3 Ways to Help Pay for College
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3 Ways to Help Pay for College
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As with most financial goals, one of the best things you can do to help fund a child's education is to plan ahead and start saving as soon as possible.

Education is an
important investment
in your child's future.
Plan ahead; start
investing early.

With the cost of college constantly rising, you may wonder how you can possibly fund a child's higher education expenses while keeping your other financial goals on track. The average cost for four years of tuition and fees at a private four-year college reached $109,000 in 2010, up 4.5% from 2009, according to the College Board's Trends in College Pricing 2010. And that's just the average. The study reports that during the past 10 years, tuition and fees at public four-year institutions rose 5.6 percentage points per year over and above the rate of general inflation.

First, put time on your side and begin saving when your child is born, if not sooner. Then, educate yourself on your financing options. "There are three main approaches you can take to help finance college," says Richard J. Polimeni, director, Education Savings Programs, Merrill Lynch. They are:

1. Controlling your costs
2. Investing for the future
3. Finding additional sources of funding.

With all of these, you may have more options than you think.

1. Controlling Your Costs
Estimate how much college will cost. You can take advantage of Merrill Edge's College Planning Tool to help gauge costs as well as learn more about college investment strategies that can be used to help cover them.

Although the national figures are daunting, you can exert some control over how much you pay. For example, costs for public schools — especially in-state — are considerably lower than those for private colleges and universities. If a child wants to earn a degree from a particular school and it isn't affordable, he or she might help manage costs by spending two years at a public or community college and then transferring. As your children approach college age, discuss these expenses and your expectations. Help them understand not only how much you will pay but also whether and how much you expect them to contribute through part-time jobs or work-study programs.

2. Investing for the Future
Once you've determined how much you'll likely spend, you'll have several investment vehicles to consider.

Custodial Accounts, such as Uniform Gift to Minor Accounts/Uniform Transfer to Minor Accounts (UGMA/UTMAs) are taxable accounts but can be used to fund any part of a child's expenses — including education. In 2012,


  • the first $950 of a child's income is generally tax-exempt;
  • the next $950 of unearned income is generally taxed at the child's tax rate;
  • unearned income over $1,900 is generally taxed at the parent's tax rate if, at the end of the year, the child is under age 19 or is a full-time student under age 24.

Coverdell Education Savings Accounts (ESAs) offer tax advantages that may make them a better option than custodial accounts for many families: When you use the account assets for qualifying elementary, secondary or higher education expenses, such as tuition and fees, required books, supplies and equipment, and room and board,1 withdrawals — including any earnings — are free from federal (and possibly state) income tax.2 You can contribute as much as $2,000 a year for each beneficiary who has not attained age 18 or is a special-needs student of any age as long as your modified adjusted gross income is less than $110,000 for an individual taxpayer or $220,000 for joint taxpayers.3

Section 529 plans offer tax advantages similar to those of ESAs, in that withdrawals (including any earnings) for qualified higher-education expenses are free from federal (and possibly state) income tax.4 However, there is greater flexibility for Section 529 plan contributions. These state-established plans generally allow lifetime contributions of $200,000 or more per beneficiary, with no annual limits, although contributions larger than $13,000 for a single tax filer ($26,000 for joint filers) in one year can reduce your lifetime gift and estate tax exemptions under the current tax law. Be sure to check your own state's established Section 529 plan, as well as those of other states.5

Anyone can make contributions to a Section 529 plan, so giving the "gift of education" by making a contribution to a 529 plan as a birthday or holiday gift is a good option to consider. Polimeni notes that Section 529 plans include an accelerated gifting provision that lets you contribute as much as five years' worth of gifts in a single year ($65,000 for single tax filers, $130,000 for married couples) without triggering the federal gift tax.6 What's more, you can easily change the beneficiary of a Section 529 account to another family member as defined by the Internal Revenue Code, including yourself if you choose. And today's Section 529 plans offer a range of investment options — generally portfolios of mutual funds or similar investment vehicles. Certain states may also offer tax or other benefits for investing in their Section 529 plan. However, some states may reduce or eliminate those benefits if you invest in Section 529 plans administered by a state other than your home state or your beneficiary's home state.

3. Finding Additional Sources of Funding
If savings aren't enough, consider federal aid, such as Stafford and Perkins loans. You can also tap the value of your home with a home equity line of credit. "You might open a $100,000 line of credit in anticipation of drawing on that as needed," says Carl Flatau, senior vice president and home equity product manager, Bank of America. "You don't have to take the $100,000 as an immediate loan to pay interest up front." You should also be aware that some financial aid takes the family finances into account, including Section 529 plans in the parents' names. Because of this, Coverdells and 529s can be good choices for grandparents looking to fund their grandchildren's education, since accounts in grandparents' names aren't factored into financial aid calculations.7

Grants and Scholarships
Grants and scholarships remain an option as well. Be aware, though, that the tight economy is restricting the funds available, making these awards more competitive. Even so, they may significantly reduce college costs for a student who is strong academically or particularly talented in sports or the arts. You can visit studentaid.ed.gov and students.gov for some ideas on where to start. Most awards cover only a portion of total expenses, however.

Education is an important, if expensive, investment in your child's future. Plan ahead, start investing early — and be prepared to supplement your savings with the variety of resources available to you.

Next Steps

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1 The definition of "qualified education expenses" was expanded by the Economic Growth and Tax Relief Reconciliation Act of 2001 to include qualified elementary and secondary school expenses. Unless extended, the expanded portion of that definition will expire after December 31, 2012. The beneficiary must be attending an accredited institution at least half-time for room and board to be considered an eligible expense.

2 To be eligible for the favorable tax treatment afforded to any earnings portion of withdrawals from Coverdell ESAs, withdrawals must be for "qualified higher education expenses" or "qualified elementary and secondary education expenses," as defined in the Internal Revenue Code. Any earnings withdrawn that are not used for such expenses are subject to federal income tax and may be subject to a 10% additional federal tax, as well as state and local taxes. The 10% additional tax does not apply to withdrawals made as a result of the designated beneficiary receiving a scholarship or the designated beneficiary's attendance at a U.S. military academy, provided the withdrawals do not exceed the amount of the scholarship or value of attendance at the academy. The 10% additional tax also does not apply as a result of withdrawals made due to the death or disability of the designated beneficiary.

3 Unless extended, the provision relating to the use of assets for qualified elementary and secondary education-related expenses (kindergarten through 12th grade) and the contribution limit of $2,000 will expire after December 31, 2012, and the law in effect prior to the effective date of the Economic Growth and Tax Relief Reconciliation Act of 2001 will apply. This means that eligible expenses will include only higher education expenses, and the annual contribution limit will be reduced to $500 per beneficiary. The eligibility limit for contributors depends on the individual's tax-return filing status and modified adjusted gross income ("MAGI"). There is a phaseout on the ability to contribute for individual taxpayers with MAGI between $95,000 and $110,000 and for joint-return taxpayers with MAGI between $190,000 and $220,000. If your MAGI is $110,000 (single) or $220,000 (joint) or more, you cannot contribute to an educational savings account.

4 To be eligible for favorable tax treatment afforded to any earnings portion of withdrawals from Section 529 plans, such withdrawals must be used for "qualified higher education expenses," as defined in the Internal Revenue Code. Any earnings withdrawn that are not used for such expenses are subject to federal income tax and may be subject to a 10% additional federal tax as well as state and local income taxes.

5 It is important to carefully consider any benefits available in your home state (or the home state of your designated beneficiary), along with a plan's investment manager, investment options, plan performance, and underlying fees and expenses prior to investing. Certain states may also require the recapture of all or part of previously claimed tax benefits if the proceeds are not used for qualified higher-education expenses (as defined in the Internal Revenue Code) or if the assets are transferred to another state's Section 529 plan.

6Contributions between $13,000 and $65,000 ($26,000 and $130,000 for married couples filing jointly) made in one year can be prorated over a five-year period without subjecting you to gift tax or reducing your federal unified estate and gift tax credit. If less than the $65,000 ($130,000 for married couples filing jointly) maximum is contributed, additional contributions can be made without subjecting you to federal gift tax, up to a prorated level of $13,000 ($26,000 for married couples filing jointly) per year. Gift taxation may result if a contribution exceeds the available annual gift tax exclusion amount remaining for a given beneficiary in the year of contribution. For contributions between $13,000 and $65,000 ($26,000 and $130,000 for married couples filing jointly) made in one year, if the account owner dies before the end of the five-year period, a prorated portion of the contribution may be included in his or her estate for estate tax purposes.5/9/2012

7Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more complete information visit the Department of Education Web site.

Before you invest in a Section 529 plan, request the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary's home state offers any state tax or other benefits that are available only for investments in such state's 529 plan.

Please remember there's always the potential of losing money when you invest in securities.

Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Merrill Edge® does not provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.

Section 529 plans are not bank, state or federal guaranteed.