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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
• How much is current tuition?
• How much is tuition expected to increase in the future?
• What other costs are associated with a college
• 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
• 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
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
• 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.
Federal Pell Grant
Teacher Education Assistance for College and Higher Education
Academic Competitiveness Grant (ACG)
National Science and Mathematics Access to Retain Talent
Federal Supplemental Educational Opportunity Grant (FSEOG) Copyright© 2011 Money Education, LLC Chapter 7 Financial Aid – Loans
11 Stafford Loans are administered by the U.S. Department of
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
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
Copyright© 2011 Money Education, LLC Tax Deferred Savings
13 Allow planning for a college education goal that is 10 or more years
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.
Qualified Tuition Plans –Includes Prepaid Tuition and College
Coverdell Education Savings Accounts
U.S. Government Savings Bonds
Internal Revenue Services Publication 970 provides information on
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
Qualified education expenses include: tuition and fees, books, supplies
and equipment as well as room and board for students enrolled at least
Qualified education expenses include computer technology or
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
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
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
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
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,
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
• From a traditional IRA are generally included in taxable
• From a Roth IRA are generally excluded from taxable
• From an IRA prior to age 59½ are subject to a 10
• 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
Earnings in the UGMA / UTMA may cause a “kiddie tax”
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
• 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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