Financial-Information Zone

There are basically four different account types that can be used for saving for higher education:

• 529 accounts – Both in-state sponsored and out-of-state sponsored.

• Coverdell Education Savings accounts.

• UGMA/UTMA accounts with a named custodian for the minor child.

• Parents’ investment accounts.

Other sources of funds may include a distribution from an IRA for expenses that qualify as higher education expenses, a loan from a life insurance policy, or a home equity line of credit. Each of the above accounts has some advantages and some disadvantages with regards to contribution limitations, tax implications, and ownership. For instance, in 2007 the NC National College Saving Program (In-state 529 plan) offers a state income tax-deduction of $2,000 for single filers (AGI below $60,000), and $4,000 for joint filers (AGI below $100,000) for contributions made to this plan. Out-of-state 529 plans at this time do not offer any kind of deduction for NC residents. On the other hand, investors may prefer the investment options of an out-of-state plan over the NC plan and elect to forego the state tax deduction. Coverdell accounts are limited to a $2,000 contribution per year per beneficiary, while some 529 plans have a $250,000 total contribution limit per beneficiary. The 529 plan removes the contributions from the contributor’s estate, but he/she retains control of the 529 account for the designated beneficiary or another beneficiary if a change is necessary. On the other hand, the UGMA/UTMA account is considered an asset of the child for financial aid purposes, and in NC under the UTMA account the child assumes control of the account at age 21. All these variables must be considered when determining which is the best approach to take for your situation.

The “kiddie tax” in 2007 applies to UGMA/UTMA accounts where the child is under 18 years old. The first $850 of earnings is tax-free, earnings between $850 and $1,700 are taxed at the child’s rate, and earnings in excess of $1,700 are taxed at the parents’ rate. All earnings for children age 18 and older are taxed at the child’s rate. In 2008, the “kiddie tax” age will be extended to include children under 19 and full-time students under 24 whose earned income does not exceed one-half of their support. Some parents with a child who is either 18 or a full-time student under age 24 whose earned income does not exceed one-half of his/her support, may want to consider selling assets in taxable accounts before December 31, 2007. Anyone considering this option should consult their tax advisor before making this decision.

It depends on the account type. There is no penalty for withdrawals not used for education coming out of a UGMA/UTMA account. However, both the 529 plans and Coverdell Education Savings accounts do assess ordinary income tax and a 10% federal tax penalty on earnings if the withdrawal is considered a non-qualified withdrawal. Qualified expenses typically include tuition, room and board, and books and supplies for higher education. The Coverdell account includes these expenses for kindergarten through high school as well.