Free Education Cost Worksheet

The "Earnings Growth Rate" column can be used to project an annual earnings and/or appreciation rate for your investments. The rate will depend on the type of investment(s) that you choose. (See Investments for more information.) The average stock mutual fund earned approximately 15% per year over the past 18 years, whereas Series EE Savings Bonds are paying a mere 5% or so per year. Most financial planners recommend that you invest in more volatile securities if you have a good number of years before you will need the cash, and that you gradually shift those savings into less volatile, lower-return investments as your child approaches college age. However, for purposes of this worksheet, you must estimate an average, blended rate of return for the entire period.

If all earnings will be reinvested in the account so that it compounds, then enter the full expected rate of return on the investment. However, if all or a portion of the earnings will be withdrawn to be used for other purposes, including paying income taxes on those earnings, then reduce the rate of return accordingly.

Example. Your child is 5 years old. Because you have 13 years before you will need to pay for college, you have chosen to make periodic contributions into a high-volatility stock mutual fund. Based on historical data and/or projected assumptions, you estimate that the fund will earn an average of 12 percent per year. But, when your child reaches age 13 and therefore has only 5 more years before college, you plan to gradually shift your savings from the high-volatility fund into a low-volatility fund and eventually into a money market fund. You do not expect to need any of the earnings for other purposes and therefore you plan to reinvest all earnings, AND you expect that you can afford to pay the income taxes on those earnings from other sources each year. Therefore, you decide that a reasonable blended rate of return for the entire savings period for this child is 10 percent. (If, instead, you expected to need to withdraw from the investment an amount each April to cover the income taxes attributable to the earnings, then you would reduce that 10 percent rate by your estimated income tax bracket percentage, such as 28%, which would result in an expected earnings growth rate of 7.2%.)

The cost of attending college represents one of the largest expenditures ever to be incurred by parents. Planning and saving for college should begin as early as possible. This interview will assist you by estimating how much you will need to save on an annual basis. Using suggestions from the program hints, you will enter details regarding the expected cost of college for your child and the expected earnings on your college savings. The interview will then print an investment schedule for each child. This schedule can serve as your investment goal, which can be reviewed and revised as conditions and assumptions change. The interview also provides recommendations and information about what types of investments to consider, education tax incentives, and college financial aid.

The Taxpayer Relief Act of 1997 provides some help to low- and middle-income families paying for college. The restrictions and qualifications are lengthy and you should consult with your tax advisor for full details, but the following is an oversimplified description of several of the provisions.

Hope Scholarship Credit. This is a tax credit of up to $1500 per student for tuition and fees paid during the first two years of college. This credit is not available for joint filers with adjusted gross income over $100,000.

Lifetime Learning Credit. This is a tax credit of up to $1000 ($2000 beginning in 2003) per (parent's) tax return for tuition and fees paid during any year of college. This credit is not available for joint filers with adjusted gross income over $100,000.

Education IRA. You can contribute up to $500 per student per year (from birth to age 18) into an IRA to be spent only for college tuition and fees, room and board, books and equipment. The contributions are made after-tax (no deduction) but the earnings are never taxed, so all withdrawals are tax-free. Contributions cannot be made by joint filers who have an adjusted gross income over $160,000 (but grandparents or others could contribute instead). (Note: for financial aid purposes, because the Education IRA is in the student's name, each year (s)he will be expected to contribute 50% of the withdrawals ("income") and 35% of the principal of the account.)

(Note: You must choose between the Hope Scholarship Credit, the Lifetime Learning Credit or tax-free Education IRA withdrawals related to the same student in any given year.)

(Retirement) IRA Withdrawals. Withdrawals from a Regular IRA or Roth IRA to pay college costs are exempt from the normal 10% early-withdrawal penalty.

Deductible Interest. Interest paid on qualified education loans can be deducted (whether or not you itemize deductions) for the first 5 years that interest payments are required. The deduction is limited to $1,500 in 1999, $2,000 in 2000 and $2,500 in 2001 and beyond. This deduction is not available for joint filers with adjusted gross income over $75,000.

Qualified State Tuition Programs.

1. Prepaid Tuition Plans. Tuition and fees, room and board, books and equipment can be prepaid to a chosen college, usually at today's rates. "Earnings" on the account (i.e., the excess of the total value received over the amount invested) are tax-deferred (but not tax-free) until the child begins attending the college and therefore begins "using" the account.
   
2. Savings Plans. Many states offer a state-sponsored savings plan (some are open to residents and nonresidents alike) with the mix of securities selected and adjusted (for levels of risk and liquidity) as is considered appropriate to the child's remaining number of years before entering college. The contributions are made after-tax (no deduction) but the earnings are tax-deferred (until withdrawn to pay for college expenses) and then taxed at the student's (usually lower) rate, EVEN THOUGH such withdrawals remain under the direction and control of the contributor (i.e., parent or grandparent). The plans are available to contributors in any income tax bracket, and the maximum contribution per student is determined by the individual state; some states offer a per-student ceiling of well over $100,000 (limited to the estimated maximum amount that might be needed for the student's undergraduate college career). An estate-planning advantage: the account's value is shifted from the contributor's estate to the student's estate.

Typically, early in the year when your child will enter college, you will fill out a financial aid application form listing your family's assets, liabilities, income, and other personal information. You will receive a report indicating the amount of your "expected family contribution" (EFC). The amount of your EFC may surprise you. The formula is complex and includes many variables, but as an example, parents may be expected to contribute each year an amount equal to 5.6% of your assets (net of liabilities, and excluding your residence, auto, household items and retirement accounts) and 47% of your after-tax income (voluntary contributions to your retirement accounts are treated as if you received them). The student is expected to contribute 35% of his or her assets (including any retirement accounts) and 50% of his or her income. Your EFC will be reduced if you have more than one student in college at the same time. Some private colleges require that you also complete their own application form and perhaps report the amount of equity in your home, the family farm or business, and the assets of all of your children.

The report showing your EFC will also be provided to the school(s) that your child has applied to for admission, and you will receive a report from each school indicating the total "cost of attendance" (COA) at that school, minus your EFC, resulting in the amount of financial need. The school's financial aid office will attempt to cover this financial need with a financial aid package which may include grants, work programs, and loans. Scholarships are usually awarded based on merit and are not considered "financial aid." If the college cannot meet all of the student's financial need, the student must furnish the difference if (s)he expects to attend that college. The type of financial aid offered can depend on the student's merit (grades, achievements, etc.). Prospective students who would rank in the top 10% of the incoming freshman class are much more likely to receive more (free) grant aid and less loans than students who are average or below average. The college obviously wants to enroll the more academically-attractive students. Also, private colleges, using contributions from alumni and corporations, are often able to offer more (free) grant aid than public colleges in an attempt to equalize the net cost to the student so that they can compete effectively for the best students. Therefore, you should not automatically assume that a private college is unaffordable.

Upon receiving the financial package offers from several schools, you can then compare them and perhaps even negotiate for a better package at your preferred school by citing a more attractive financial aid package offered by a competing school. Your negotiation success will depend on the school's ability to be more generous (private schools usually have more flexibility), as well as how much that school would like to enroll your child. Good high school grades and standardized test scores and a well-rounded record of extracurricular activities will clearly improve your chances.

Because the cost of college is staggering and still rising faster than inflation, you want your college savings to grow as fast as possible. Stocks have historically earned the highest long-term returns when compared to other types of investments. But stocks can be quite volatile in the short term, just when you might need to sell them to pay for college. The rule of thumb is: "the higher the risk, the higher the return." The "risk" with stocks is that some stocks provide a high rate of return, others a low rate, some lose a modest amount, and still others become completely worthless. And the stock market as a whole goes through peaks and valleys in terms of growth. However, the first of these two problems -- volatility of individual stocks -- can be addressed by investing in a "mutual fund" of stocks, made up of hundreds of companies. The gains generated by the high performers are balanced against the losers, and result in a more stable return which is still higher ON AVERAGE than what could be gained with fixed income investments. The second problem -- volatility of all stocks together -- should be handled by balancing your portfolio among stocks and other more stable investments, with the ratio dependent upon the number of years before you will need to cash in the investment. For example, if you have 10 years or more before you will need the investments to pay for college, consider investing a large percentage, or all, of your college funds in a high-quality stock mutual fund. When you are within 5 years of your child beginning college, gradually shift your investments (both new investments and those in stocks) into fixed income securities (bonds, money market funds, certificates of deposits, etc.). In this way, you can better avoid having to sell stocks to pay for college when the stock market may be depressed. Consult a financial advisor for more information.

Finally, do not neglect your regular savings program for your retirement, in favor of saving for college. Saving into tax deferred retirement accounts is usually the best possible investment that you can make. Furthermore, your retirement accounts are ignored in the college financial aid formula. And, if necessary, you can use your retirement savings to pay for college by either withdrawing (without penalty) from your IRA accounts or taking a loan from your 401(k) plan.

Parents can gift assets to their children either outright or perhaps through a custodial or trust arrangement. There are many good reasons to consider shifting assets to a child in this way, the primary reason being that the child may be in a lower income tax bracket than his or her parents. You should discuss this strategy with your tax advisor. However, there are also several factors to consider which lessen or eliminate such advantages.

First, although the income on assets titled in the name of a child are generally taxed to that child, 'kiddie tax" rules apply if the child is under age 14. The first $700 (for 1999) of unearned income to a child is sheltered by the child's standard deduction, the next $700 (for 1999) is taxed at the child's rate (usually 15%), but amounts over $1400 are taxed at the parents' top marginal rate.

Second, if the assets are placed into a custodianship account (under your state's Uniform Gifts to Minors Act, Uniform Transfers to Minors Act, or equivalent legislation) for the benefit of the child, the income generated is subject to the "kiddie tax" and the assets must be distributed to the child upon reaching the age of majority (usually age 18 or 21, depending on state law) to be used for anything that (s)he desires.

Finally, the assets in either a custodial account or an "education trust" will be counted as owned by the child for financial aid purposes, which generally means that (s)he will be expected to contribute 50% of the income generated by those assets and 35% of the principal of the account or trust, per year, toward the cost of college. (If the assets were held instead by the parents, the expected contribution rate applied to the principal may be only 5.6%.)

The Education Cost Worksheet is not a legal document and does not require any signatures, witnesses, or notarization.

While most "four-year" undergraduate programs are just that, it has become increasingly common for students to spend one or more extra semesters in college before graduating. Also, consider the possibility of graduate or professional school.