Mutual Fund Education Alliance - Section

Custodial Accounts (UGMA/UTMA)
An adult can establish a "custodial" account in the name of a minor, wherein any gains are taxed at the child's tax rate (10%). Depending on state laws, the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) allows adults to transfer up to $12,000 tax-free per year to a custodial account as a gift. The UTMA permits ownership of all property, whereas the UGMA is limited to securities. In both, the custodian may control the assets until the minor reaches the age of 18, 21 or 25, depending on state laws. Such an account offers an additional advantage over an account established in your own name: It may prove easier to maintain a college investment program in an account legally named and earmarked for your child. However, colleges will consider a higher percentage of money held in custodial accounts than in normal accounts when making financial aid eligibility decisions.

Trusts
Another account option for a college investment plan is a trust account, which can stipulate exactly how and when a recipient is to spend the funds. However, trusts can be costly to establish, may require an attorney and may disqualify your child from receiving financial aid, because trusts must be included in calculations for financial aid eligibility.

Account Type	Advantages	Disadvantages
Account in Parent's Name	Simple to establish. Only a small percentage of assets are considered in financial aid qualification criteria.	Taxed at parent's rate, usually higher than the child's.
Custodial Accounts (UGMA and UTMA)	Parental control until child reaches 18 or 21, depending on the state. Discipline: funds are earmarked for the child. Investment earnings of up to $850 gross are tax-free. Income of $851 to $1,700 are taxed at child's rate (often 10%), which is usually lower than parent's. Earnings over $1,700 taxed at parent's rate.	Transfer is irrevocable. Loss of parental control when child reaches 18 or 21, depending on the state. 35% of assets considered in financial aid criteria.
Trust Accounts	Parent retains control over investments, withdrawals and spending.	Expensive and complex to establish and administer. Lawyer needed. Even if not designated for college tuition, funds may be counted in financial aid calculation.

Coverdell Education Savings Accounts (Education IRAs)
Coverdell Education Savings Accounts can represent a substantial part of a tuition investment plan. Although contributions are non-deductible, you are now able to contribute up to $2,000 per year, and your investment grows tax-free. Individuals earning as much as $95,000 ($110,000 joint) can make maximum contributions. The contribution allowance gets phased out and disappears at incomes of $110,000 (single) and $220,000 (joint). Funds can be withdrawn penalty-free to be used for any of the child’s educational expenses--from grade school to grad school.

If your child decides not to go to college, the account must be withdrawn by the time they are 30 years old, and they would have to pay taxes and a 10% penalty on the withdrawals. If there are funds remaining, the balance can be rolled into an Education IRA for another child under 30 years old in the same family. Before investing in an Education IRA, we suggest checking with your personal financial advisor and/or tax advisor as to any potential effects it may have on your eligibility for financial aid.

Gifts, Financial Aid and Other Resources
There is no single best method for meeting tuition expenses. But determining ways to cut costs are important for all tuition planners. Although many parents cover most of the costs themselves, other sources, such as family gifts, financial aid or tax breaks, often prove to be crucial in supplementing college investment programs.

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529 Plans
Depending on which state you live in, 529 Plans offer a variety of benefits. The biggest one is that all distribution taken from a 529 Plan to help meet qualified higher education expenses are not subject to federal income tax.

529 Plans also offer another important tax advantage. As you may be aware, you are generally allowed to give up to $12,000 a year to another person without triggering federal gift tax, which can be as high as 55%. With a 529 Plan, you may contribute as much as $60,000 in one year ($120,000 for married couples) for the benefit of each child. This $60,000 contribution is, in effect, treated as five separate $12,000 gifts--one for the current year and one for each of the next four years. As long as you don’t make another gift to the child during this five-year time frame, you do not incur the gift tax on dollars contributed to the 529 Plan.

Prepaid Tuition Plans
Various states now offer college savings plans that allow parents to lock in a guarantee that the funds will grow in line with future tuition increases. The advantage of Prepaid Tuition Plans is that earnings will be subject to federal taxes only at the child's rate. The potential disadvantage is that contributors may miss out on higher returns from equity securities, which historically have outpaced the rate of tuition inflation. States that do offer Prepaid Tuition Plans don’t always permit you to use assets for colleges located outside the state. Others may allow you to use the assets for out-of-state colleges but extract a portion of the return for the privilege, while others don’t impose any penalty at all.

College Savings Plans
These are more investment-oriented than Prepaid Tuition Plans. Your assets are not guaranteed a rate of return. Rather, they are invested in diversified, professionally managed portfolios of stocks, bonds and money market instruments. Some states manage the assets themselves; others hire professional outside managers to perform this task.

Some College Savings Plans offer asset allocation according to the age of the child, such that stocks occupy the lion’s share of the assets while the child is young and bonds become predominant as the child approaches college age, when preservation of capital becomes more important.

Loans
The most common way to finance college expenses is through borrowing. In fact, almost half of all undergraduates take out loans to finance college, and the average student borrower graduates with $13,000 of debt. Some of the most popular loans include:

· Perkins loans. The neediest students qualify for Perkins loans, which have the lowest interest rate--5%. The government gives a lump sum to participating colleges, which then lend the money to students. Repayment usually begins nine months after graduation but may be deferred if, for example, the student serves in the Peace Corps or the military. Undergraduates can usually borrow up to $4,000 per year.

· Stafford loans (unsubsidized). Unsubsidized Stafford loans do not require students to prove financial need, although they do need to apply for financial aid. Interest (currently at 6.8%) starts accruing immediately, but students can defer payments of interest and principal until six months after graduation. A dependent undergraduate can borrow up to $2,625 as a freshman, $3,500 as a sophomore and up to $5,500 for juniors and seniors, with the total borrowed capped at $23,000.

· Stafford loans (subsidized). Subsidized Stafford loans are based on proven financial need, and the federal government pays the interest on these loans while the student is enrolled in college. Like the unsubsidized Stafford loan, repayment of interest and principal can be deferred until six months after graduation, and the amount that can be borrowed is the same.

· PLUS (Parents' Loans for Undergraduate Students). If there is still unmet financial need, creditworthy parents can borrow up to that remaining amount through low-interest PLUS loans (currently at 8.5%). Interest on these loans begins accruing immediately, and repayment generally starts 60 days after the loan is made. Lenders may charge various fees in addition to the interest due.

Merit Aid and Scholarships
Rather than being based on financial need, there are several forms of aid based on nonfinancial factors. Because colleges want to attract the best students, merit aid is available to students who have exceptional academic records, talent or athletic ability.

There are also a variety of private scholarships available from clubs, organizations, corporations and foundations. However, the time spent writing essays for these private scholarships would be better used looking for major sources from the government, states and colleges. Often these scholarships are small (the average award is just $2,050), and a college may reduce the amount of a grant or loan in a student's financial aid package by the amount received from these other scholarship funds.

Work-Study
Many financial aid packages include a job for the student that is subsidized by the Federal Work-Study Program. However, there are limits on earnings and hours, so this is often not a significant part of a financial aid package. Some students might figure they would make more money working off campus. But the federal government, when determining aid, expects students to contribute half of their outside earnings above a certain amount toward college.