The rising annual cost of higher education Which grow faster?Your children or college costs? Source: Based on the average 2005-06 cost of tuition, fees, room and board, as published in the College Board’s “Trends in College Pricing” report, 2005. Projected annual cost of college assumes annual inflation of 6%.
College graduates have greater earning power than high school graduates. Bachelor’s degree recipients earn 60% more than high school graduates. Investment for a lifetime Invest for a Lifetime • High School Diploma • Some College • Bachelor's Degree • Advanced Degree Median Annual Income Source: U.S. Census Bureau, “Annual Demographics Survey,” 2004
Education planning in perspective • For parents and grandparents, integrating education planning into your overall financial strategy makes sense. While the prospect of saving enough money to pay for college may seem daunting, there are several excellent ways to save and invest that can provide significant tax benefits. • Parents: Making a tax-advantaged savings plan part of your overall financial strategy can help you enhance your overall investment and retirement plans, as well as provide for education expenses. • Grandparents: An education savings plan can help you pass the value of education to your grandchildren and enhance your estate plan by removing assets from your taxable estate, depending on the investment vehicle you choose.
CREATE A LEGACY OF EDUCATION AN EDUCATION FOR THEM, TAX SAVINGS FOR YOU CHOOSE SMART FUNDING STRATEGIES UNDERSTAND YOUR EDUCATION FUNDING OPTIONS Making your education funding strategy work for you
Choose funding vehicles according to your needs Loans UNDERSTAND YOUR EDUCATION FUNDING OPTIONS
Depending on your situation, loans may play a role in your education funding strategy. When are loans right for you? • Vehicle Advantages Limitations • An accessible option; accounts for 46% of financial aid.1 • Average college student graduates with debt exceeding $20,0001 • Can have a negative impact on long-term financial security. Loans 1 Source: The College Board’s “Trends in Student Aid 2005” report
Consider taxable options Loans Taxable savings options • Savings accounts • Mutual funds • Brokerage accounts UNDERSTAND YOUR EDUCATION FUNDING OPTIONS
Depending on your situation, taxable vehicles may play a role in your education funding strategy. What are your taxable options? • Vehicle Advantages Limitations • No tax advantages; typically low rates of return. • An accessible option. • Diversify your portfolio. Savings Accounts Mutual Funds • Must pay income tax each year on mutual fund distributions and on capital gains when you sell the funds. • Must pay taxes each year on stock dividends and corporate bond interest, as well as pay capital gains tax when you sell the stock. Brokerage Accounts • Access a wide range of investment options.
Consider tax-efficient options Loans Taxable savings options • Tax-advantaged savings options • Section 529 college savings plans • Coverdell Education Savings Accounts • UGMA/UTMA custodial accounts UNDERSTAND YOUR EDUCATION FUNDING OPTIONS
Tax-advantaged options: Section 529 college savings plan Section 529 college savings plans are tax-advantaged, state-sponsored, qualified tuition programs designed help you save and invest for higher-education expenses* while retaining control of the assets. • Advantages • Limitations • Earnings grow federal income-tax-free if withdrawals are used for higher-education expenses. • Account owner retains control and can change beneficiary at any time. • Assets are not part of account owner’s taxable estate. • No age or income limitations. • Treated more favorably for federal financial aid purposes. • Five-year front-loading of contributions. • Earnings portion of withdrawals not used for higher-education expenses is subject to income tax and possibly a 10% penalty tax. • Available investment options are determined by the 529 plan. • Certain state tax benefits, if any, may be available only for contributions to the client’s or beneficiary’s particular state 529 plan. • Can be funded only with cash. * To be eligible for the favorable tax treatment afforded to withdrawals from Section 529 accounts, expenses must be “qualified higher education expenses,” as defined in the Internal Revenue Code.
Tax-advantaged options:Coverdell Education Savings Account (ESA) The Coverdell ESA is a trust or custodial account that is designed to pay a beneficiary’s education expenses. • Advantages • Limitations • Earnings and withdrawals are federal income-tax-free for kindergarten through 12th grade and/or higher-education expenses.* • Account owner retains control and can change the beneficiary at any time. • No restrictions on investment options. • Treated more favorably for federal financial aid purposes. • Contributions limited to $2,000 per year per beneficiary.* • Ability to contribute subject to income limitations. • Can fund account only until beneficiary’s 18th birthday, unless the contribution is made on behalf of a special needs beneficiary. *Unless extended, the provision relating to the use of assets for kindergarten through 12th grade and the contribution limit of $2,000 will expire after Dec. 31, 2010; and the law in effect prior to the effective date of the Economic Growth and Tax Relief Reconciliation Act of 2001 will apply. This means that eligible expenses will include only higher-education expenses, and the annual contribution limit will be reduced to $500 per beneficiary.
Tax-advantaged options:UGMA/UTMA custodial accounts An UGMA/UTMA custodial account is set up in a minor’s name and allows you to contribute cash or securities. The beneficiary assumes control of the assets at the age of majority (usually 18 or 21) and may use them for any purpose. • Advantages • Limitations • First $850 of earnings each year is federal income-tax-free. • Fund with cash or securities. • Assets may be used for any purpose to benefit the designated beneficiary. • No restrictions on investment options. • Limited tax advantages on annual earnings above $851.* • Beneficiary gains control of the assets at age of majority. • Cannot change the beneficiary. • May be considered part of the custodian’s estate. • Treated less favorably for federal financial aid purposes. *For a beneficiary under age 18, annual earnings between $851 and $1,700 are taxable at the beneficiary’s tax rate. Annual earnings above $1,700 are taxable at the parents’ tax rate. For a beneficiary age 18 or older, annual earnings above $850 are taxable at the beneficiary’s tax rate.
Understanding the tax-law implications • Impact of recent tax-law changes on your education savings options • Section 529 college savings plans • UGMA/UTMA custodial accounts • Coverdell ESAs CHOOSE SMART FUNDING STRATEGIES
How tax-law changes affect your education funding options Section 529 College Savings Plan UGMA/UTMA Account • The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the capital gains tax rate for the two lowest income tax brackets to 5% through 2007 and to 0% in 2008. There is a 2008 sunset provision. • The Deficit Reduction Act of 2005 requires that any growth above $1,700 a year in an UGMA/UTMA account be taxed at the parents’ ordinary income tax rate until the child reaches age 18, instead of age 14 under the previous law. The Pension Protection Act made permanent several provisions for Section 529 plans. The act: • Allowed federal (and in most cases state) tax-free withdrawals when used for eligible higher-education expenses.* • Increased the amount for tax-free room and board withdrawals for students not living in a campus-run facility. • Permitted rollovers between 529 plans once every 12 months without tax or penalty. • Permitted beneficiary changes and rollovers between first cousins, in addition to other family members. • Permitted tax-free withdrawals for certain expenses related to special needs beneficiaries. * To be eligible for the favorable tax treatment afforded to withdrawals from Section 529 accounts, expenses must be “qualified higher education expenses,” as defined in the Internal Revenue Code.
How tax-law changes affect your education funding options Coverdell ESA • The 2001 tax law increased annual contribution limits to $2,000. • The income phaseout range increased to $190,000-$220,000 for married couples, while remaining at $95,000-$110,000 for individuals. • Eligible expenses were expanded to include costs for kindergarten through high school. • Contributions to both Coverdell ESAs and 529 plans were made possible. • Unless extended by Congress, all these provisions will expire after Dec. 31, 2010.
Take advantage of innovative funding strategies • Impact of recent tax-law changes on your education savings options • Innovative funding strategies • Creating a comprehensive education funding strategy CHOOSE SMART FUNDING STRATEGIES
Case Study: Should you contribute to an UGMA/UTMA account or a Section 529 plan account? • Meet the Smith Family • Bob and Mary Smith are married. Both are 40 years old. • The Smiths have three children, all of whom they hope will attend college and graduate school. • All three children are under age 18. • The Smith’s Financial Situation and Goals • The Smith’s portfolio is worth $1 million, with 40% invested in highly appreciated employer stock. • Bob and Mary are in the 33% income tax bracket. • Bob and Mary want to diversify their investment portfolio by reducing their holding of company stock over time. • The couple also wishes to enhance their education savings plan. Note: There are potential income tax and other tax implications from exercising stock options and subsequently selling the stock. Please consult your tax and other advisors before making any decisions.
Possible Strategies Option 1: Fund an UGMA/UTMA account Option 2: Fund a Section 529 plan account Case Study:Contribute to an UGMA/UTMA account or a 529 plan
Possible Strategies • Bob and Mary can contribute the maximum $24,000 of highly appreciated employer stock to each child’s separate UGMA/UTMA account and sell the stock within that account to diversify. • This strategy provides only minimal tax savings because the children are under age 18, and most of the gain will still be taxable at Bob and Mary’s current long-term 15% capital gains rate (20% beginning in 2009). Case Study: Contribute to an UGMA/UTMA account Note: There are potential income tax and other tax implications from exercising stock options and subsequently selling the stock. Please consult your tax and other advisors before making any decisions.
What issues should the Smiths consider? • Considerations With an UGMA/UTMA Account • Bob and Mary cannot change the minor for whom the account is established, and the minor gains control of the assets at the age of majority. • They may have to file annual tax returns for the children for the assets. • UGMA/UTMA account assets can be used for any purpose, including private kindergarten and high school.
Possible Strategies • Bob and Mary can sell the stock outright, pay the long-term 15% capital gains tax rate and then use the proceeds to fund separate Section 529 plan accounts for each child (up to $120,000 each). • This strategy allows them to benefit from the current reduced capital gains tax rate and diversify their investments. They also can benefit from a Section 529 plan account’s control, flexibility and tax advantages. Case Study: Contribute to a Section 529 plan account Note: There are potential income tax and other tax implications from exercising stock options and subsequently selling the stock. Please consult your tax and other advisors before making any decisions.
What issues should the Smiths consider? • Considerations With a Section 529 Plan Account • Investment choices are limited to the Section 529 plan’s options. • Earnings grow federal income-tax-free if withdrawals are used for higher-education expenses.* • Assets can be used only for higher-education expenses. The earnings portion of nonqualified withdrawals is subject to income tax and may be subject to a 10% federal penalty tax. • Bob and Mary have the ability to change the designated beneficiary on their children’s Section 529 plan accounts and transfer all or a portion of the assets to the new designated beneficiary. • Bob and Mary can even take the assets back, subject to possible taxes and penalties. * To be eligible for the favorable tax treatment afforded to withdrawals from Section 529 accounts, expenses must be “qualified higher education expenses,” as defined in the Internal Revenue Code.
Pass the value of education to future generations Making education planning part of your estate plan • Estate planning features of Section 529 plans • Benefits of a lump-sum contribution CREATE A LEGACY OF EDUCATION
Estate-planning features of Section 529 plans • Assets generally are considered completed gifts and are not part of the donor’s estate. • Donor retains control of assets and still has control of funds.1 • Individuals can contribute as much as $60,000 and married couples as much as $120,000 in one year to a Section 529 account for a designated beneficiary without creating a taxable gift, assuming no other gifts are made in the subsequent five-year period.2 • No gift-tax implications for qualifying change of beneficiary of the same generation (e.g., siblings, cousins). • Generation-skipping transfer (GST) tax exclusion if gift-tax annual exclusion also is used. 1 The earnings portion of nonqualified withdrawals will be subject to regular income taxes and possibly a 10% federal penalty tax. 2 If you die before the five-year prorating period has expired, the contribution allocated to the remaining years moves back into your taxable estate. For example, if you contribute $60,000 to a Section 529 account for your granddaughter and die in year four, then $12,000 (only the fifth-year gift) would be included in your gross estate. However, any and all appreciation on the entire original gift (i.e., $60,000) is not considered part of your estate.
Case Study: Maximize contributions to a Section 529 plan account • Meet Bob Smith’s Parents • Bob’s parents, Lily and John Smith, are married and are both 68 years old. • Lily and John want to contribute to their three grandchildren’s education funding plans. • The Smith’s Financial Situation and Goals • The couple’s portfolio is worth $5 million, and they are concerned about estate taxes. • Lily and John want to instill the value of education in their grandchildren and help them to complete college and graduate school without loans. • They also would like to maintain control of the assets and ensure that the funds are used for their intended purpose—higher-education expenses.
Solution • Lily and John can make a lump-sum contribution of $120,000 to Section 529 plan accounts for each of their three grandchildren. • Within five years, $360,000, plus any growth, will have been removed from their estate. Lily and John contribute $120,000 to each of three Section 529 accounts in year one for a total of $360,000. The contribution is prorated as a series of five annual gifts of $72,000 each ($24,000 X three beneficiaries). Year 1 Year 3 Year 2 Year 4 Year 5 $360,000, plus earnings, removed from Lily and John’s estate within five years = $72,000 $72,000 $72,000 $72,000 $72,000 Case Study:Maximize contributions to a Section 529 plan Note: If you die before the five-year prorating period has expired, the contribution allocated to the remaining years moves back into your taxable estate. For example, if a grandfather contributes $60,000 to a Section 529 account for his granddaughter and dies four years later, then $12,000 (only the fifth-year gift) would be included in his gross estate. Also, any and all appreciation on the entire original gift (i.e., $60,000) is not considered part of his estate.
Other education funding strategies • Use a combination of plans to achieve your goals. • Coverdell ESA and a Section 529 plan account • UGMA/UTMA account and a Section 529 plan account • Use existing UGMA/UTMA account or trust assets to fund a Section 529 plan account. • Improve tax efficiency • Eliminate the need to file an annual tax return for UGMA/UTMA or trust assets that are held in the Section 529 plan account
A closer look: Section 529 college savings plans • Before choosing a Section 529 plan, consider these questions: • What is the range of investment options that are available? • Who are the program and investment managers? • What are the fees and investment performance for the program? • How does this plan compare with other plans? • Does my home state plan offer state tax advantages? • If I contribute to my current home state plan, are there any consequences if I move to another state or withdraw assets for a nonqualified purpose? Before you invest in a 529 plan, request an official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the 529 plan, which you should carefully consider before investing. You also should consider whether your home state offers any state tax or other benefits that are only available for investment in such state’s 529 plan.