Current tax laws provide great education savings incentives, but how long will they last?
Parents faced with the challenge of funding their children’s education received some real relief with the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001. But the cloud to that silver lining is that the entire bill “sunsets” on December 31, 2010, and tax laws revert back to the 2001 levels. It will literally take an act of Congress to prevent it. But the Bush Administration is back at it, trying to make this bill permanent.
Whether or not that will happen is anybody’s guess. Knowing what Congress will do ten, five or even one year down the road is as tricky as knowing where the stock market will be in a year. If you’re serious about helping finance your child’s education, you should start planning and saving now, regardless of what the rules may or may not be down the road.
Reasons to Get Started Now
For parents who want to save for their children’s education, now is the time to start planning. The cost of a college education continues to grow at nearly three times the rate of inflation. When on-campus housing, books, supplies, transportation and other personal costs are factored in, the average cost to attend a public four-year university or college for one year is $10,636, and $26,584 at a private institution.
Besides, the favorable provisions of the current law are simply too good for education savers to pass up. If you’re not taking advantage of them, you may be missing the boat.
By starting a college funding program sooner rather than later, you have a greater ability to maximize the benefits of compounding, Not only that, but now is the time to take full advantage of these savings programs at current levels, which may or may not last.
Here are some of the advantages available to college savers under the current tax law:
- Contribution limit for Coverdell Education Savings Accounts currently $2,000 per child from birth through age 17 (was $500 in 2001). Additionally, more taxpayers can establish a Coverdell Education Savings Account (formerly Education IRA) because the adjusted gross income “phase-outs” for joint filers are now double that of single filers—$190,000 to $220,000.
- When it comes to taking distributions, “qualified expenses” now cover elementary and secondary tuition and expenses in either public or private schools. Prior to 2001, such expenses covered only tutoring, computer equipment, room and board, and extended day care.
- Extension of the annual deadline for making contributions from December 31 of the tax year to the tax filing deadline on the following April 15th—the same as for traditional and Roth IRAs.
Why Were The Changes So Significant?
Coverdell Savings Education Accounts offer parents and/or grandparents excellent vehicles to invest money to be used for qualified education expenses and let the earnings grow on a tax-deferred basis. For example, parents who are able to save $2,000 a year in an Education IRA over 17 years with an investment earning eight percent per year (compounded annually) could see their $34,000 investment grow tax-deferred to $72,900. Although the initial contribution is not tax-deductible, the account grows tax-deferred and distributions from the account are also tax-free as long as they are used to pay for the beneficiary’s education expenses—a big benefit to anyone saving for education.
Another benefit to parents is that the current tax law impacts distributions from qualified prepaid tuition programs such as Section 529 plans. Prior to 2001, these distributions were taxed at the student’s top marginal income tax rate. However, until the current law sunsets in 2011, all distributions from these plans are excluded from gross income as long as the money is used to pay for qualified higher education expenses.
Where to Begin
When you look at the entire pool of options available to help save for the cost of your children’s education, selecting the right tools can become a daunting task. Consider taking some or all of the following steps to ensure you make the most of the tax incentives available as you save for your child’s education:
- Meet with a trusted financial professional. He or she will be able to help you sort through all your options based upon your financial picture, investment objectives and time frame. A qualified financial representative can also provide assistance in selecting savings and/or investment vehicles appropriate to your risk tolerance level.
- Develop a plan. It’s almost impossible to reach your destination if you don’t chart your course ahead of time. Your child’s education and your future financial well being hang in the balance. Make sure you have a realistic plan in place that will help you accomplish your goals.
- Review and stick to your plan. Don’t stray from the steps outlined in your plan and make adjustments necessary to keep pace with any changes. A quality education is one of the greatest gifts you can give to your child. Remember that your dedication to this goal will be appreciated and have an enduring impact long after graduation day. iBi
