Funding your child's college education

Contribution Limits

• Up to $2,000 per child (under age 18) for con­tributors with modified adjusted gross income of $190,000 if filing jointly or $95,000 for single filers. The maximum is reduced and gradually phased out for those with modified adjusted gross income between $190,000 and $220,000 (joint filers) or between $95,000 and $110,000 (single filers). Those who exceed these income limits are not eligible to make contri­bu­tions.

Tax Treatment

• Tax-deferred growth.
• Earnings are tax-free if used for eligible educa­tion expenses, which include room and board, tuition, books, supplies and equipment, academic tutoring, and special needs services.

Control of Assets

• Responsible individual (generally a parent or guardian)

Restrictions

• To avoid penalty, must be used for eligible education expenses
• Must use funds by the time the beneficiary reaches age 30

Financial Aid Impact

• Treated as an asset of the account owner. If the account owner is the student, this has a high impact on financial aid eligibility. The Higher Education Reconciliation Act of 2005 added special treatment for Coverdell, Prepaid Tuition, and 529 College Savings Plan accounts owned by a dependent student. The impact on need-based aid for dependent students will therefore be minimal. If the account owner is the parent, this has a low impact on financial aid eligibility. Qualified distributions from a Coverdell account are not counted as income on the FAFSA and thus do not reduce financial aid eligibility.¹

Pros

• Account can be transferred to another relative of the beneficiary
• Adults other than parent can make contributions
• Can be used for elementary, secondary and higher education

Cons

• Not available to high-income families
• Low contribution limit
• Penalty for withdrawals not used to pay eligible education expenses

Note: One important feature of these tax benefits is the "sunset" provision which sets a limited time for the changes to apply. All new provisions of the Economic Growth and Tax Relief Recon­cili­a­tion Act of 2001 expire after December 31, 2010. On January 1, 2011, all tax provisions in effect prior to signing of the Act will be reinstated if future legisla­tion is not passed ($500 annual limit).

Additional Resource

Coverdell Education Savings Account

Contribution Limits

• None

Tax Treatment

• Since 2008, the first $900 of a child's investment income is tax free and the next $900 is taxed at his or her own rate, but any unearned income in excess of $1,800 is taxed at the parents' presumably higher tax rate.
• In 2008, the kiddie tax was expanded to include dependents under 19 and dependent full-time students under 24. Children who provide more than half of their own support are not affected by this kiddie-tax change.

Control of Assets

• Custodian (until the child reaches age prescribed under applicable UGMA or UTMA)

Restrictions

• Must be used for benefit of child

Financial Aid Impact

• For financial aid purposes, custodial accounts are considered assets of the student. This means there is a high impact on financial aid eligibility.

Pros

• No contribution limits based on family income
• Adults other than parent can make contributions

• No tax-advantaged growth
• Contributions are not deductible
• Child gains control of assets at age prescribed under applicable UGMA or UTMA

Additional Resource

• UGMA/UTMA Custodial Account

Contribution Limits

• Depends on plan rules, but typically ranges from $15,000 to $30,000

Tax Treatment

• Tax-deferred growth
• Withdrawals are federal income tax-free if used for qualified higher education expenses

Control of Assets

• Adult in whose name the account is registered (account owner)

Restrictions

• Usually must attend school in state that sponsors the plan
• Must be used to pay for qualified higher education expenses

Financial Aid Impact

• Depends on whether they are owned by the student or the parent. Please see FinAid.org for specific information

Pros

• No contribution limits based on family income
• Adults other than parent can make contributions

Cons

• Penalty on withdrawals that don't qualify as higher education expense
• Plans frequently offer low rate of return
• Use of funds may be limited to in-state schools or particular institution

Contribution Limits

• Depends on plan, but contribution limit is typically based on estimated cost of colleges in a particular state or region for 4 years (and in some cases, an additional 2 years)

Tax Treatment

• Earnings are free from federal (and possibly state) income taxes
• Withdrawals are federal income tax-free if used for qualified higher education expenses
• Potential gift tax and estate tax savings
• The availability of such tax or other benefits may be conditioned on meeting certain requirements

Control of Assets

• Adult in whose name the account is registered. The account is registered for the benefit of the student (designated beneficiary), but the control remains with either the donor or the account owner

Restrictions

• Must be used to pay for qualified higher education expenses in order to avoid penalty

Financial Aid Impact

• Depends on whether they are owned by the student or the parent. Please see FinAid.org for specific information

Pros

• Contribution limits are based on cost of higher education rather than family income
• Adults other than parent can make contributions
• May be used at any eligible higher-education institution in the U.S. and some abroad

Cons

• Penalty on withdrawals that don't qualify as higher education expense
• Limited flexibility once money is invested (can change investment strategy once per calendar year)

Additional Resource

The State Farm® College Savings Plan