College Countdown: 14 Ways to Pay Tuition Bills
You’ve been saving and investing steadily for your child’s education over the years, and now your child is entering the final stretch before beginning his or her college journey. Now you’ll want to consider your options as you prepare to pay those upcoming tuition bills. What’s the best way to draw on your accounts? Are there rules about how you spend the money? What if your child decides not to go to college? Here are 14 ways to help pay for your child’s education.
1. 529 college savings plans. When you’re ready to tap your account, make sure your expenses are “qualified withdrawals.” These include tuition and fees, books, computers, technology, internet access and some room and board if your child lives off-campus (and attends college at least half- time). Transportation and student loan repayments don’t qualify. Keep records as proof that your 529 withdrawals were for qualified higher education expenses as you go along.
What if your child decides not to go to college? You can switch the account to another family member, such as a sibling or a nephew, and preserve the tax benefit for anyone who meets any age requirements as determined by the plan. What if you have excess funds? You can hold the funds in the account in case the beneficiary wants to attend graduate school later or make yourself the beneficiary and continue your own education. If your beneficiaries opt out of college altogether, you can cash in the account and use the money for whatever you want. You’ll just owe tax and a 10 percent penalty on the earnings. (The principal is not taxed, nor does the penalty apply to it.)
2. Prepaid tuition plans. Generally, these plans share many of the same rules as the 529. Qualified withdrawals under prepaid programs cover tuition however, most, do not cover other expenses, such as room and board. But you’ll need to follow the agreement from whatever state or independent college plan you chose, as the distribution of your account assets will be subject to their rules and limits. For instance, state-sponsored prepaid plans may only cover specified costs at certain state institutions. And for the 300-member, independent Private College 529 Plan? This program covers only tuition at the participating institutions.
3. Coverdell Education Savings Accounts. Coverdell contributions are not tax deductible, but amounts deposited in the accounts grow tax-free until withdrawn. Coverdells can be used only to pay for qualified education expenses, such as tuition and fees; the cost of books, supplies and other equipment; and in some situations, the cost of room and board. If money is withdrawn for nonqualified purposes, the earnings portion will be taxed at the beneficiary’s tax rate and subject to a 10 percent federal penalty. Funds can be rolled over without penalty into another Coverdell account for a qualifying family member. All the assets, however, must be withdrawn within 30 days after the earlier of the following: beneficiary reaches age 30, or the beneficiary’s death (unless the beneficiary is a person with special needs).
4. Roth IRAs. A Roth individual retirement account allows you to take out your contributions at any time, tax- and penalty-free, so you can tap that money for college expenses. You also can withdraw any earnings penalty-free if you use the funds to pay qualified education expenses, although you will still owe tax on the withdrawals if you are under 59 ½ at the time. (Of course, if you leave those earnings in the account until you retire, you won’t pay a penalty or any taxes).
5. U.S. Savings Bonds. Series EE and I savings bonds let you exclude from your gross income some or all the earnings on any amount you redeem that covers tuition and fees at a qualified post- secondary institution. To get the education break, you must be 24 or older when you purchase the bond and only bonds purchased after 1989 qualify.
6. Custodial accounts. Also known as UGMAs or UTMAs, after the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act. Things to keep in mind: All gifts to custodial accounts are irrevocable. Once your child reaches the “age of majority” (as defined by your state law, typically 18 or 21), the account terminates and the child can use the assets for college or anything else.
7. Life insurance. Within certain policies, such as whole life or indexed universal life (IUL), any accrued cash value can generally be accessed through policy loans or withdrawals to help supplement college funding (assuming the policy remains in force). With IULs, in particular, you can access the cash value at any age, at any time and for any reason.
*Policy loans and withdrawals will reduce cash value and death benefit. Policy loans are subject to interest charges.
8. American Opportunity Credit. This credit applies to qualified education expenses incurred by eligible students attending at least half-time during their first four years of undergraduate education. A parent, spouse or student who is not claimed as a dependent can take a federal income-tax credit equal to 100 percent of the first $2,000 spent on qualified education expenses and 25 percent of the next $2,000, for a total of $2,500. You must meet income limits to claim this credit.
9. Lifetime Learning. With this credit, you can 20 percent of your out-of-pocket costs for tuition, fees, and books, up to a maximum of $2,000 a year per family. Unlike the American Opportunity Credit, however, the credit is not limited to undergraduate educational expenses, nor does the credit apply only to students attending at least half time. Income limits, however, do apply.
10. Education deduction. After having been reinstated and extended multiple times in recent years, this tax break is scheduled to expire again in 2017. Generally, you may only claim this deduction for qualified educational expenses on your return in lieu of taking either one of the two higher education tax credits: the American Opportunity Tax Credit and the Lifetime Learning credit. With the tuition-and-fees deduction, single filers can claim the maximum $4,000 deduction up to MAGI of $65,000; the deduction drops to $2,000 if MAGI ranges between $65,000 and $80,000. Joint filers can claim the maximum $4,000 deduction up to MAGI of $130,000, and a maximum of $2,000 if MAGI ranges between $130,000 and $160,000. Higher-income earners get no deduction.
Financial Aid Sources
11. Scholarships. This type of free money, awarded to students based on academic or other achievements, is universally coveted. (Sallie Mae estimates there are 5 million sources of college scholarships). Scholarships generally don’t have to be repaid, so they’re often called “gift aid.” Programs that award them may specify how scholarship funds must be used, set time restrictions for disbursing the funds or set a ceiling on qualifying family income.
12. Grants. Grants are often based on financial need. Like scholarships, they don’t need to be repaid (unless, for example, you withdraw from school and owe a refund). The U.S. Department of Education offers a variety of federal grants to students attending four-year colleges or universities, community colleges, and career schools. Go to www.ed.gov and click on grants for more information.
13. Student loans. Student loans can come from the federal government or from private sources such as a bank or financial institution. Federal student loans usually offer borrowers lower interest rates and have more flexible repayment options than loans from banks or other private sources. To apply for a federal loan, you must complete a Free Application for Federal Student Aid (FAFSA) – which is basically the starting point for government-sponsored loans and grants, as well as for state aid from colleges. Based on the results of your FAFSA, your college or career school determines a financial aid offer. Income, not assets, is by far the biggest factor in financial aid. And the formula excludes assets held in retirement accounts, the cash value of life insurance policies, and the value of your home and other personal property.
14. Work-study jobs. The Federal Work-Study program provides part-time jobs for undergraduate and graduate students with financial need, allowing them to earn money to help pay education expenses. The program encourages community service work and work related to the student’s course of study. Schools that participate award funds on a first-come, first-serve basis. Three things influence the total work-study award: when you apply, your level of financial need and your school’s funding level.
*Policy loans and withdrawals will reduce cash value and death benefit.Policy loans are subject to interest charges.
Mutual of Omaha Investor Services, Inc and its representatives do not provide tax or legal advice. Consult with and rely on your tax advisor or attorney for your specific situation.