Week 5: Personal Finance

Week 5: Personal Finance

“College Savings Options … Nationwide College Savings”
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Summaries

  • Week 5 > Module 4: College Savings Options > Paying for Post-Secondary Education in the USA
  • Week 5 > Module 4: Nationwide College Savings Plans > Federal College Savings Plans
  • Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans
  • Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans - Part 2: Prepaid Plans
  • Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans - Part 3 State 529 Plans
  • Week 5 > Module 4: State-Specific College Savings Plans > College Savings Plans
  • Week 5 > Variety of Ways to Pay for College > College Savings Plan Example- Avatar Linda Chen

Week 5 > Module 4: College Savings Options > Paying for Post-Secondary Education in the USA

  • There’s three types of help available: grant and gift aid, aid that comes through the tax system and lets you use what would be paid in taxes to pay for education, and finally there’s student loans.
  • Grant and gift aid, on average, runs between 15% and 36% of the cost of your education after high school.
  • So how can you get a handle on how much grant and gift aid you might receive? Well you do this by comparing the list and the net price of the particular education and training program.
  • Once you have the list price and the net price, the difference between the two is your amount of grant and gift aid.
  • Grant and gift aid is a particularly desirable form of help with post-secondary education because you don’t have to repay it.
  • So what are the sources of this grant and gift aid? The aid comes from governments, from educational institutions, and from other private sources.
  • So after grant and gift aid, how much will you need to pay? On average you’ll need to pay between $16,000 and $30,000 a year, or for a four year course of study between $64,000 and $120,000.
  • So let’s look in more detail at each of these ways you can get help financing your education and training.
  • First of all, who can save to help you pay for your education? A large variety of people- members of your family ranging from your parents to distant cousins, your friends and your neighbors.
  • What vehicles could they use to save and get tax advantage for your education and training? First they could use the federal Coverdell Education Savings Account.
  • The Roth IRA has provisions that allow you to save both for education and for your retirement.
  • So suppose you didn’t have the ability or foresight to save prior to enrolling in an education and training program.
  • You can take out student loans, or your parents can take out Direct Plus loans to pay for your education.
  • Finally, you can work, and that work will pay for part of your education.
  • You withdraw money from these savings plans for education and those withdrawals are tax-free.
  • The interest that you pay and the need to pay back the loans lower your return to your education and training.
  • They also affect your life after you’ve completed the education and training.
  • It may make you take on a different type of job because you need to make more money to pay off the loans, and it will certainly lower the amount you can buy and save after you’ve completed the education.
  • Try to maximize your savings and to minimize your need to borrow for education and training.

Week 5 > Module 4: Nationwide College Savings Plans > Federal College Savings Plans

  • In this module, we hope to empower you so you can use these programs effectively to lower the out-of-pocket cost of your education and training.
  • Withdrawals from these accounts are tax-free if they’re used for qualified education expenditures for the beneficiaries or beneficiaries allowed.
  • What educational savings plans are available? First, there are two plans offered by the federal government- Roth IRAs and Coverdell Educational Savings Accounts.
  • These 529 plans come in two forms- prepaid tuition plans and college savings programs.
  • How can you choose among the different education and savings plans? First, you should look at the program characteristics.
  • The first risk is common to all savings and not unique to educational savings.
  • The first risk is that the beneficiary may not pursue post-secondary education.
  • If that happens, you will have no qualified education expenses and hence will not be able to withdraw money from the accounts tax-free.
  • The second unique feature is that education and training increases in price over time, and indeed has increased quite rapidly in recent years.
  • If education and training costs increase more rapidly than the earnings on your savings account, then your money will fall short of paying for the cost of the education and training.
  • You may have multiple accounts in different places and for different beneficiaries.
  • The Roth is a multipurpose account and you should use it fully.
  • It can be used to pay for education, retirement, disability, or the purchase of a first home.
  • One thing you could do is you could use your contributions to pay for education and then use the earnings on those contributions for your own retirement.
  • Roth IRAs can be used for qualified education expenses for you, your spouse, and your children.
  • The Roth is a good vehicle for older adults who want to save for the education of some younger people; for example, grandparents.
  • Those withdrawals can be used for education expenses or anything else.
  • You can gain up to $2,000 off your taxes dollar for dollar if you contribute to a Roth and take the saver’s tax credit.
  • Where can you establish a Roth IRA? Most brokerage houses, banks, and mutual fund companies have them.
  • Minimum investments for these accounts are generally between $500 and $1,000.
  • Five years after you’ve first contributed to your Roth, your Roth account becomes very flexible.
  • The earnings on your contributions can also be withdrawn for qualified education expenses for any dependent on your tax return, including yourself.
  • If the account owner is over 60, there are no restrictions on withdrawals and all withdrawals are tax-free.
  • An important and unique feature of the Coverdell is that funds in the Coverdell can be used for K-12 expenses as well as for higher education.
  • To summarize the federal programs that you can use to save for education expenses, an important thing about them is that they’re the same program nationwide.
  • Funds in the Roth can be used for qualified education expenses, purchase of a first home, retirement, or disability.
  • The Coverdell Education Savings Account can be used for K-12 expenditures as well as higher education expenditures.
  • The Coverdell, like the Roth, has a limit on the income you can have and still contribute.

Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans

  • ANN WITTE: In this video we’re going to look at state and private college programs that let you save for education and lower your taxes.
  • All of these plans are established under Section 529 of the Internal Revenue Code and they have features in common.
  • The plans are operated by states and educational institutions.
  • There’s generally no income limitation for use and they’re the only plans available for higher income people.
  • There is tax free rollovers from one to another 529 plan and they are not part of an estate for estate tax purposes.
  • 529 plans come in two flavors, prepaid tuition plans, which are offered both by states and private colleges, and college savings plans, which are offered only by states.
  • We’re going to cover the prepaid tuition plans first and then turn to the college savings plans.

Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans – Part 2: Prepaid Plans

  • ANN WITTE: Let’s first look at state prepaid plans.
  • What are the uses for these plans? You should consider these plans if you or the beneficiary are a resident of a state with a good plan that offers a state tax exemption.
  • Some state plans offer very low risk and very few hassles.
  • You’ll want to use these plans if you are risk-averse and don’t have the time for hassles.
  • You would use these plans to cover tuition and fees, and have another savings plan to cover other college expenses.
  • So let’s look more closely at prepaid tuition plans.
  • These plans are currently offered by 17 states- Alabama to Wisconsin.
  • Many plans are only open to residents, and some plans have been closed to new enrollment.
  • The advantages of these plans range from little or none to a great deal.
  • An example of a good plan would be the Texas Tuition Promise Plan.
  • So what are the characteristics of state prepaid tuition plans? The contribution limits are often quite high- over $200,000.
  • Clearly, you want a plan that has a strong a guarantee as possible.
  • So you’ll want to check the website of these plans during the fall if you plan to enroll.
  • So who should use prepaid tuition plans? And how can you do it? People who want to manage tuition and costs and not manage investments should take advantage of these plans.
  • You should take advantage of these plans if you live in a state with a good plan or a state that provides a tax deduction regardless of what state plan you use.
  • We provide a link to the Virginia plan, so you can see what these websites will look like.
  • If your beneficiary decides not to go to one of the participating colleges, the funds in the plan can be rolled over to other 529 plans.
  • What are the characteristics of the private college plan? No fees are charged.
  • Funds can be rolled over to any other 529 plan after 12 months.
  • So who should use the private college 529 plan? People who want to manage tuition, but don’t want to manage investments.
  • You should consider this plan if you think your beneficiary will go to a participating college.
  • This plan, like other prepaid plans, offers low risks and hassles.
  • You use this plan to cover tuition and fees, and have another savings plan to cover other college expenses.

Week 5 > Module 4: Nationwide College Savings Plans > State and Private College Savings Plans – Part 3 State 529 Plans

  • You can combine these plans with prepaid tuition plans.
  • These plans will cover the college costs other than tuition and fees.
  • You also have to be comfortable with the risk of increases in the cost of education and training since you have no protection from those increases with this kind of plan.
  • You can have state tax advantages with these plans as well as federal tax advantages if you live in a state that allows a state tax deduction or in a tax parity state.
  • 529 Savings Plans are offered by 49 states from Alabama to Wyoming.
  • The returns on these plans depend upon the underlying investments so you need to choose a plan that has good investment choices.
  • State provided plans have the lowest fees so try to use these plans.
  • You generally have a more limited set of investment choices in these state plans than you do in the federal plans that we covered in the previous video.
  • How can you select a good State 529 Savings Plan? The first thing you want to do is to look at your state’s plan and see if there are going to be any possible state tax savings and how large those savings will be.
  • Use the spreadsheet we’ve provided to compare good state plans to your state’s plan.
  • Let’s summarize the characteristics of state and private college 529 plans.
  • These plans have the lowest investment and inflation risk.
  • The funds in these plans can only be used for tuition and fees, and not for other educational expenses.
  • Turning then to State 529 Savings Plans, just like the prepaid tuition plans there are no age or income limitations.

Week 5 > Module 4: State-Specific College Savings Plans > College Savings Plans

  • For families with income below $200,000 a year, we recommend that you establish Roth IRA accounts as soon as possible.
  • You have withdrawn money from your Roth IRA to pay for expenses other than tuition and fees.
  • How are you going to pay for tuition and fees? Well, you can withdraw funds from your Roth IRA for that purpose, but prepaid plans may be better for you.
  • You may want to use these prepaid tuition plans to cover tuition and fees, rather than withdrawals from your Roth.
  • You may also want to use the prepaid plan of the private colleges, if both you and your beneficiary want your beneficiary to go to one of the colleges that participate in the plan.
  • So how could Ana Maria have used the information we just provided to save more effectively for Natalia’s college education? She should open a Roth as soon as she can.
  • Laws in the United States say that if you’re under 50, you can contribute up to $5,500 a year to your Roth IRA.
  • So if you want, you can lower this to 4% and see how this changes the growth of Ana Maria’s Roth IRA.
  • We do this each year, and compounding takes over and lets these savings grow at a very good clip.
  • You can see that in 2015- the end of 2015- when Natalia is just getting ready to go to college, Ana Maria has over $155,000 in her Roth IRA.
  • Now let’s move forward and see how she uses the Roth IRA to pay for Natalia’s college education.
  • The first year, she uses the $6,500 that she would have contributed to the Roth, and gets the remaining resources needed by withdrawing them from her Roth IRA.
  • At the end of Ana Maria’s college payments, and at Natalia’s graduation, Ana Maria has successfully used her Roth to pay for Natalia’s education, and she still has almost $150,000 in her Roth IRA as retirement savings.
  • This is how you can use a Roth both to pay for education and to save for retirement.
  • So why didn’t we recommend that Ana Maria combine a Roth IRA and a 529 plan? Recall that the prepaid tuition plans have some definite advantages.
  • What about a simple 529 savings plan? Recall from our discussion that these plans are very complicated and require a good deal of knowledge of the US institutional system.
  • The 529 savings plan is far less flexible than the Roth IRA.
  • So how can grandparents and other older adults use educational savings plans to save for the education of their younger generation? Use a Roth if you can.
  • One interesting aspect of a Roth is that you can continue to contribute to the Roth into your 70s and 80s, as long as you are working.
  • So what if you can’t use a Roth IRA? In that situation, you’ll need to use 529 plans.
  • These are complicated, but using the material from previous modules, you should be able to choose a good plan and provide for the education of your younger generation.
  • You can use a prepaid tuition plan to cover tuition and fees.
  • You use a 529 savings plan to cover other educational costs, costs other than tuition and fees, and to pay for graduate school.

Week 5 > Variety of Ways to Pay for College > College Savings Plan Example- Avatar Linda Chen

  • Savings for education is very complicated in the US. And it took David’s father, who is also a CPA, to help us decide how best to save for our children’s education.
  • As a member of the cello section with a base salary of- back then it must have been around $100,000 per year, David was able to save starting at an early age.
  • Even with David’s high annual income, we decided to wait before purchasing a home because we wanted to make sure we would have enough saved for a substantial down payment.
  • In addition to a very high cost of living and taxes, mind you, David and I wanted to save for our retirement and the purchase of a home, as well as start saving for the twin’s education.
  • Both of our employers match employee contributions to the 401K plans by contributing $1 for every $2 that we contribute.
  • We very much wanted to pull down the full amount of the employer match, or what we thought of as free money, which means that we needed to contribute $16,500 to each of our 401K plans.
  • Shortly after I found out I was pregnant with twins, David’s father, Sam, said that we needed to open tax-advantaged educational savings plans after the children were born.
  • He indicated that our dilemma of needing to save for a home, retirement, and our children’s education all at the same time was actually pretty typical.
  • He said that he would talk with my parents and do some research and get back to us with a plan.
  • Shortly before the twins were born, Sam called and invited David, me, and my parents to dinner.
  • Unbeknownst to David and me, Sam and his wife Ruth had talked to my parents.
  • Sam explained that there were two types of plans- plans that allowed you to pay for tuition and fees at today’s prices, and plans with no protection for education cost inflation.
  • That allowed you to save for most education expenses, not just tuition and fees.
  • Second, he had evaluated 529 Plans using both Morningstar’s rankings and the rankings by savingforcollege.com.
  • He said that while New York’s plan was not the most highly rated plan, that it was a solid plan and that the state income tax savings meant that it was the best way to save for college expenses other than tuition and fees.
  • We would set up a New York’s 529 College Savings Plan for each of the twins and contribute the $5,000 that our parents provided for each child.
  • This allowed us to claim a $10,000 deduction on our state income taxes and use the tax savings to accumulate money for the down payment on a home for our family.
  • It was a big relief because we weren’t sure how we were going to juggle saving for a home, saving for retirement and college all at the same time.
  • Sam also said that we should consider setting up a plan that allowed us to pay our kid’s future tuition at today’s prices.
  • He indicated that New York does not have such a plan and that most states that do require that either the beneficiary of the plan or the owner be a state resident.
  • He explained that the plan was set up and run by a wide variety of colleges ranging from Amherst to Wellesley.
  • Saving in the plan would protect us from college cost inflation.
  • If the children chose to go to a college that does not participate in the plan, we would lose the inflation protection.
  • We could roll over the funds to the children’s 529 Plan, but we would only receive contributions plus investment gains or losses of the plan capped at plus or minus 2%. Sam explained that the plan was like a tuition inflation protected bond.
  • We liked the idea of the private college plan because we hoped that our children would go to a liberal arts college, just as I had done.
  • We began contributing to the plan in 2005 when I was promoted to vice president for design and my salary had increased to $250,000 per year.

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