How Can I Save for My Child's College Education?
by Bruce Kajiwara, CPA When planning for college, everyone is concerned about costs. Of course we will take advantage of financial aid, loans, grants, scholarships, and work-study programs. Whether or not a student receives some form of financial aid, however, all families are expected to contribute to their students' education. Most of us will use a combination of resources, including loans, a portion of current income, the student's part-time earnings, and money we have saved over time. Previously, our savings vehicles were limited to gifting (UGMA/UTMAs and trusts), using Series EE savings bonds, or establishing a separate investment fund earmarked for college. However, tax advantages were limited, and each depositor was required to understand and control their investment selection. Prepaid tuition programs, which have been around for over a decade, guaranteed the cost of tuition. However, the student either had to attend a particular college, or had their tuition guaranteed only at public colleges in their state of residence. But California has not authorized a prepaid tuition program. In 1998 the government approved the Education IRA, although a $500 maximum contribution obviously limited its effectiveness. Plus, high-income taxpayers were not allowed to contribute to an Education IRA. It is clear the ideal college savings program would provide these advantages:
Well, such a program is under development here in California. It is called the Golden State ScholarShare Trust College Savings Program. This new tax-deferred college savings program will help California families save in order to meet future college expenses. At the time of this writing, enrollment had not yet begun. But it is expected to begin very soon. About 18 states now have college savings plans, with many more to follow. This is unlike the prepaid tuition plans that have been in place for many years. These plans are more like IRA accounts, whereby earnings build up tax-free until the funds are used for school. Payouts of income are taxed to students for federal tax purposes. In 1996, Congress passed the Small Business Job Protection Act. It included Internal Revenue Code Section 529, which codifies the tax treatment of qualified state tuition programs and their participants. The California Student Aid commission, through a contract with the Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF), will administer the program. Investment policies and practices will be overseen by a three-member Investment Board consisting of the State of California's Director of Finance, the Executive Director of the California Student Aid commission and California's State Treasurer, who will serve as chair. The Student Aid commission recently selected TIAA-CREF to provide the day-to-day operation of the Golden State ScholarShare Trust. TIAA-CREF is the world's largest pension funding system with over one-quarter trillion dollars under management. Under the direction of the Student Aid commission, TIAA-CREF will provide all the marketing, investment management, and account administration and recordkeeping functions for the ScholarShare Trust. Moneys deposited in ScholarShare will be pooled into a large fund and invested by experienced professionals selecting diversified investments. The goal is to maximize earnings while reducing investment risks over the long term, so that funds will be available to families when the child enters college. While the funds are invested in the trust, annual earnings on investments will not be taxed at the federal or state level until they are used for higher education. When moneys are withdrawn to pay higher education expenses, taxes on the earnings are paid at the beneficiary's tax rate. Depositors may include parents, grandparents, or anyone who has reached the age of majority. They may contribute as little as $25 per month, or as much as a lump sum of the calculated cost of higher education in California (this amount varies depending on the age of the beneficiary). Higher education expenses carry a broad meaning. Disbursements are authorized to be used for most of the expenses of attending college, including tuition and fees, room and board, books, supplies and equipment required by enrollment. Also, it is not necessary to choose a college when the account is opened. Disbursements from the ScholarShare Trust can be used at any accredited institution within the U.S. (community college, state university, private institution, etc.) and need not be determined until the disbursement is made. However, the type of college the beneficiary plans to attend will affect the amount needed for college expenses, so it is important to attempt to save toward an expected type of institution. The earnings from excess contributions are subject to a proposed, 10 percent penalty if those funds are withdrawn for purposes other than qualified, education expenses. If the beneficiary does not attend college, the depositor has two choices -- they may cancel the agreement or change the designated beneficiary. In the event of cancellation, the depositor is entitled to a refund of the value of the account, minus a penalty (proposed at 10 percent of earnings). The second option is to name a new beneficiary. This substitute beneficiary must be a member of the original beneficiary's family, most likely a brother or sister. But it can also include a spouse, child, parent, grandparent, nephew/nieces, uncles/aunts, or in-laws. If a substitute beneficiary is named, all future distributions will be made to the new beneficiary's school of choice. No program is void of risk. Unlike state prepaid tuition plans, college savings plans do not guarantee the cost of tuition. So if the investment performance is not what you expect, or worse, you happen to have invested during a bear market, the funds may not fully cover the cost of your child's college education. There is talk that these programs may become a better deal from a tax standpoint. Legislation was introduced that exempts most distributions from federal tax. However, it was part of a bill that was vetoed last year for other reasons. Bruce Kajiwara, CPA/PFS, CFP, is with Genovese, Forman & Burford in Sacramento, California. The firm specializes in investment advisory services and employee benefits consulting Have a question for a CPA? Ask it here.
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