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- Start early with a 529 College Savings Plan.
Thanks to Section 529 of the tax code which clarifies that money in
"Qualified Tuition Programs" can grow tax deferred, with families paying no federal tax on the appreciation when they cash in the fund if the proceeds are used for "qualified" educational expenses-college tuition, fees, books, room and board-otherwise plan participants are assessed a 10% penalty, and face immediate taxation. (The penalty is waived for students who receive full scholarships.) However, the money can be used by another family member including a first cousin. Everyone may benefit from 529's, regardless of income, and some states permit maximum (aggregate) contributions as high as $269,000. To build funds fast, individuals can make lump sum contributions of up to $60,000 without incurring a gift tax by consolidating five years of their $12,000 gift-giving exclusion. But be warned, when the time comes to file for financial aid, these assets count against the parent and are assessed 5.6% and if in the child's name at 25%.
- Boost savings with Coverdell Education Savings Accounts, Bank CDs and more.
Formerly called Education IRA's, the Coverdell Education Savings Accounts were renamed in tribute
to Paul Coverdell, the Georgia Senator who pushed for their enactment. They let you put away up to
$2000, per year per student-to-be under the age of 18. Contributions are not tax deductible, but
earnings accumulate tax-free, and remain tax free upon withdrawal assuming the proceeds are used for
tuition, fees, books, room and board. You can also use the money for pre-college education expenses,
for example private secondary school, extended-day programs, school uniforms, computer equipment,
even monthly Internet access. These accounts are more flexible than 529's - you can invest the funds
however you choose-in stocks, bonds mutual funds, or whatever your comfort index permits, but the money
must all be used by the time the child turns 30, or rolled into a younger family members' account or a
first cousin's account. (The Coverdell Education Savings Account is not available for single filers
with incomes between $95,000 and $110,000 and joint filers with incomes between $190,000 and $220,000.)
Unless your child is starting college within the next year, bank CDs, savings accounts and mutual funds should be a small piece of your college savings portfolio, due to minimum returns. Additional Zero Coupon Bonds, bonds stripped for their interest coupons, are advisable. Owners receive no income while holding the bonds; instead income compounds and reinvests semi-annually. At some future date, you receive a fixed sum that is much larger than your original purchase price.
- Reduce your tax bill.
Refinancing and home equity loans and lines of credit are great instruments to consolidate and restructure debt, offering a low interest rate on a refinanced first mortgage and tax deductibility. In addition, a second mortgage, especially a line of credit, will provide access to dormant equity. You're free to use it when needed and pay for the amount you use without having to reapply while receiving a tax deduction. To use the funds, you simply write a check or use a credit card. Interest rates float about one percentage point above prime. As an added bonus, any items you charge, such as college tuition, become part of your home mortgage, so your interest payments on loans up to $100,000 become tax-deductible. For families who earn too much to deduct interest payments on education loans, borrowing against home equity may be the better option.
- Discover smart investment options.
Tax-efficient mutual funds are best way for small investors to play the market. Because your money is pooled with other investors, you gain the advantage of diversification and professional fund management. Currently, there are over 13,000 mutual funds to choose. Some of the top premier fund companies offer tax-efficient mutual funds, whose capital gains, interest and dividend income are reduced by the management style of after-tax returns, seek to avoid large embedded gains. Realized capital gains offset by realized losses is what makes this mutual fund unique.
Many people are confused by the endless variety of life insurance options as well as annuities. However, one particular life instrument (in which death benefits and cash values vary with the performance of your portfolio) is Variable Life. It's touted as a good vehicle for long-term savings needs such as college tuition. Variable Life provides investors with a great deal of flexibility, however, because the cash value is invested in the market, it is subject to market risk. When long-term investment horizons, moderate risk tolerances and simplicity are the investor's objective, Variable Annuities offer features not found in most equity-based brokerage or mutual fund accounts. These include living benefits that guarantee principal and/or growth lifetime income in spite of market fluctuation, and a death benefit option that ensures the highest account value to beneficiaries and also pass outside of probate of the owner's estate. This, coupled with professional money management of sub-accounts and the changing between sub-accounts without cost and tax consequences, make annuity contracts a viable investment vehicle. It also escapes the eye of the needs analysis when applying for financial aid.
Which is right for you?
The College Market Consultant can estimate what your college costs will be per child as well as determine which long-term plan is right for you.
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