Investing For Dummies. Eric Tyson
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If you plan to apply for financial aid, it’s a good idea to save non-retirement account money in your name rather than in your child’s name (as a custodial account). Colleges expect a greater percentage of money in your child’s name (20 percent) to be used for college costs than money in your name (5.6 percent). Remember, though, that from the standpoint of getting financial aid, you’re better off saving inside retirement accounts.
However, if you’re affluent enough that you expect to pay for your cherub’s full educational costs without applying for financial aid, you can save a bit on taxes if you invest through custodial accounts. Parents control a custodial account until the child reaches either the age of 18 or 21, depending upon the state in which you reside. For tax year 2020, prior to your child’s reaching age 18, the first $2,200 of interest and dividend income generally isn’t taxed. Over the $2,200 threshold, unearned income is taxed at the relatively high rates that apply to trusts and estates:
Up to $2,600 falls into the 10 percent bracket.
Between $2,600 and $9,450 is in the 24 percent bracket.
Between $9,450 and $12,950 is in the 35 percent bracket.
Above $12,950 is in the 37 percent bracket.
Upon reaching age 18 (or age 24 if your offspring are still full-time students), all income generated by investments in your child’s name is taxed at your child’s rate, which is presumably a lower tax rate than yours.
Education Savings Accounts
One final detail about ESAs. Most investment companies have done away with these accounts since 529 plan account holders (discussed next) may now use withdrawals to pay for K–12 educational expenses. Thus, there are no longer notable differences between the two types of accounts, and the 529 plan allows for saving and investing far greater balances than the ESA.
Section 529 plans
Also known as qualified state tuition plans, Section 529 plans offer a tax-advantaged way to save and invest more than $100,000 per child toward college costs (some states allow upward of $300,000 per student). After you contribute to one of these state-based accounts, the invested funds grow without taxation. Withdrawals are also tax-free so long as the funds are used to pay for qualifying higher educational costs (which include college, graduate school, and certain additional expenses of special-needs students) and for up to $10,000 per year for K-12 educational expenses. The schools need not be in the same state as the state administering the Section 529 plan.
Allocating college investments
If you keep up to 80 percent of your investment money in stocks (diversified worldwide) with the remainder in bonds when your child is young, you can maximize the money’s growth potential without taking extraordinary risk. As your child makes his way through the later years of elementary school, you need to begin to make the mix more conservative — scale back the stock percentage to 50 or 60 percent. Finally, in the years just before your child enters college, whittle the stock portion down to no more than 20 percent or so.
PAYING FOR COLLEGE
If you keep stashing away money in retirement accounts, it’s reasonable for you to wonder how you’ll actually pay for education expenses when the momentous occasion arises. Even if you have some liquid assets that can be directed to your child’s college bill, you will, in all likelihood, need to borrow some money. Only the affluent can truly afford to pay for college with cash.
One good source of money is your home’s equity. You can borrow against your home at a relatively low interest rate, and the interest is generally tax-deductible. Some company retirement plans — 401(k)s, for example — allow borrowing as well.
A plethora of financial aid programs allow you to borrow at reasonable interest rates. The Unsubsidized Stafford Loans and Parent Loans for Undergraduate Students (PLUS), for example, are available, even when your family isn’t deemed financially needy. In addition to loans, a number of grant programs are available through schools and the government as well as through independent sources.
Complete the Free Application for Federal Student Aid (FAFSA) to apply for the federal government programs. Grants available through state government programs may require a separate application. Specific colleges and other private organizations, including employers, banks, credit unions, and community groups, also offer grants and scholarships.
Many scholarships and grants don’t require any work on your part — simply apply for such financial aid through your college. However, you may need to seek out other programs as well. Check directories and databases at your local library, your kid’s school counseling department, and college financial aid offices. Also, try local organizations, churches, employers, and so on, because you have a better chance of getting scholarship money through these avenues than through countrywide scholarship and grant databases.
Your child can also work and save money for school during high school and college. In fact, if your child qualifies for financial aid, she’s generally expected to contribute a certain amount to education costs from employment (both during the school year and summer breaks) and from savings. Besides giving your gangly teen a stake in her own future, this training encourages sound personal financial management down the road. For more advice and specific strategies regarding affording and paying for higher education, please see my book Paying For College