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Unformatted text preview: Chapter 7 Copyright© 2011 Money Education, LLC Chapter 7 Introduction 2 Planning for a college education is one of the top two or three goals for most families. Planners should be able to answer client questions regarding: • How much is current tuition? • How much is tuition expected to increase in the future? • What other costs are associated with a college education? • What type of financial aid is available and where to locate information regarding financial aid? • What are the tax advantaged plans, deductions, and credits available for education funding? Copyright© 2011 Money Education, LLC Chapter 7 Current Education Costs 3 Is it worth the cost? Average annual earnings (for workers age 25 and older for 2008): • High School Diploma - $33,800 • Bachelor’s Degree - $55,700 • Masters Degree - $67,300 • Doctorate Degree - $91,900 • Professional Degree - $100,000 Chapter 7 Copyright© 2011 Money Education, LLC Tuition and Other Costs 4 Average tuition and fees for 2010 to 2011 • Public University In State Tuition - $7,605 • Public University Out of State Tuition - $19,595 • Private University Tuition - $27,293 Total cost of attending college is significantly greater than just tuition and fees. It is not uncommon for the total cost of education to be twice the amount of tuition and fees. Copyright© 2011 Money Education, LLC Chapter 7 Tuition Inflation (per year) 5 Copyright© 2011 Money Education, LLC Chapter 7 Tuition Inflation (Cumulative) 6 Chapter 7 Copyright© 2011 Money Education, LLC Financial Aid 7 Is an important tool for families that are not adequately prepared. Is administered by the U.S. Department of Education. 79.5 percent of all full-time undergraduate students received some type of financial aid in 2007 – 2008. Information about financial aid is available online, at high schools and college campuses. http://studentaid.ed.gov/PORTALSWebApp/students/english/ind ex.jsp http://wdcrobcolp01.ed.gov/Programs/EROD/org_list.cfm?catego ry_ID=SHE • • Copyright© 2011 Money Education, LLC Chapter 7 Financial Aid Process 8 Is initiated by completing the Free Application for Federal Student Aid (FAFSA). Is used to determine a student’s eligibility for all types of financial aid. Is used to determine the Expected Family Contribution amount (EFC). Federal Methodology determines the EFC using one of three methods: • Regular Formula: Income and Assets • Simplified Method • Automatically Assessed Formulas Copyright© 2011 Money Education, LLC Chapter 7 Financial Need vs. EFC 9 The EFC is subtracted from the cost of attendance at a university and can include living expenses. Information contained in the FAFSA can be provided to universities. Chapter 7 Copyright© 2011 Money Education, LLC Grants 10 Grants are money provided to students for postsecondary education that does not require repayment. Typically awarded based on financial need. Federal government only awards grants for undergraduate studies. Types: • Federal Pell Grant • Teacher Education Assistance for College and Higher Education (TEACH) Grant • Academic Competitiveness Grant (ACG) • National Science and Mathematics Access to Retain Talent (SMART) Grant • Federal Supplemental Educational Opportunity Grant (FSEOG) Copyright© 2011 Money Education, LLC Chapter 7 Financial Aid – Loans Stafford Loan 11 Stafford Loans are administered by the U.S. Department of Education. Funds are provided by the federal government. Students with low incomes and large loan balances are only required to repay up to 10 percent of their income each year. Forgives loans after 20 years of repayment. For a subsidized loan, the federal government pays interest on the loan while the borrower is in school. For an unsubsidized loan, the borrower is responsible for interest from the time the funds are dispersed. Interest rates for Stafford Loans can be found at the U.S. Department of Education’s website: http://ifap.ed.gov/ifap Copyright© 2011 Money Education, LLC Chapter 7 Loan Programs 12 Federal Perkins Loan program: • • Parent PLUS Loans: • • Is for undergraduate and graduate students with exceptional financial need. Has a low interest rate loan (5%). Are for parents to borrow to help pay for a dependent’s undergraduate education expenses PLUS Loans are not based on financial need, but are instead based on the parent’s credit history. Graduate PLUS Loans: • • Chapter 7 Are for student’s seeking graduate and professional degrees. Based on the parent’s credit history, and is not based on financial need. Copyright© 2011 Money Education, LLC Tax Deferred Savings 13 Allow planning for a college education goal that is 10 or more years away. Allow families to save towards an education goal and permit the account to grow on a tax- deferred basis. If the funds are used for qualified education expenses, then any distributions from the savings accounts are tax-free. Types: • Qualified Tuition Plans –Includes Prepaid Tuition and College Savings Plans • Coverdell Education Savings Accounts • U.S. Government Savings Bonds Internal Revenue Services Publication 970 provides information on education funding. Copyright© 2011 Money Education, LLC Chapter 7 Qualified Tuition Plans or Savings Plans 14 Prepaid Tuition: • Allows a parent to purchase college credits today and use those credits when the child attends college. • Requires parents to reside in the state • Use those credits to attend a college that is part of the state university system. • No income tax consequences to the parents for the difference between the amount paid for the college credits and the current cost of the college credits. Copyright© 2011 Money Education, LLC Chapter 7 College Savings Plans (or 529 Savings Plans) 15 Allow for college saving on a tax-deferred basis with attendance at any eligible education institution. Distributions from a College Savings Plan are federal and state income tax-free, as long as they are used to pay for qualified education expenses. Qualified education expenses include: tuition and fees, books, supplies and equipment as well as room and board for students enrolled at least half-time. Qualified education expenses include computer technology or equipment. A federal income tax deduction is not permitted for contributions to a College Savings Plan. Are no phase-outs (income limitations) on who can contribute to a College Savings Plan. Chapter 7 Copyright© 2011 Money Education, LLC Savings Plans 16 Distributions from a Savings Plan: • Not used for qualified education expenses will result in the earnings portion included in the account owners income as ordinary income. • Earnings may be subject to a 10 percent penalty. Investment options for a Savings Plan includes mutual funds and annuities. Offer a unique advantage for grandparents looking for ways to provide for the grandchildren’s college educations. Assets in a College Savings Plan owned by the parent are considered assets of the parent for financial aid purposes. Copyright© 2011 Money Education, LLC Chapter 7 Coverdell Education Savings Account (ESA) 17 An ESA is a tax deferred trust or custodial account established to pay for qualified higher education or qualified elementary / secondary school expenses. Qualified higher education expenses include tuition, fees, books, room, board, and computer related expenses. Qualified elementary and secondary expenses include tuition, fees, books, supplies, equipment, tutoring, computer related expenses, and special needs services for special needs beneficiaries. Distributions from a Coverdell ESA for qualified education expenses are taxfree, as long as the distribution does not exceed the qualified education expenses, reduced by any financial assistance. Distributions in excess of qualified education expenses or distributions not used for qualified education expenses will cause the earnings to be included in ordinary income and a 10 percent penalty on the earnings. Contributions to a Coverdell ESA are limited to $2,000 per beneficiary, and are not deductible for federal or state income taxes. Copyright© 2011 Money Education, LLC Chapter 7 U.S. Government Series EE and Series I Bonds 18 Can be redeemed to pay for qualified education expenses and the interest earned on the bonds is excluded from taxable income. Qualified education expenses include tuition and fees, but do not include room and board. Must be purchased in the name of the parent (or parents) Bonds must be issued when the owner is at least 24 years old. Must be redeemed in the year that qualified education expenses are incurred. May convert the bonds into a College Savings Plan (529 Plan) or Coverdell Education Savings Account. Chapter 7 Copyright© 2011 Money Education, LLC Student Loan Interest Deduction 19 May deduct up to $2,500 of interest expense per year. Loan proceeds must have been used to pay for qualified education expenses which include tuition and fees, books, supplies, equipment, and other necessary expenses such as transportation, room and board. Copyright© 2011 Money Education, LLC Chapter 7 Loan Forgiveness 20 Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs, and the National Health Service Corps Loan Repayment Program are not taxable. Forgiveness of the remaining balance under incomecontingent repayment and income-based repayment after 25 years in repayment is considered taxable income. Copyright© 2011 Money Education, LLC Chapter 7 Tax Credits for Education Related Expenses 21 Federal tax law permits two types of tax credits for education related expenses: • American Opportunity Tax Credit • Lifetime Learning Credit Credits are a dollar for dollar reduction in any federal income taxes owed. Chapter 7 Copyright© 2011 Money Education, LLC American Opportunity Tax Credit (AOTC) 22 AOTC is currently available for the 2011 tax year. Provides a tax credit of up to $2,500 (2011) per student per year for the first four years of qualified education expenses for postsecondary education. 100% x the first $2,000 of qualified education expenses, plus 25% x the second $2,000 of qualified education expenses. Since the AOTC is “per student,” a family that has multiple children in the first four years of college may qualify for multiple American Opportunity Tax Credits in one year. Qualified education expenses include tuition and fees (including student activity fees) as long as those fees are paid directly to the university. Also includes books, supplies and equipment, but they do not have to be purchased directly from the university. Copyright© 2011 Money Education, LLC Chapter 7 AOTC Example 23 John has two children, Bob and Sara, who are attending the University of Oregon. John pays qualified education expenses of $6,000 for Bob and $3,000 for Sarah. John is entitled to an AOTC of $2,500 for Bob [(100% x $2,000) + (25% x $2,000)] and $2,250 for Sara [(100% x $2,000) + (25% x $1,000)] for a total tax credit of $4,750. Copyright© 2011 Money Education, LLC Chapter 7 Lifetime Learning Credit 24 Provides a tax credit of up to $2,000 (2011) per family for an unlimited number of years of qualified education expenses. Must be related to a postsecondary degree program or to acquire or improve job skills. 20% x qualified education expenses (up to $10,000) Qualified education expenses include tuition and fees, student activity fees, books, supplies and equipment as long as those fees are paid directly to an eligible education institution. Patrick and Jill are married and both have an undergraduate degree. Patrick goes back to school for a certificate in financial planning while Jill goes back to school to earn her master’s degree in nursing. Patrick incurs $5,000 of qualified education expenses and Jill incurs $15,000 of qualified education expenses. Patrick and Jill can take a total Lifetime Learning Credit of $2,000 (($5,000 + $15,000) x 20% limited to $2,000 maximum credit) in the current year. Next year, if Patrick and Jill incur the same amount of qualified education expenses, they can take another $2,000 Lifetime Learning Credit. Chapter 7 Copyright© 2011 Money Education, LLC No Double Dipping on Benefits 25 The general rule is that a taxpayer is not allowed to receive a double benefit for the same expenses. The taxpayer cannot claim both the AOTC and Lifetime Learning Credits for the same child in the same year. The taxpayer cannot claim either the AOTC or Lifetime Learning Credit and the tuition and fees deduction for the same child in the same year. The taxpayer cannot claim the AOTC and the Lifetime Learning Credits for the same qualified education expenses. The taxpayer cannot use the same expenses used for a tax-free distribution from a Qualified Tuition Plan (529 Savings Plan) or Coverdell ESA and use those expenses to calculate an AOTC/Hope or Lifetime Learning Credit. The taxpayer cannot claim an AOTC or Lifetime Learning Credit if the taxpayer received tax-free education assistance such as a scholarship, grant or employer provided education assistance. Copyright© 2011 Money Education, LLC Chapter 7 Summary of Education Related Tax Credits 26 American Opportunity Maximum Amount Lifetime Learning 100% x 1st $2,000 + 25% of 2nd $2,000 Calculation 20% x up to $10,000 $2,500 $2,000 Single: $80k - $90k MFJ: $160 - $180k Single: $51k - $61k MFJ: $102 - $122k Qualified Education Expenses Include Textbook and Equipment Yes – Does not have to be paid directly to university Yes – Only if paid directly to the university Qualified Education Expenses Include Room and Board No No Phase-Out (2011) Phase-Out as of 2011. Copyright© 2011 Money Education, LLC Chapter 7 Scholarships and Fellowships 27 Scholarships are a grant of financial assistance made available to students to assist with the payment of education related expenses. Information can be found on the Federal Student Aid website, https://studentaid.ed.gov and https://studentaid2.ed.gov/getmoney/scholarship/v3browse.asp Fellowships are typically paid to students for work, such as teaching while studying for a Master’s degree or conducting research while working towards a Doctorate of Philosophy degree (Ph.D.). A scholarship or fellowship is tax-free to the recipient if the recipient is: • A candidate for a degree at an eligible education institution, and • The recipient uses the proceeds to pay for qualified education expenses. Qualified education expenses for the purpose of tax-free scholarships and fellowships include tuition and fees, course related expenses such as books, supplies, and equipment that are required by the eligible education institution. Chapter 7 Copyright© 2011 Money Education, LLC IRA Distributions 28 Distributions: • From a traditional IRA are generally included in taxable income. • From a Roth IRA are generally excluded from taxable income. • From an IRA prior to age 59½ are subject to a 10 percent penalty. • If used for qualified education expenses, the 10 percent penalty is waived. Copyright© 2011 Money Education, LLC Chapter 7 Uniform Gift to Minors Act (UGMA) & Uniform Transfer to Minors Act (UTMA) Custodial Accounts 29 UGMA allows minors to own cash or securities. UTMA allows minors to own cash, securities, and real estate. When the child reaches age of majority (18 or 21 depending on the state), the child can access the account without permission of the custodian. Two primary disadvantages to using UGMA / UTMA accounts to fund a college education: • Once a child reaches the age of majority, he can use the assets in an UGMA / UTMA for something other than a college education. • Earnings in the UGMA / UTMA may cause a “kiddie tax” issue. Copyright© 2011 Money Education, LLC Chapter 7 Employer Provided Education Assistance 30 Is a program established by an employer to reimburse employees for education expenses. May or may not be directly related to the employee’s current job duties; it depends on the employer’s policy. Reimbursement of education expenses by an employer, up to $5,250 (2011) per year, is not taxable to the employee. To qualify: • Education assistance program must be in writing • Must be for tuition, fees, books, supplies, and equipment. Chapter 7 Copyright© 2011 Money Education, LLC Education Funding 31 Represents some of the more challenging time value of money calculations. Four primary methods are: • Uneven Cash Flow Method • Traditional Method • Account Balance Method • Hybrid Approach Copyright© 2011 Money Education, LLC Chapter 7 Education Funding Alternatives 32 Additional college education funding alternatives include: • Fully fund the plan today as might a grandparent using a 529 Plan. • Fund the plan from date of birth to the start date of college. • Fund the plan from date of birth through the expected college years (or some other fixed period). • Fund the savings in an ordinary annuity funding plan on a monthly or yearly basis. • Fund the savings in an annuity due funding plan on a monthly, yearly, or serial payment. Copyright© 2011 Money Education, LLC Chapter 7 Uneven Cash Flow Method 33 Is a good approach for education funding calculations because it is only two steps and it works for any type of education funding situation. The uneven cash flow method has two steps: 1. Determine the net present value of the cash flow stream in today’s dollars. 2. Determine the annual savings required to fund the education goal. Chapter 7 Copyright© 2011 Money Education, LLC Saving Until the Child Reaches College Age 34 Jan wants to plan for her daughter’s education. Her daughter, Rachel was born today and will go to college at age 18 for five years. Tuition is currently $15,000 per year, in today’s dollars. Jan anticipates tuition inflation of 7% and believes she can earn an 11% return on her investment. How much must Jan save at the end of each year, if she wants to make her last payment at the beginning of her daughter’s first year of college? Copyright© 2011 Money Education, LLC Chapter 7 Determine the NPV 35 Copyright© 2011 Money Education, LLC Chapter 7 Determine the Annual Savings 36 Chapter 7 Copyright© 2011 Money Education, LLC Saving Until the Child’s Last Year of College 37 Assume that Julie decides to save until the beginning of her daughter’s last year of college, how much would Julie have to save at the end of each year to meet her goal? Recall the other facts are: tuition is currently $15,000 per year, tuition inflation is 7%, Julie’s investment return is expected to be 7%, and her daughter will go to college at age 18 for five years. Copyright© 2011 Money Education, LLC Chapter 7 Determine the NPV 38 Copyright© 2011 Money Education, LLC Chapter 7 Determine the Annual Savings 39 Chapter 7 Copyright© 2011 Money Education, LLC Multiple Children 40 Best approach to use in calculating education funding for multiple children is using the uneven cash flow method. Jill has two children, Sydney age 5 and William age 2. Jill wants to provide for their education funding. Currently, tuition is $10,000 per year and tuition inflation is 6%. Jill expects to earn 10% on her investments and she expects the children to start college at age 18 and go to college for 4 years. Jill wants her last savings payment to be made when the oldest child starts college. How much must Jill save at the end of each year? Copyright© 2011 Money Education, LLC Chapter 7 Determine the NPV 41 Copyright© 2011 Money Education, LLC Chapter 7 Determine the Annual Savings 42 Chapter 7 Copyright© 2011 Money Education, LLC Traditional Method 43 Uses real dollars and the annuity due funding plan to calculate the present value of the cost of education. Robin wants to plan for her daughter’s education. Her daughter, Reese was born today and will go to college at age 18 for five years. Tuition is currently $15,000 per year, in today’s dollars. Robin anticipates tuition inflation of 7% and believes she can earn an 11% return on her investment. How much must Robin save at the end of each year, if she wants to make her last payment at the beginning of her daughter’s first year of college? Copyright© 2011 Money Education, LLC Chapter 7 Determine the Present Value at Age 18 44 Copyright© 2011 Money Education, LLC Chapter 7 Determine the Present Value at Age Zero 45 Chapter 7 Copyright© 2011 Money Education, LLC Grandparent Opportunity 46 Copyright© 2011 Money Education, LLC Chapter 7 Summary of Savings Options 47 Present a client with alternative strategies to save for a college education. Lower the amount of annual savings required include continuing to save while the child is in college and making savings payments at the beginning of each year. Saving Until Age 18 Saving Through College (Age 22) Saving Through College (Age 22) and Saving at the Beginning of Each Year Annual Savings $4,680.37 $4,408.95 $3,928.45 Total Savings Contributions $84,246.66 $96,996.90 $90,354.35 Copyright© 2011 Money Education, LLC Chapter 7 Account Balance Method 48 Is a three-step approach that determines the lump-sum amount needed when the child starts college, and how much must be saved to attain that lump-sum amount. Seth was born today. Harold and Maude Clark anticipate that Seth will begin college at age 18. College education expenses are $25,000 per year in today’s dollars and are expected to increase at an annual rate of six percent. The Clarks can earn an after-tax annual return of 11 percent. How much should the Clarks deposit at the end of each year to pay for Seth’s education. The last deposit will be made when Seth reaches his 18th birthday. Chapter 7 Copyright© 2011 Money Education, LLC Calculate the FV Cost 49 Copyright© 2011 Money Education, LLC Chapter 7 Calculate the Education Funding Needed 50 Copyright© 2011 Money Education, LLC Chapter 7 Calculate Annual Savings Needed 51 Chapter 7 Copyright© 2011 Money Education, LLC Conclusion 52 Paying for their children’s college education is one of the top two or three largest financial goals. Financial planner should help the client prioritize how to allocate their cash flow and savings. Paying off a mortgage, fully funding a retirement, and saving an adequate amount for education may not be possible for some families. Tax deferred savings is an ideal way to save for education funding for clients with the means to save for a college education and a time horizon greater than 10 years. Chapter 7 Copyright© 2011 Money Education, LLC ...
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