Topic 6

Education Planning

Topic 6: Education Planning

• Learning Objectives – (a) Calculate the funds needed to meet the

education goals of a client. – (b) Recommend the appropriate use of funding

sources including loans, scholarships, grants, and fellowships in funding education.

– (c) Compare, contrast and recommend appropriate education savings vehicles given tax implications, risk tolerance, investment alternatives, and funds needed.

Topic 6: Education Planning

• Needs analysis • Tax credits/ adjustments / deductions • Funding strategies • Ownership of assets • Vehicles

Topic 6: Needs Analysis

• Planning for education funding will typically require calculating the amount that will be needed to pay for four years of expenses at a college or university and then determining the amount that must be saved annually to reach that goal

Topic 6: Needs Analysis Example - Step 1

• Paige and Jason have a two year old son Caden. Approximately how much will they need for Caden’s freshman tuition in 16 years from today if tuition is currently $10,000 a year and tuition is expected to increase 7% a year?

• Answer = $29,500 – N = 16, I = 7, PV = 10,000, PMT = 0, Solve for FV

which is $29,522

Topic 6: Needs Analysis Example - Step 2

• Approximately how much do Paige and Jason need to have saved by the time Caden starts school in order to pay for all 5 years of his college tuition if tuition inflation remains at 7% and their investments earn 5% ?

• Answer = $153,000 – N = 5, I = (1.05 / 1.07 – 1) x 100 = -1.8692, PMT =

29,522, FV = 0, Solve for PV using begin mode which is $153,341

Topic 6: Needs Analysis Example - Step 3 (Lump Sum)

• Approximately how much do Paige and Jason need to set aside today to pay for all 5 years of Caden’s college tuition if they earn 5% on their investments?

• Answer = $70,000 – N = 16, I = 5, PMT = 0, FV = 153,341, Solve for PV

which is $70,247

Topic 6: Needs Analysis Example - Step 3 (Monthly Payments)

• Approximately how much do Paige and Jason need to save at the end of each month to have the funds needed when Caden starts school to pay for all 5 years of Caden’s college tuition if they earn 5% on their investments?

• Answer = $525 – N = 16 x 12 = 192, I = 5/12 = 0.4167, PV = 0, FV =

153,341, Solve for PMT which is $523

Topic 6: Needs Analysis Example - Cash Flow Lump Sum

• Short cut method to solve for the amount Paige and Jason need to set aside today to fund Caden’s education

• Year Cash Flow • 0 0 • 1 – 15 0 • 16 – 20 10,000 • Input above cash flows and the inflation adjusted rate of

return ((1.05 / 1.07 – 1) x 100 = -1.869159), then solve for NPV which is $70,247 – Note: Used six digits on interest rate to eliminate rounding

difference

Topic 6: Tax Credits• American Opportunity Tax Credit

– Formerly called Hope Scholarship Credit – Up to a $2,500 tax credit – Only eligible during first 4 years of college – AGI phaseout starts at $80,000 and $160,000 for single and

married taxpayers, respectively in 2015 • Lifetime Learning Credit

– Up to a $2,000 tax credit – Do not need to be a full-time student – AGI phaseout starts at – $55,000 in 2015 for single taxpayers – $110,000 in 2015 for married taxpayers

• Child can claim either credit if parents’ AGI exceeds the threshold

Topic 6: Tax Adjustments / Deductions

• An above-the-line deduction of up to $2,500 may be taken annually for interest paid on qualified higher education loans – The deduction phases out between $65,000 and $80,000 for singles

and between $130,000 and $160,000 for married taxpayers in 2015 • Expired for 2015: an above-the-line deduction of up to $4,000

annually for qualified educational expenses – The $4,000 deduction was allowed for taxpayers with an AGI under

$130,000 for married taxpayers and $65,000 for all other taxpayers – The deduction was reduced to $2,000 for taxpayers with an AGI in

excess of the above amounts but below $160,000 for married taxpayers and $80,000 for all other taxpayers

Topic 6: Funding Strategies

• There are several different ways for a parent to fund a college education besides saving money in the parent’s investment account or relying on tax credits and deductions

• The most commonly used techniques include – Transferring assets to a child or a trust – 529 plans – ESAs – UGMAs and UTMAs – Savings bonds

Topic 6: Ownership of Assets

• Most clients prefer to keep control over the assets earmarked for education – There are some tax advantages for transferring

these assets to a child or a trust – Watch out for the Kiddie Tax rules which cause any

unearned income above $2,100 (2015) for a child under the age of 19 (24 if a student) to be taxed at the parents’ marginal tax bracket

Topic 6: 529 Plans

• Money can be set aside in special accounts, usually in mutual funds, to grow on a tax-deferred basis – Can front load account with 5 years of annual gift tax exclusions

• Money can be taken out tax-free if used to pay qualified education expenses, including tuition, room and board, travel, and other costs – Monies withdrawn for purposes other than education are

taxable and carry a 10% penalty tax • If the child named as beneficiary of the plan elects not to

go to college, the money can be rolled over to a 529 plan for another child

Topic 6: Coverdell Education Savings Accounts (ESA)

• Coverdell education savings accounts (ESAs) allow for nondeductible contributions up to $2,000 per year per child – Phased out for married taxpayers filing jointly with a modified

adjusted gross income of $190,000 - $220,000 – Contributions can be made in any year until the time the child

reaches age 18 • After age 18 for children with special educational needs

• Distributions from the account are tax-free if used to pay any of a wide variety of “qualified education expenses” – Includes K-12 expenses

Topic 6: UTMAs and UGMAs

• UTMA – Uniform Transfers to Minors Act• UGMA – Uniform Gifts to Minors Act• Advantages – The funds are held in a custodial account

• Disadvantages – Kiddie tax rules will apply – The child will have access to the account at age 18

or 21 depending on state law

Topic 6: Savings Bonds• The interest earnings on EE bonds purchased after 1989

are federally income-tax-free if an amount equal to the proceeds is used to pay college tuition and fees – Bonds must have been purchased after 1989 and the purchaser

must have been at least 24 years old when the bonds were purchased

– Parental income must be below specified levels to take full advantage of the deduction (in 2015, $77,200 for single parents and $115,750 for joint filers) • the income that determines the availability of the deduction is in the

year the bonds are redeemed

– If a parent is using the bonds for a child’s education they cannot be registered in the name of the child • It is permissible for the child to be listed as a beneficiary on the bond,

but the child cannot be a co-owner

Topic 6: Financial Aid

• Pell Grants and Supplemental Educational Opportunity Grants (SEOGs) – Both are grants rather than loans – Available for undergraduate students only – Students must show financial need

• Perkins loans – Federal loans administered by the child’s college – Available for graduate and undergraduate students – Students must show financial need – No interest is charged while the student is in school and for

nine months after graduation until required payments begin

Topic 6: Financial Aid (cont.)• Stafford loans

– Subsidized loans • Based upon need • Federal government pays the interest while the student is in school

and for six months after graduation

– Unsubsidized loan • Interest accrues from the date of loan; however, payments may be

deferred

• Parent Loans for Undergraduate Students (PLUS loans) – Loans not based upon need – Available only for parents of undergraduate students or for

professional / graduate students – Interest accrues from the date of loan; however, payments

may be deferred

Topic 6: Other Loan Alternatives for Parents

• Home equity loans – Interest on up to $100,000 of home equity debt

may be tax deductible – Competitive interest rates

• Loans from cash value life insurance – Low interest rates – Income tax-free – No required repayment schedule – Death benefit reduced by outstanding loans

Topic 6: Nonfinancial Planning for Higher Education

• High school courses for college credits • Take challenging and appropriate classes in

high school • Extracurricular activities • Paid and/or volunteer work • Taking PSAT, SAT, and ACT exams • Researching scholarships • Learning to manage money and live on a

budget

End of Topic 6