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Tax-Leveraged College Funding Methods

According to the 2003-2004 Survey of Colleges conducted by the College Board, the average annual expense of a four-year undergraduate program are:

Over the past eighteen years, college expenses have increased at an annual rate of 6% while the overall inflation rate in the U.S. for the same period averaged only about 3% per year. Applying a 6% inflation rate to the above expense amounts, a child born today will need over $160,000 to attend a four-year public institution. For a private college the amount jumps to $340,000.

Whether your child is 6 months old or 16 years old, it makes a lot of sense to consider a tax-advantaged strategy to accumulate a portion of their college funding through the use of tax breaks. Here are some examples:

Section 529 Savings Plan
With a Section 529 Plan, the money you invest grows federal tax free. Down the road the funds can be used to pay qualified education expenses like tuition, books and reasonable room and board. Under the current tax laws, withdrawals used for qualified expenses are not subject to federal income tax. As an added plus, the amounts you contribute to a 529 Plan, along with future earnings growth, generally are excluded from your taxable estate.

Section 529 Prepaid Tuition Plan
A Prepaid Tuition Plan enables you to fund future tuition by locking in at the cost of that tuition today. The income tax and estate tax benefits of the Section 529 Savings Plan above are also applicable to a Prepaid Tuition Plan. Section 529 Prepaid Tuition and Savings Plans can also be used in tandem.

Coverdell Education Savings Accounts
Coverdell Savings Accounts allow you to contribute up to $2,000 per year to fund your child’s or grandchild’s college expenses. Your contributions along with the earnings growth generally can be withdrawn tax free when used to pay qualifying education expenses. Coverdell Accounts may also be used in combination with a Section 529 Plan.

Custodial Investment Accounts
For higher income parents, investments in a custodial account held in the name of the child can yield attractive tax benefits. Some or all of the earnings of such accounts generally are taxed at the child’s lower tax bracket.

Tax Deductions and Credits for Education Expenses
While there are a number of education-related tax breaks in the form of deductions and credits, they are generally subject to more modest income restrictions. However, if your adjusted gross income is too high to qualify, it may make sense to structure the use of these deductions or credits on your child’s tax return.

Real Estate Investment
If you like the idea of real estate investing, why not consider buying a rental house or condo for your child to occupy while attending college? Extra rooms can be rented out to other students producing income to offset some or all of the related costs. You then can write off certain costs of carrying and operating the investment including a reasonable salary paid to your child for managing the property.

As with any tax-saving strategies, all of the above come with certain technical restrictions and other drawbacks. Accordingly, they should be implemented only after careful consideration of all tax and financial factors applicable to your circumstances.

If you have concerns about how you will meet the escalating costs of your child’s college education, the best thing you can do is to start your planning now. We would be happy to sit down with you to discuss the available alternatives and guide you through the technical pros and cons.

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