, between 2013-14 and 2014-15, average published tuition and fee prices increased by 2.9 percent for in-state students in the public four-year sector, by 3.3 percent for out-of-state students in the public four-year sector and for in-district students at public two-year colleges, and by 3.7 percent at private nonprofit four-year institutions. These price increases are lower than the average annual increases in the past five years, the past 10 years, and the past 30 years. Despite this, college is still expensive and proper planning can lessen the financial squeeze considerably–especially if you start when your child is young.
As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different, from those used if you start when your child is age 12.
The following are often recommended as investments for education funds:
Tip: Be sure to convert the tax-free return quoted by sellers of such bonds into an equivalent taxable return. Otherwise, the quoted return may be misleading. The formula for converting tax-free returns into taxable returns is as follows:
Divide the tax-free return by 1.00 minus your top tax rate to determine the taxable-return equivalent. For example, if the return on municipal bonds is 5 percent and you are in the 30 percent tax bracket, the equivalent taxable return is 7.1 percent (5 percent divided by 70 percent).
The American Opportunity Tax Credit (AOC) was extended for through tax year 2017. The maximum credit, available only for the first four years of post-secondary education, is $2,500 for tax years 2013 to 2017. You can claim the credit for each eligible student you have for which the credit requirements are met.
Income limits. To claim the American Opportunity Credit your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $60,000 ($120,000 for joint filers). “Modified AGI” generally means your adjusted gross income. The “modifications” only come into play if you have income earned abroad.
Amount of credit. For most taxpayers, 40 percent of the AOC is a refundable credit, which means that you can receive up to $1,000 even if you owe no taxes.
Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.
“Related” expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.
Tip: The tax law says that you can’t claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.
In the past, parents would invest in the child’s name in order to shift income to the lower-bracket child. However, the addition of the “kiddie tax” mostly put an end to that strategy.
For taxable years beginning in 2015, the amount that can be used to reduce the net unearned income reported on the child’s return that is subject to the “kiddie tax” is $1,050 (up from $1,000 in 2014). The same $1,050 amount is used to determine whether a parent may elect to include a child’s gross income in the parent’s gross income and to calculate the “kiddie tax.” For example, one of the requirements for the parental election is that a child’s gross income for 2015 must be more than $1,050 but less than $10,500.
For 2015, the net unearned income for a child under the age of 19 (or a full-time student under the age of 24) that is not subject to “kiddie tax” is $2,100 (up from $2,000 in 2014).
Note: These rules apply to unearned income. If a child has earned income, this amount is always taxed at the child’s rate.
In 2015, you can contribute up to $2,000 each year to a Coverdell education savings account (Section 530 program) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year (say 2015) can be made through the (unextended) due date for the return for that year (April 15, 2016).
Note: For the $2,000 contribution limit, there is no adjustment for inflation and therefore, the limit is expected to remain at $2,000 for 2013 and beyond.
Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.
Anyone can establish and contribute to a Section 530 account, including the child, and you may establish 530s for as many children as you wish. The child need not be a dependent. In fact, he or she need not be related to you, but the amount contributed during the year to each account cannot exceed $2,000. In 2015, the maximum contribution amount for each child is phased out for modified AGI between $190,000 and $220,000 (joint filers) and $95,000 and $110,000 (single filers).
Many families find themselves in the same boat. Fortunately, there are ways to generate additional funds both now and when your child is about to enter school:
Grants-the best type of financial aid because they do not have to be paid back — are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.
Tip: Don’t assume that middle class families are ineligible for needs-based aid or loans. The assessment of whether a family qualifies as “in need” depends on the cost of the college and the size of the family.
Tip: Try negotiating with your preferred college for additional financial aid, especially if it offers less than a comparable college.
There are various student loan programs available. Some are need-based, and others are not. Here is a summary of loans:
Here are some strategies that may increase the amount of aid for which your family is eligible:
Example: If your child owns $1,000 worth of stock, the amount of aid for which he or she is eligible for is reduced by $350. On the other hand, the amount of aid is reduced by (effectively) only 5.6 percent of your assets and from 22 to 47 percent of your income.
If you decide to invest in your child’s name, here are some tax strategies to consider: