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
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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
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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
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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
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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
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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